From Your Lips to (Fraud's) Ears: Supreme Court Signals a Potential Blow to SEC In-house Enforcement — Part 2 of 2

In the two-hour proceedings, the petitioner and respondent offered two drastically distinct portrayals of SEC adjudications in relation to “common law.” Speaking first on behalf of the government, Deputy Solicitor General for the Department of Justice Brian Fletcher argued that the forum in which claims applied was the determining factor of whether a suit was common law. By definition, he argued, a suit that is brought in a non-Article III tribunal is not common. He plainly argued that the Seventh Amendment’s right to trial by jury does not apply to claims made in tribunal courts.

Neither liberal nor conservative justices seemed to find Fletcher’s argument convincing. Justice Kentaji Brown Jackson questioned why “the forum is the first question,” emphasizing that “the right or duty” is the initial question. It is fallacious to claim that because a suit is not handled in federal court, it’s not common law– when the question before the judges is whether cases are being kept out of federal court when they shouldn’t be.

Justice Alito questioned why an individual’s right to a jury trial is dependent on the SEC’s unilateral decision to decide where to bring enforcement actions: “Doesn’t it seem like a pretty patent evasion of the Seventh Amendment to say this protection, which was regarded at the time of the adoption of the Bill of Rights to merit inclusion in the Constitution, can be nullified simply by changing the label that is attached to a tribunal?”

The SEC maintained that when Congress creates “new statutory obligations, impose[s] civil penalties for their violation, and then commit[s] to an administrative agency the function of deciding whether a violation has in fact occurred,” public rights were being adjudicated. Securities laws are distinct from common law claims because the government “acts in the public interest to remedy harm to the public at large.’

In a drastically different portrayal of private rights, representation for Jarksey alleged that the SEC “federalizes common law fraud.” Mr. McColloch argued that Congress was circumventing the judicial branch by moving common lawsuits to the authority of the executive, and that the “public right” empowering the SEC to sue individuals is actually a private right. Under the ruling established in Granfinaciera, the Supreme Court rejected the taxonomic change of a common law private right to a public right through fraudulent conveyance, holding that Congress could not move common law claims into bankruptcy, or non-Article III courts. Granfinanciera, S.A. v. Nordberg, 492 U.S. 33 (1989).

How do common law fraud and statutory fraud compare?

Mr. McCollough attempted to establish that the claim a private party can bring against an individual for fraud under common law is analogous to the claim the SEC can bring against an individual for fraud, such that fraud claims remain a private right even when the government is on one side of the case. In his argument, private rights are based on the nature of the underlying claim, not the forum in which the case is filed and not who the parties are. Since “the statutory claims pursued in this case had been around since the 1930’s, were prosecuted in federal courts for decades, and analogous claims had been litigated—including by the government—for centuries before that,” the court should be compelled to find the issues of fraud involved in Jarkesy private. See page 34 of Brief for Respondents.

Additionally, he argued that unlike disputes concerning government benefits, where the government is the interested party, SEC actions involving civil penalties resemble private rights where a defendant is deprived of property. An administrative law judge deciding whether to give an individual social security benefits may differ in substance from an administrative law judge deciding to take money from an individual, such that a greater amount of due process is required.

When pressed by Justice Sotomayer if, in that case, the EPA, Postal Service, Commodities Commision and ““any suit that seeks civil penalties that has not an exact duplicate but an analogue in common law” would have to go to federal court, Mr. McCollough argued that those issues have historically been adjudicated outside of court, unlike fraud claims which were historically brought under common law. 

McCollough, receiving skepticism from the justices that the entire statutory scheme of the SEC duplicated common law, encouraged the justices the case could be decided on narrow grounds. If the Justices take this opinion, it may be that enforcement actions for prophylactic registration, disclosure, etc. (functions that are markedly different from common law claims) can continue to be adjudicated in-house. Similarly, remedies that do not impose a civil penalty can continue to be adjudicated in-house. However, traditional fraud claims, where the government is seeking civil penalties, will be unconstitutional to bring in-house because the statutory securities fraud claims are “sufficiently closer to common law fraud action, and the elements of the statutory claim are a logical subset of the former” (a leading question by Chief Roberts, possibly suggestive of his position).

McCollough also suggested that the SEC could “fix this problem this afternoon by giving defendants the option” to choose between agency and federal adjudication. This position is similar to the legislative powers Congress grants to the majority of other agencies, such as the Federal Energy Regulatory Commission and the Department of Housing and Urban Development.

Why does it matter?

Even if a ruling is narrow, this case has huge implications on the outcomes of future fraud cases. Cases brought before an administrative law judge are almost always found in favor of the SEC, compared to cases in federal court. Although the SEC prevailed in 61% of its federal cases in 2013, it won every case heard before an administrative law judge during the same period. In 2016, the Wall Street Journal found the SEC’s win rate before ALJ’s was 90%, compared to 69% of federal cases. Whether the outcome can be attributed to the jury, differing rules of evidence and discovery standards, or simply that the SEC acts as both prosecutor and judge, is unclear.

Future defendants are likely to embrace a change should the Supreme Court rule in Jarkesy’s favor. Limiting the SEC’s capacity to swiftly pursue cases in administrative settings will likely decrease the number of cases the SEC brings overall. The SEC may concentrate its resources on pursuing the most egregious cases against corporate profiteers, deciding not to bring cases against low-level scammers even when SEC investigations of such circumstances demonstrate viable claims.

This case also comes at a time where the court is poised to clamp down on the administrative state, a term used to describe the power government agencies have amassed to write, judge, and enforce their own laws. This term, the Supreme Court has heard two other cases that have profound implications to weaken the authority of executive agencies and return power to the judicial and legislative branches. The question to be answered in June is: will these rulings be a punch or a knock-out?

Carly Noble (‘24.5) is a senior at Brown University, concentrating in Education Studies with a certificate in Engaged Scholarship. She is a staff writer for the Brown Undergraduate Law Review and can be contacted at carly_noble@brown.edu.

Kourtney Beauvais is a sophomore at Brown University, concentrating in Applied Math-Economics and International and Public Affairs. She is an editor for the BULR and can be contacted at kourtney_beauvais@brown.edu.