U.S. SUPREME COURT LIMITS ENFORCEMENT ACTIONS IN SEC V. JARKESY
August 22, 2024
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The Supreme Court also took action to limit the enforcement capabilities of the Securities and Exchange Commission (“SEC”) in in its recent decision in SEC v. Jarkesy, No. 22-859 (S. Ct. June 27, 2024) (6-3 decision). While the decision only addresses the SEC’s authority to seek civil penalties for securities fraud violations, now requiring SEC to file suit in federal Article III courts and providing parties an opportunity to have their case decided by a jury, the reasoning behind the majority decision could potentially be used to restrict other enforcement capabilities at agencies such as the DOT or Federal Aviation Administration (“FAA”).
This issue arose after the SEC initiated an enforcement action for civil penalties against an investment firm, Patriot28, LLC (“Patriot28”), and its owner George Jarkesy, Jr. (“Jarkesy”), for alleged violations of federal securities laws. Prior to the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the SEC could only pursue civil penalties against an unregistered investment in federal court, but following the passage of Dodd-Frank, the SEC could adjudicate these types of enforcement actions through in-house administrative proceedings. Pursuant to a final agency order issued by the SEC, Jarkesy and Patriot28 were found liable for securities violations and were fined $300,000. Jarkesy and Patriot28 then petitioned for judicial review at the Fifth Circuit Court of Appeals, which vacated the SEC’s order and civil penalty on the grounds that the SEC’s administrative adjudication process violated the defendants’ Seventh Amendment right to a jury trial. The Supreme Court has now affirmed the Fifth Circuit’s decision, at least with respect to the requirement for Article III courts and jury trials for SEC civil penalties proceedings involving securities fraud. The 5th Circuit’s decision also identified two additional constitutional problems: i) that Congress had violated the nondelegation doctrine by authorizing the SEC, to choose between Article III courts or in-house adjudication; and ii) that SEC ALJs having two layers of for-cause removal protections violated the separation of powers. However, because the Supreme Court resolved the issue based on the need for jury trials, they did not address the additional issues raised by the 5th Circuit in their decision.
The majority decision relies upon the Seventh Amendment requirement that civil litigants generally have a right to a jury trial “in suits at common law.” The “common law” broadly refers to judge-made law developed in English courts prior to start of the United States, which was then imported into American jurisprudence and still provides a basis for how courts handle many matters, such as those involving torts and contracts where a judgement could be assessed against one party. While the Seventh Amendment has a general requirement for jury trials, for nearly two-hundred years courts have recognized a “public rights exception” to that necessity. The public rights doctrine was originally created by Murray’s Lessee v. Hoboken Land & Improvement Co., 59 U.S. 272 (1856), and has been refined since then, most notably in Atlas Roofing Co. v. Occupational Safety and Health Review Comm’n, 430 U. S. 442 (1977). In Atlas Roofing, the Supreme Court found that in “cases in which the Government sues in its sovereign capacity to enforce public rights created by statutes within the power of Congress to enact, . . . the Seventh Amendment does not prohibit Congress from assigning the factfinding function and initial adjudication to an administrative forum with which the jury would be incompatible.” Generally, this public rights exception to the Seventh Amendment only applies to cases brought by the federal government to enforce a federal statute which involves a specific right that did not already exist under the common law. In those circumstances, the case may be heard before an agency Administrative Law Judge (“ALJ”) in an administrative hearing without a jury.
In Jarkesy, the SEC was seeking to adjudicate claims under the anti-fraud provisions of federal securities laws for alleged fraudulent conduct. The Court determined that, while Congress had specifically created a new statutory scheme for civil penalties assigning the SEC enforcement and adjudication responsibilities, general fraud claims have a basis in the common law and traditional civil suits. In many cases, an SEC fraud claim looks very similar to a fraud claim that could be asserted in a suit between private individuals. For that reason, the Court held that the SEC’s anti-fraud adjudications did not fall under the public rights exception and all such cased, therefore, must be tried in federal court before a jury.
Unfortunately, Jarkesy does not provide much guidance on what types of enforcement actions, or what other agencies, might be similarly affected, nor does it provide clear guidance on how to easily distinguish between private and public rights. The only areas the majority notes that have historically been covered under the public rights exception are: i) relations with Indian tribes; ii) the administration of public lands, and iii) the granting of public benefits such as payments to veterans, pensions, and patent rights. The majority opinion acknowledges that the Supreme Court “has not always spoken in precise terms” with regard to the public rights exception and that this is an “area of frequently arcane distinctions and confusing precedents.” Justice Roberts, who authored the majority decision, recognized that the Supreme Court had not previously “definitively explained the distinction between public and private rights” and wrote that the Court would not be doing so with the Jarkesy decision either, ultimately leaving the full reach of this decision and its application to other agency adjudication schemes open to later court challenges.
While the Jarkesy decision will not have any immediate effect on DOT or FAA’s ability to pursue enforcement actions as a whole, similar challenges could be brought involving specific issues that these agencies adjudicate through administrative proceedings. Courts have considered the public rights exception in the context of FAA licensing enforcement in the past, finding in Hill v. National Transp. Safety Bd., 886 F.2d 1275, 1282 (10th Cir. 1989) that administrative proceedings regarding suspension of pilot certificates involve the special expertise of FAA and are not akin to suits at common law for which a jury trial is required. However, there are likely DOT or FAA agency adjudications that are beyond the public rights exception. Most notably, DOT’s ability to enforce the unfair and deceptive practices rules through agency adjudicated civil penalties, could potentially be at risk in the same way as SEC’s anti-fraud enforcement.
