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SEC v. Jarkesy: A New Horizon for Securities Litigation
By Robert R. Boeche, Partner; and Ben Kaplan, Associate Attorney of Shustak Reynolds & Partners, P.C. posted on Monday, November 11, 2024.
Robert R. Boeche II
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Location: San Diego, California
Phone: (619) 696-9500 (Ext. 122)
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The Supreme Court's decision in SEC v. Jarkesy (“Jarkesy”) curtails the Securities and Exchange Commission’s (SEC) use of SEC-appointed judges in its enforcement actions. Jarkesy sets a new precedent for how regulatory enforcement actions might be adjudicated moving forward, not only for SEC actions, but also enforcement actions across other regulatory agencies, including the Financial Industry Regulatory Authority (FINRA). Such potential ramifications of this ruling are detailed below.
Background
Jarkesy stems from the SEC’s use of SEC-appointed administrative law judges (ALJs), and whether the ALJs’ role in enforcement actions violated Jarkesy’s Seventh Amendment right to a federal jury trial. The Seventh Amendment provides defendants the right to a trial by jury for claims meant to punish or deter.[1] Citing “the close relationship between federal securities fraud and common law fraud,” the Supreme Court explained civil penalties awarded by ALJs are similar to monetary damages awarded for common-law fraud.[2] As a result, the Supreme Court ultimately ruled for Jarkesy, and deemed the SEC’s use of ALJs in this matter as a violation of Jarkesy’s Seventh Amendment right to a jury trial.[3]
Impact to the SEC
The Jarkesy decision will now require the SEC to seek civil penalties from defendants in federal court. The ruling itself is monumental in that defendants are now afforded the opportunity to defend themselves in front of an unbiased judge. It is still uncertain as to the ruling’s impact on pending enforcement actions. However, it is likely that pending proceedings will either be transferred to a court of law at the defendant’s request; or shall be transferred by the SEC should the defendants not waive their Seventh Amendment right to a jury trial.
Also, the SEC may become more selective in bringing enforcement actions since approximately 21% of enforcement actions are ruled against the SEC when tried in court. [5] Consequently, the Jarkesy decision may also result in increasing the SEC’s appetite to settle matters, reserving enforcement actions solely for serious offenders.
Impact to FINRA
FINRA is an independent self-regulatory organization which operates under the SEC’s oversight. While FINRA primarily deals with member brokerage firms and exchange markets, the principles set forth in the Jarkesy decision may also influence its disciplinary action procedures due to its use of punitive fines. However, Jarkesy’s impact on FINRA has yet to be decided as legal challenges to its enforcement procedures are pending. [6]
One case spearheading the legal challenge is Blankenship v. Financial Industry Regulatory Auth. Blankenship involves a broker previously charged by FINRA for engaging in unsuitable mutual fund trading practices, leading to excessive broker commissions and unwarranted customer fees.[7] Blankenship argues that because FINRA’s enforcement actions involve punitive penalties, Blankship should also be afforded judicial review under the Seventh Amendment. This decision, assuming the case is not resolved prior to trial, may transform the nature of FINRA’s regulatory procedures should Blakenship’s argument be successful.
Broader Implications for Regulatory Practices
The Jarkesy decision is not only pivotal to the SEC and FINRA, but it also signals potential limits on other regulatory agencies’ power to enforce laws via their internal administrative proceedings when the agency is seeking punitive fines.[8] Although the Supreme Court did not directly state the extent of Jarkesy applying to other agencies’ administrative proceedings; the decision is already causing a broader reevaluation of how regulatory oversight is exercised across federal agencies.[9] This impact likely encompasses the operational frameworks of multiple entities, such as the Commodity Futures Trading Commission, the Consumer Financial Protection Bureau, and others who rely heavily on administrative adjudications. As Justice Sotomayor noted in her dissent, Jarkesy likely creates uncertainty for “more than two dozen agencies that can impose civil penalties in administrative proceedings.”[10] Further, while some agencies have statutes allowing them to pursue penalties in both in-house proceedings and federal court, other agencies do not, such as the Federal Communications Commission (FCC) and the Occupational Safety and Health Review Commission.[11]
For financial institutions and their advisors, this ruling may be a double-edged sword. On one hand, it offers the chance to have a case heard in a potentially more favorable venue with better odds of success. However, on the other hand, matters tried in court are not private like administrative hearings in that court records are available to the public, even if the case is resolved before trial. Since unfavorable disclosures of misconduct are not taken lightly in the financial industry, financial institutions and advisers might be pressured into settling their disputes before the SEC files a court complaint.
Industry Response
Some legal experts and advocates for due process rights view the decision as a necessary correction to the overreaching powers regulatory authorities currently possess, while protecting the accused’s constitutional rights.[12] [13] Conversely, some critics argue the decision could hinder the SEC’s ability to effectively police the financial markets, as ALJs are typically experts in the industry and arguably better equipped to deal with the complex subject matter.[14] [15]
The financial industry has mixed opinions about the Jarkesy ruling as well.[16] Advocates against the Jarkesy decision believe it undermines the industry’s decades-long fight for self-regulation. However, advocates in favor of the decision believe it is progress as SEC’s procedures lack transparency and are overseen by what certain commentators believe to be biased judges.[17] [18] Time will tell if either opinion is correct.
Conclusion
While the impacts of the Jarkesy decision are still unfolding, its implications are far-reaching, potentially reshaping the enforcement landscape of securities law. It is crucial for those in the securities and financial industries to stay informed and prepared. Businesses and individuals in the securities industry should revise their litigation strategies to account for additional procedures and costs associated with jury trials.
Our firm regularly advises clients on FINRA and SEC regulations, and we are closely monitoring these developments. With offices in San Diego, Irvine, Los Angeles, San Francisco, and New York, Shustak Reynolds & Partners, P.C. represents investment advisers, broker-dealers, registered representatives, and high net worth investors across the country. We are prepared to help our clients understand and navigate these changes with strategic advice and robust legal representation. Contact Shustak Reynolds & Partners, P.C. today for a confidential consultation.
Shustak Reynolds & Partners, P.C. focuses its practice on securities and financial services law and complex business disputes.
We represent many investment advisors, financial professionals, broker-dealers, registered representatives, investors and businesses.
Attorney Robert R. Boeche can be reached in the firm’s San Diego office at (619) 696-9500.
[1] SEC v. Jarkesy, 144 S. Ct. 2117 (2024).
[2] Id., at 2139.
[3] Id., at 2130.
[4] Lucia v. SEC, 138 S. Ct. 2044 (2018).
[5] Jarkesy, at 2141.
[6] See https://www.advisorhub.com/supreme-court-ruling-against-sec-will-fuel-finra-challenges-lawyers.
[7] Blankenship v. Financial Industry Regulatory Auth., Docket No. 2:24-cv-03003 (E.D. Pa. Jul 10, 2024).
[9] See https://natlawreview.com/article/sec-v-jarkesys-implications-environmental-enforcement-actions.
[10] Jarkesy, at 2173–74.
[11] Id.
[15] See https://www.axios.com/2024/06/27/scotus-sec-jarkesy-decision.
[17] “A Major Question for the SEC: Analyzing Constitutional Limits on Regulatory Authority,” 29 Fordham J. Corp. & Fin. L. 427 (2024).
[18] See Brief for North American Securities Administrators Association, Inc., as Amicus Curiae in Support of Petitioner, SEC v. Jarkesy.
