The U.S. Court of Appeals for the Fifth Circuit recently denied rehearing en banc in Jarkesy v. Securities and Exchange Commission, a case with significant implications for the use of administrative law judges (ALJs) by federal agencies, including the CFPB. The SEC is expected to file a certiorari petition with the U.S. Supreme Court.
The underlying case in Jarkesy involved an SEC investigation that resulted in an administrative action against the petitioners in which the SEC alleged that the petitioners had committed securities fraud and sought both monetary and equitable relief. The petitioners then sued in the U.S. District Court for the District of Columbia to enjoin the proceedings, claiming violations of several constitutional rights. The district court, and subsequently the U.S. Court of Appeals for the D.C. Circuit, refused to issue an injunction, deciding that the district court had no jurisdiction and that the petitioners were required to continue the administrative proceeding and then appeal.
After an evidentiary hearing, an SEC ALJ found that the petitioners had committed securities fraud. The petitioners sought review by the SEC, which affirmed the fraud finding and ordered the petitioners to pay a civil penalty of $300,000, banned the individual petitioner from participating in the securities industry, and ordered the company petitioner to pay nearly $685,000 in disgorgement. Petitioners then sought review by the Fifth Circuit.
A divided 3-judge Fifth Circuit panel ruled that the proceedings suffered from three constitutional defects:
- The SEC’s use of an administrative court violated the petitioners’ Seventh Amendment right to a jury trial because the SEC’s fraud claims are analogous to traditional fraud claims at common law to which a right to a jury trial applies when civil penalties are sought. In addition, such actions are commonly considered by federal courts even when the claims are brought by the government rather than private plaintiffs. The SEC’s involvement did not convert the case to one involving the vindication of public rights that could be assigned to agency adjudication.
- Congress unconstitutionally delegated legislative power to the SEC by failing to provide an intelligible principle to guide the SEC’s use of its discretion to decide whether to bring securities fraud enforcement cases either in district court or within the agency. Article I of the U.S. Constitution vests “all legislative Powers” in Congress and the decision whether to assign certain actions to agency adjudication is a power that only Congress possesses.
- The removal restrictions that apply to SEC administrative law judges are unconstitutional because they interfere with the President’s ability to “take Care that the Laws be faithfully executed” as required by Article II of the Constitution. The Administrative Procedure Act (5 U.S.C. § 7521(a)) provides that ALJs may be removed by the agency in which the ALJ is employed “only for good cause established and determined by the Merit Systems Protection Board on the record after opportunity for hearing before the Board.”
These holdings have significant implications for other federal agencies, including the CFPB. First, to the extent the CFPB’s authority to challenge deceptive practices is rooted in common law fraud claims, the CFPB’s use of an ALJ in an enforcement action involving an alleged deceptive act or practice could be found to violate the respondent’s Seventh Amendment right to a jury trial. Second, because the Dodd-Frank Act gives the CFPB unfettered discretion to choose whether to bring an action before an ALJ or in federal district court, the CFPB’s use of an ALJ for any enforcement action could be challenged as an unconstitutional delegation of authority. Third, assuming an ALJ used by the CFPB would be subject to the same APA for-cause removal restriction as an SEC ALJ, the removal restriction could be the basis for a constitutional challenge to the CFPB’s use of an ALJ in any enforcement action.
The CFPB has only used administrative proceedings infrequently to bring enforcement actions and instead has primarily brought enforcement actions in federal district court. Given the cloud that Jarkesy creates for the use of ALJs, it seems unlikely that the CFPB will use administrative proceedings while the constitutional challenges raised in Jarkesy remain a threat. However, in any enforcement action it brings in federal court, the CFPB can expect to face a constitutional challenge to its funding mechanism based on the Fifth Circuit panel decision in Community Financial Services Association v. CFPB.