DOT’s rules on unfair and deceptive rules were most recently updated in December 2020. Under 49 U.S.C. § 41712, DOT has the authority to investigate and decide whether an air carrier, foreign air carrier, or ticket agent is engaged in an unfair or deceptive practice in air transportation or the sale of air transportation. Section 41712 also provides air carriers with notice and an opportunity for an agency hearing, and DOT has the authority to issue orders to stop an unfair or deceptive practice. Under 49 U.S.C. § 46301, DOT has the authority to issue civil penalties for violations of Section 41712 or for any regulation issued under the authority of Section 41712. Until the Defining Unfair and Deceptive Practices final rule was issued in 2020, DOT did not have any official definition of “unfair” or “deceptive” practices. DOT’s treatment of these terms was based loosely on the Federal Trade Commission’s (“FTC”) own policy and definitions of these terms, though their meaning had been determined through DOT’s adjudication process and agency guidance. However, the 2020 final rule removed any doubts and specifically defined these terms based on FTC’s own definitions and the FTC’s 1980 Policy Statement on Unfairness.
Now the question is, do unfair and deceptive practices have a basis in the common law which would prohibit the application of the public right exceptions? The majority opinion discusses two cases concerning the application of the public rights to unfair methods of competition and interstate commerce. The Court cites Ex Parte Bakelite Corp., 279 U. S. 438, 446 (1929), which upheld a law authorizing tariffs on goods imported through unfair methods of competition, stating that Congress and the Executive branch had traditionally held exclusive power in this area of foreign commerce, and therefore Article III courts were not required. But the majority opinion declined to apply the precedent of Oceanic Steam Navigation Co. v. Stranahan, 214 U. S. 320 (1909), which upheld an immigration law that allowed administrative civil penalties without a jury for aliens with “loathsome or dangerous contagious diseases.” The majority opinion asserted Oceanic Steam was solely limited to administrative authority over foreign commerce, and explicitly states in a footnote that “Nowhere does Oceanic Steam Navigation say that the public rights exception applies to cases concerning the securities markets or interstate commerce more broadly.” (Jarkesy at FN 1). However, the Supreme Court precedent does not otherwise clearly indicate whether the public rights exception would apply to unfair and deceptive practice adjudications before agency ALJs.
However, the FTC’s 1980 Policy on Unfairness cites to an earlier 1964 FTC statement on determining what constituted consumer unfairness. The 1964 FTC statement provides:
Whether the practice, without necessarily having been previously considered unlawful, offends public policy as it has been established by statutes, the common law, or otherwise-whether, in other words, it is within at least the penumbra of some common-law, statutory, or other established concept of unfairness. (emphasis added).
Based on this language, it appears that a reasonable argument could be made that the adjudication of unfair and deceptive practices has at least some basis in the common law. As Jarkesy notes, the creation of a novel statutory scheme by Congress (such as protecting consumers from unfair and deceptive practices) is not enough alone to supplant the requirements of the Seventh Amendment, especially when the statutory schemes are related to common law claims.
While it is not certain that DOT enforcement of unfair and deceptive practice law claims through agency adjudication would fall to a court challenge similar to Jarkesy, it is reasonable to question whether this, or other similar agency adjudicatory practices, are in danger of suffering a similar fate. Ultimately, it will require an air carrier that is subject to an unfair and deceptive practice civil penalty to challenge in a federal appeals court the scope of DOT’s authority under the public rights doctrine. If DOT’s enforcement of 49 U.S.C. § 41712 was found to be beyond the public rights exception, DOT would likely face an uphill battle in effectively enforcing its rule.
First and foremost, a requirement to bring any civil penalty action for unfair and deceptive practices in a federal court would likely limit the number of actions that DOT could bring. Pursuing an action in federal court would certainly be more costly than in-house adjudications in front of an ALJ, and agencies do not have an infinite source of funding to support these actions. Additionally, while ALJs are supposed to be independent fact finders, it is very likely that a federal jury of normal citizens would give much less deference to an agency’s explanation of the facts and relevant law than an ALJ who technically works for that same agency. As noted in Jarkesy, the SEC won about 90% of agency proceedings compared to 69% of its jury trials in federal court. If DOT were similarly required to adjudicate all unfair and deceptive practice actions in federal courts, it would likely be a boon for air carriers who certainly want to limit DOT’s ability to pursue these actions.
This Aviation Blog is intended to keep readers current on developments in the law. It is not intended to be legal advice. If you have any questions, please contact Evelyn Sahr at 202.659.6622 or esahr@eckertseamans.com; Drew Derco at 202-659-6665 or dderco@eckertseamans.com; Jay Julien at 202.659.6648 or jjulien@eckertseamans.com, Andrew Orr at 202-659-6625 or aorr@eckertseamans.com, or Samanta Walter at 412.566.1920 or swalter@eckertseamans.com, or any other attorney at Eckert Seamans with whom you have been working.
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