In a Louisiana federal court case, Jarkesy v. SEC, the U.S. 5th Circuit Court of Appeals has now issued a constitutional ruling that is far more important than the merits of the case itself. The case involves a hedge-fund founder, George Jarkesy, and an investment adviser.
In 2013, the Securities and Exchange Commission (SEC) charged the two men with securities fraud for allegedly inflating the value of fund assets, contending that the higher valuation allowed them to earn higher management fees. The pair were ultimately found to have engaged in fraud, ordered to pay civil penalties, and make restitution of the illegal financial gains.
These kinds of financial charges by the SEC are routine and unremarkable by themselves and the two men may well have committed the fraud of which they are accused. However, the core issue for constitutional purposes is the process and procedures through which the SEC reached its conclusion.
Mr. Jarkesy wasn’t allowed to defend himself in a federal court where the iron clad guarantees of due process, the right to a trial by a jury, and “innocent until proven guilty” exist.
Instead, the case was adjudicated before one of the SEC’s own administrative law judges (ALJ) who ruled that the defendants had committed financial fraud. This SEC ALJ’s ruling was then affirmed by the SEC Commissioners themselves and, in addition to fines and restitution, the ruling barred Mr. Jarkesy from the securities industry.
Again, merits aside, the problem is that the SEC acted as prosecutor, judge, and jury (often referenced in criminal law matters as “judge, jury and executioner”). This procedural process, the 5th Circuit made clear, did not afford “due process” and was therefore plainly unconstitutional.
How did we get to the point that a federal agency like the SEC can handle agency adjudications in this way? Because the highly suspect, often arbitrarily onerous Dodd-Frank law allows a federal agency like the SEC to decide whether to bring charges before one of its own administrative law judges or in federal court. Most federal agencies tend to bring these matters before their own ALJs in their own internal court system. What could go wrong!
This incestuous favoritism for the “home team” is what we lawyers call “home cookin'” which in this case violated fundamental constitutional rights.
The 5th Circuit found that these kinds of SEC tribunals weaponize their own ALJs and violate the 7th Amendment’s right to trial by jury because the guarantee of a jury extends to all suits of “common law” as understood at the time of the writing of the Constitution and that certainly includes fraud charges like these.
So, the issue addressed was that Congress’ delegation of legislative power to the SEC to determine where it will bring fraud prosecutions violates the Constitution’s separation of powers. As the Court noted, “Congress may grant agencies prosecutorial discretion to decide what cases to bring, but it cannot give them free rein to decide their judicial forum.” (Wall Street Journal, 5-23-22.).
While the ruling here applied only to the SEC, what I find so encouraging about the decision is that it lays a foundation to begin to pull back and restrain our all-too-powerful federal agencies and the runaway administrative state they have constructed.
The fundamental question is the appropriate role of federal agencies in our “separation of powers” constitutional structure, which was the basis of the legal infirmity identified by the 5th Circuit in this case.
That’s because the appropriate law and policy-making branch of government in our constitutional scheme is the Legislative Branch. However, Congress has been unwilling to discharge its lawmaking/policy obligation so that power vacuum is filled by the numerous federal agencies.
And, because federal agencies—staffed by unaccountable bureaucrats who were never elected to anything—develop an expertise for handling legal issues like those in this case—securities fraud—they are afforded broad legal deference by the federal courts.
This practice of deferring to agencies has now transpired into allowing these agencies to interpret their own rules, try their own cases and render their own rulings and sanctions. This is unconstitutional madness.
While Congress may assign certain investigative and rulemaking authority to be handled by another entity like the SEC, it may not delegate away its core constitutional function.
And where Congress abdicates its core role by delegating lawmaking to the Executive Branch through administrative agencies like the SEC, the federal courts, such as the U.S. 5th Circuit here, must step up to fortify and vindicate this essential constitutional structure of government.