The United States Court of Appeals for the Fifth Circuit issued a ruling on May 18, 2022, vacating an administrative decision by the Securities and Exchange Commission (“SEC”) that found George Jarkesy (“Jarkesy”) and his investment fund advisor, Patriot28, committed securities fraud. In its decision, the court concluded that Congress had constitutionally delegated to SEC the authority to resolve enforcement actions through the process and use of Administrate Law Judges (“ALJ”). This court decision is in addition to other ongoing cases that question the scope of authority Congress may delegate to federal agencies. The Fifth Circuit’s ruling may shape the way other federal governmental agencies, such as the Federal Crop Insurance Corporation (“FCIC”) and the Environmental Protection Agency (“EPA”), conduct administrative proceedings against persons suspected of violating federal law.

Background

This lawsuit, Jarkesy v. Sec. & Exch. Comm’n, 34 F.4th 446 (5th Cir. 2022), began in 2013 when the Securities and Exchange Commission (“SEC”) brought an administrative action against Jarkesy and Patriot28 for committing securities fraud. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) (Pub. L. 111-203), Congress provides SEC the power to impose civil penalties against persons through its own internal administrative process. Essentially, SEC has the option to either file a lawsuit in federal court or bring an administrative action against suspected violators. 15 U.S.C. § 78u-2(a); 15 U.S.C. § 78u-3. SEC’s administrative action involves a hearing that is similar to federal civil trial where both the accused (or “respondent”) and SEC offer their legal arguments by presenting evidence and calling witnesses to testify. Administrative actions differ from lawsuits filed in a federal court because SEC actions are heard by an ALJ—who serves as the judge and the jury—rather than a federal judge. However, ALJs preside over administrative proceedings in a way similar to federal court judges, meaning the ALJ decides motions, resolves evidentiary disputes, and determines whether the respondent is liable to SEC for violating securities laws.

Under the Dodd-Frank, SEC has the opportunity to review a claim against a suspected violator before an appeal to a federal court. This means the law precludes a respondent from filing a lawsuit in a federal court to challenge SEC’s administrative proceeding before an ALJ and SEC issues a ruling. In fact, before the ALJ and SEC issued a ruling, Jarkesy and Patriot28 filed a lawsuit against the agency in the U.S. District Court for the District of Columbia arguing that the administrative proceeding violates various constitutional rights. The district court and the U.S. Court of Appeals for the D.C. Circuit determined that the federal court had no jurisdiction and could not hear the case because SEC has exclusive authority to adjudicate the securities fraud claims and parties typically cannot bring claims to a federal court until SEC issues an order under its administrative process. See Jarkesy v. SEC, 48 F. Supp. 3d 32, 40 (D.D.C. 2014), aff’d, 803 F.3d 9, 12 (D.C. Cir. 2015).

Having to continue with SEC’s administrative proceedings, the ALJ concluded that Jarkesy and Patriot28 committed securities fraud and the two appealed. During their appeal, Jarkesy and Patriot28 raised various constitutional challenges to SEC’s administrative enforcement action. SEC rejected these arguments and affirmed the ALJ’s ruling. After the agency’s decision, Jarkesy and Patriot28 filed a lawsuit against SEC in the Fifth Circuit.

Fifth Circuit’s Ruling

In the Fifth Circuit’s opinion, the court held that there are aspects of SEC’s administrative proceedings that are unconstitutional. First, the court determined that SEC’s administrative action deprived Jarkesy and Patriot28 of their Seventh Amendment right to a jury trail because the agency’s proceeding is similar to traditional actions at law to which the right to a jury trial attached. Second, the court determined that Congress had unconstitutionally assigned SEC authority to decide whether an enforcement action should be heard by an ALJ or a federal court.

According to the Fifth Circuit, Congress cannot assign the adjudication of claims that are “traditional actions at law” to a federal agency. To determine whether a claim is a traditional action, the court relied on the following two-step test: (1) whether the claims in the action arise “at common law”, and (2) if so, whether Congress is permitted to assign the claims to an agency for administrative proceedings without a jury trial because the claims solely involve “public rights.” Under the first step, the court determines that actions that arise at common law must be tried by a jury. Common law, which is also known as case law, are laws based on legal precedent established by courts. According to the Fifth Circuit, fraud claims arise under common law, and civil monetary penalties are a type of sanction that courts can impose under common law. Because the fraud claims and civil monetary penalties raised by SEC against Jarkesy and Patriot28 both arose under common law, the court found that by assigning the case to an ALJ, SEC had violated Jarkesy’s and Patriot28’s constitutional right to a jury trial.

For the second step of the two-part test, the court determined that securities fraud claims do not solely involve public rights. Public rights are rights established by the legislature that can be exercised by a citizen, such as the right to vote. These rights differ from private rights because citizens cannot enforce public rights. The Fifth Circuit asserts that public rights are established by statute without any basis in common law. Because SEC’s claims against Jarkesy and Patriot28 consisted of securities fraud, which are common law claims, the claims did not involve purely public rights. Therefore, the court concluded that Jarkesy and Patriot28 were deprived of their right to a jury trial.

