SEC’s use of in-house judge violates rights of defendants, appeals court says

A divided federal appeals court panel on Wednesday fixed the way the Securities and Exchange Commission processes some enforcement actions by ruling that its administrative procedures may violate a defendant’s constitutional rights.

The U.S. Court of Appeals for the Fifth Circuit, in a 2-1 decision, ruled that the SEC violated a hedge fund manager’s Seventh Amendment right to a jury trial when it allowed an in-house judge decided a civil fraud case. Such administrative procedures are common among regulatory agencies, which use them to decide some enforcement actions.

The ruling by the Fifth Circuit, one of the most conservative federal appeals courts in the country, is another legal challenge to the SEC’s growing reliance on administrative law judges, rather than filing civil lawsuits in federal court. But for now, the ruling’s impact is limited to federal courts in the court’s jurisdiction, which covers Texas, Louisiana and Mississippi.

“The Seventh Amendment guarantees petitioners a trial by jury because the SEC’s enforcement action is similar to traditional legal actions to which the right to trial by jury is attached,” Circuit Judge Jennifer Walker Elrod wrote in the majority opinion.

Judge Elrod, who was appointed to the court by former President George W. Bush, said the SEC did not have the authority to take such a case to administrative court because it did not involve only “public rights.”

The majority opinion said the in-house judge’s ruling against George Jarkesy in a securities fraud case should be overturned and returned to the regulator. The court said the SEC should act on the appeals court ruling, presumably requiring the case to be refiled in federal court.

In a dissenting opinion, Justice W. Eugene Davis wrote that the majority misunderstood the Supreme Court’s definition of what constitutes “public rights.” Judge Davis said that Congress allows agencies to try cases before domestic judges if they involve “public rights,” such as protecting investors and “advancing the public interest.”

An SEC spokesman said the agency was “evaluating the decision to determine the appropriate next steps.”

This month, the Supreme Court said it would take up another Fifth Circuit ruling that challenged a different aspect of the SEC’s administrative procedure process. In 2018, the Supreme Court ruled 7-2 that the SEC’s administrative law judges had been unconstitutionally appointed to the position.

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