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Court rules SEC’s internal judges are unconstitutional

The Hill logo The Hill 5/19/2022 Brad Dress
AP Photo/Andrew Harnik © Provided by The Hill AP Photo/Andrew Harnik

The 5th Circuit Court of Appeals on Wednesday ruled the Securities and Exchange Commission (SEC) is denying defendants their constitutional right to a jury trial by putting them in front of its own internal judges.

In a 2-1 ruling, the court ruled for George Jarkesy and Patriot28 LLC, who sued the SEC in 2011 after the agency imposed a $300,000 fine and other punishments in a securities fraud case.

Judge Jennifer Walker Elrod wrote in the majority opinion that the SEC violated the Seventh Amendment’s right to a jury trial by bringing defendants before in-house judges and allowing the agency to “act as both prosecutor and judge.”

Congress also unconstitutionally delegated power to the SEC to act as a legislative body, Elrod wrote.

“‘We the People’ are the fountainhead of all government power. Through the Constitution, the people delegated some of that power to the federal government so that it would protect rights and promote the common good,” Elrod said. “But that accountability evaporates if a person or entity other than Congress exercises legislative power.”

In a dissenting opinion, Judge Eugene Davis disagreed, saying the right to a jury trial did not pertain to administrative proceedings and that the SEC was enforcing laws and statutes in the public interest.

Davis also said Congress did not overreach in empowering the SEC to enforce action through its administrative proceedings.

The ruling comes two days after the U.S. Supreme Court agreed to a hear a separate but similar case involving the SEC’s administrative powers and in-house judges in a suit brought by Texas accountant Michelle Cochran.

In the 5th Circuit case, Jarkesy created two hedge funds and selected Patriot28 as an investment adviser. In 2011, the SEC brought action against Jarkesy and Patriot28, accusing them of overvaluing their investment fund and misrepresenting data to attract investors.

An administrative law judge within the SEC ruled that Jarkesy and Patriot28 had committed securities fraud, as did the SEC’s internal commission.

They were fined $300,000, and Jarkesy was barred from interacting with brokers, investors and others within the industry.

Before bringing the case to the 5th Circuit Court of Appeals, Jarkesy and Patriot28 had attempted to bring the case before the U.S. District Court in Washington, D.C., and the U.S. Court of Appeals for the D.C. Circuit but were denied and sent back to the SEC’s administrative process.

The Dodd-Frank Act, passed after the 2008 financial crisis, empowered the SEC to bring cases before its own internal judges and institute penalties against defendants.

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