The Securities and Exchange Commission (SEC) has filed a petition for certiorari with the U.S. Supreme Court seeking review of the Fifth Circuit’s decision 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 underlying case in Jarkesy involved an SEC investigation that resulted in an administrative action against the petitioners in which the SEC alleged that the respondents had committed securities fraud and sought both monetary and equitable relief.  The respondents 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 respondents were required to continue the administrative proceeding and then appeal. 

After an evidentiary hearing, an SEC ALJ found that the respondents had committed securities fraud.  The respondents sought review by the SEC, which affirmed the fraud finding and ordered the respondents to pay a civil penalty of $300,000, banned the individual respondent  from participating in the securities industry, and ordered the company respondent to pay nearly $685,000 in disgorgement.  The respondents then sought review by the Fifth Circuit.  A divided 3-judge Fifth Circuit panel ruled that the proceedings suffered from three constitutional defects, vacated the SEC’s decision, and remanded the matter to the SEC for further proceedings.  The SEC filed a petition for rehearing en banc which was denied by the Fifth Circuit.

The following two questions presented in the SEC’s certiorari petition could have significant implications for the CFPB’s use of ALJs:  

  • Whether the statutory provision that empowers the SEC to initiate and adjudicate administrative enforcement proceedings seeking civil penalties violated the Seventh Amendment of the U.S. Constitution.  The Fifth Circuit panel concluded that the SEC’s use of an administrative proceeding 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 its petition, the SEC argues that Congress’s power to assign an enforcement proceeding to a non-Article III tribunal does not depend on the extent to which that proceeding resembles common-law actions.  To the extent the CFPB’s authority to challenge deceptive practices is rooted in common law fraud claims or other enforcement actions brought by the CFPB are deemed to resemble common-law actions, the CFPB’s use of ALJs in a proceeding seeking civil penalties could similarly be challenged as a violation of  the respondent’s Seventh Amendment right to a jury trial.
  • Whether statutory provisions that authorized the SEC to choose to enforce the securities laws through an agency adjudication instead of filing a district court action violate the nondelegation doctrine.  The Fifth Circuit panel concluded that 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.  In its petition, the SEC argues that in deciding whether and how to enforce the securities laws, the SEC does not exercise legislative power and instead exercises only enforcement discretion, which is a classic executive power.  As 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 an enforcement action could similarly be challenged under the nondelegation doctrine. 

The third question presented by the SEC’s petition is whether Congress violated Article II of the Constitution by granting for-cause removal protection to ALJs in agencies whose heads can only be removed by the President for cause.  While CFPB ALJs, like SEC ALJs, can only be removed for cause established and determined by the Merit Systems Protection Board, the CFPB Director, unlike SEC  Commissioners, can be removed without cause.

The CFPB recently finalized a procedural rule that updates its Rules of Practice for Adjudication Proceedings.  In a blog post about the final rule, the CFPB stated that it “still plans to bring the vast majority of its matters in district court, but in certain circumstances, administrative adjudications can be valuable.”  Nevertheless, we expect the CFPB will be deterred from using administrative proceedings as a result of the legal cloud created by Jarkesy.