WASHINGTON — A case that the Supreme Court heard last week has many in business, and government legal circles worried about how far the court will go in limiting a key enforcement mechanism that the Securities and Exchange Commission regularly uses to go after fraud.

The issue involves George Jarkesy, a conservative talk radio host and hedge fund manager who was investigated by the SEC in 2011 over allegedly overvaluing the fund’s assets to increase investor fees. As is typical in such cases, the SEC took the case before its in-house courts, known as administrative law judges, or ALJs. Jarkesy in response argued that the agency’s adjudicative system was flawed and violated his Seventh Amendment right to trial by jury.

ALJs are officials who preside over administrative hearings as arbiters chosen for their expertise in their fields. The U.S. government uses over 1,200 ALJs for its different agencies to mete out punishments or make sure agency functions are being carried out – such as at the Social Security Administration, the Environmental Protection Agency, and the Department of Labor. Therefore, the case has the potential to upend many enforcement functions of the federal government, including workers’ rights, environmental protections and Social Security benefits.

In an indication of just how closely this case is being watched, SEC v. Jarkesy garnered 35 amicus curiae briefs – well above the average of approximately 16 amicus curiae briefs filed in cases in 2019. One of these briefs, filed by Nicolas Morgan, a former SEC litigator, was written on behalf of billionaires Elon Musk, Mark Cuban, and other business leaders who have previously clashed with the SEC. 

“Potentially, you would see fewer defendants settle if they know they’re going to be able to plead their case to a jury,” Morgan said

Should the court rule in favor of Jarkesy, the SEC would be required to bring their cases in front of federal court. This would prevent the commission from imposing civil penalties on corporate perpetrators without facing expensive litigation and appeal processes. 

If the court determines that the ALJ system does not violate this constitutional right, justices may then seek to answer if allowing the SEC to enforce securities laws through an administrative law judge violates the “nondelegation doctrine,” which prohibits Congress from delegating its powers to other entities. 

For most of its history since the SEC was created in the wake of the Great Depression, the agency could only enforce securities laws by bringing an action in federal court. Because of market failures and rampant fraud, Congress enacted the Penny Stock Reform Act in 1990 and the Dodd-Frank Act in 2010, which gave the SEC authorization to use administrative enforcement proceedings before ALJs. 

“The APA created these ALJs to create these independent people within the agencies who are subject matter experts in highly technical areas of the law to be able to adjudicate things both efficiently and fairly,” said Devon Ombres, senior director of courts and legal reform for the Center for American Progress, a political advocacy group.

The Supreme Court devoted the majority of its time during oral arguments last week to discussing whether the ALJ system is in sync with the Seventh Amendment right to trial by jury.

Justice Neil M. Gorsuch suggested such a right is sacred. “The right to trial by jury, whether it’s criminal or civil,” he said, “is a very important foundational freedom in American society and a check on all branches of government.”

Jarkesy’s attorney also contended that allowing agencies rather than courts to adjudicate such legal claims contradicts English common-law tradition. 

The case started after the SEC investigated Jarkesy’s two hedge funds that were using Patriot28 LLC as the investment adviser, managing $24 million in assets from over 100 investors. After an administrative hearing, the agency required him to disgorge about $685,000 in ill-gotten gains. Jarkesy sued, and his case went before the U.S. Court of Appeals for the Fifth Circuit. 

In recent years, the Fifth Circuit – which covers Mississippi, Louisiana and Texas – has become notorious for delivering far-right legal decisions, like declaring a federal consumer protection agency unconstitutional in CFPB v. CFSA, requiring social media companies to give control of their content moderation to the government in NetChoice v. Paxton and requiring the navy to deploy soldiers who did not take the Covid vaccine in U.S. Navy SEALs 1-26 v. Biden.

“The Fifth Circuit has become extreme. There are a slight handful of judges within Texas who are the go-to for conservative activists to try and have statutes and regulations stripped down and to challenge the constitutionality of agencies through what’s known as judge shopping,” Ombres said.

This case came on the same day Facebook parent company Meta filed a lawsuit against the Federal Trade Commission for its “structurally unconstitutional authority” in another attempt to shrink the power of government agencies.

“The arguments asserted [in the Meta lawsuit] are very much in line with the arguments discussed in Jarkesy,” Ombres said in an interview. 

Brian Fletcher, principal deputy solicitor general who represented the SEC, based his legal argument on the precedent set by another Supreme Court case in 1977, Atlas Roofing Co. v. Occupational Safety Comm’n. At the time, the court decided that Congress has the power to grant agencies authority overseeing violations of a new public rights statute without infringing on the Seventh Amendment right to a jury trial.

Justice Clarence Thomas pushed back on this argument, asking, “If I don’t agree with you that we’re talking about public rights here, that private rights are involved, would you then think that it is required that it be adjudicated before a [federal]  court?” 

Justice Sonia Sotomayor explained the reason for this dispute as she said Thomas “thinks that a private right is any right that involves property, life, or liberty.” 

Michael McColloch, Jarkesy’s attorney, argued that this case concerns private rights – not public ones – because the issue at hand is similar to a right in common law. He argued that government agencies are not allowed to take a private right like the right to a jury trial and adjudicate it in a public entity to deprive an individual of property – in Jarkesy’s case, money.

Justice Elena Kagan rejected McColloch’s interpretation of the Atlas Roofing decision and appeared confused by the nature of this case. According to Kagan, nearly all of the cases involving public rights brought to the Supreme Court involved private firms arguing against each other and not public against private as they had already been settled. 

“Nobody has had the chutzpah, to quote my people, to bring it up since Atlas Roofing,” said Kagan, which drew laughter from the audience.

Sotomayor agreed with Kagan and mentioned that the words “stare decisis” – a crucial legal doctrine meaning to let precedent stand – did not appear in McColloch’s brief. Sotomayor claimed the change McColloch proposed would have dramatic ramifications for other government agencies by requiring them to go to court for standard penalties. 

Given that the majority of the hearing focused on the first constitutional question, legal experts such as Christopher J. Walker, professor of law at the University of Michigan, expect the court to deliver a narrow ruling that may not affect the ways agencies work with ALJs. He said he expects the court, in either a five or six justice majority, to require the SEC to go to federal court instead of using ALJs. However, he did acknowledge the possibility that the judges’ ruling on the other questions could have larger implications.

The Supreme Court does not set a timeline for when its decisions are released, so its opinion in this case could come as late as the end of its term in June 2024.