Next, the Fifth Circuit considered whether Congress had unconstitutionally delegated to SEC authority to bring an enforcement action either to an ALJ or a federal court. Under Dodd-Frank, SEC may choose whether to bring actions against persons in a federal court or through the agency’s internal administrative enforcement procedure. Jarkesy and Patriot28 argued that this was an unconstitutional delegation of legislative authority because Congress failed to provide SEC with an “intelligible principle” to guide how SEC should use that authority. Ultimately, the court agreed and determined that the delegation of authority to SEC was unconstitutional.

Under the United States Constitution, Congress is assigned all legislative authority. The United States Supreme Court has explained that Congress may not delegate that legislative authority to any entity without providing an “intelligible principle” instructing the entity on how to use the authority. Mistretta v. United States, 488 U.S. 361, 372 (1989). In other words, Congress cannot provide open ended legislative authority to any federal agency. An action is legislative if it affects or alters someone’s legal rights. Deciding whether to assign a dispute to an ALJ or federal court is a legislative action because it impacts the legal rights of the parties to the dispute. Therefore, the authority granted to SEC is a legislative authority. According to the court, Congress did not offer any guidance to SEC in making the decision to bring an administrative or court action against a person. Because Congress delegated legislative authority to SEC without a guiding intelligible principle, the Fifth Circuit concluded that SEC’s ability to bring enforcement actions either to an ALJ or a federal court is an unconstitutional delegation of legislative power.

Federal Crop Insurance Program

When disputes for insurance indemnities or claims of fraud involving the Federal Crop Insurance Program (“FCIP”) arise, FCIC, which administers the FCIP, conducts similar administrative procedures to SEC.

Fraud

Congress has provided FCIC with authority to impose civil sanctions on persons that commit crop insurance fraud. In general, FCIC is authorized to sanction monetary penalties on a producer, insurance agent, loss adjuster, or approved insurance providers for receiving crop insurance benefits by fraud “after notice and an opportunity for a hearing….” 7 U.S.C. § 1515(h). Under this statute, Congress does not specify the type of proceeding FCIC must institute in order to bring fraud claims against a person. Accordingly, FCIC has established regulations that require these claims be brought under an administrative procedure before an ALJ. See 7 C.F.R. § 400.451 et seq. This administrative adjudicative procedure is similar to SEC’s procedures challenged in Jarkesy. Accordingly, a person facing fraud claims may challenge FCIC’s administrative procedures based on the constitutional arguments raised in Jarkesy.

A person facing crop fraud claims may, relying on the Fifth Circuit’s decision in Jarkesy, claim FCIC’s procedures are unconstitutional. First, a person may argue the agency’s procedures violate their right to a jury trial because (1) fraud claims and monetary penalties arose under common law, and (2) fraud claims do not solely involve public rights because these claims arose under common law. A judge hearing such an argument may agree with the Fifth Circuit and conclude that FCIC’s administrative procedure for adjudicating fraud claims violates a person’s constitutional right to a jury trial because the agency’s proceeding is similar to traditional actions at law.

A person challenging FCIC’s administrative procedure may also argue Congress unconstitutionally provided the agency complete discretion to choose the method of adjudicating fraud claims. Under the FCIA, Congress explicitly states that FCIC must provide a hearing, but the law does not provide much guidance to FCIC on how to decide whether to bring this hearing through an administrative action or by filing a lawsuit in federal court. Thus, relying on the Fifth Circuit’s ruling, a person may argue this delegation of authority is unconstitutional because Congress did not provide FCIC with an “intelligible principle”. If a judge agrees, they could deem FCIC’s administrative procedure unconstitutional.

Debarment

FCIC sometimes brings an action to suspend or debar a producer, insurance agent or adjuster from participating in the FCIP. Actions for debarment are brought against a party for violating the terms of an insurance agreement or misrepresenting information. For example, FCIC may bring an action against an insurance agent for backdating insurance documents in order to provide coverage to a producer. Backdating occurs when a person signs an earlier date on a document to make it seems as if the documentation was complete on that date. Backdating crop insurance forms and documents to obtain coverage or receive policy payments does violate the terms of the insurance agreement and the FCIA. When FCIC discovers that documents are backdated, they may bring a debarment action. FCIC has established a procedure to adjudicate debarment actions under its regulations. 7 C.F.R. §§ 400.455; 400.456. In a debarment proceeding, the accused has the opportunity to defend themselves of the claims brought against them before a debarring official. Under FCIC regulations, the Manager of FCIC is the debarring official for these proceedings unless the Manager designates this authority to another person. 7 C.F.R. § 400.455(b). After the hearing, the debarring official issues a decision as to whether FCIC is debarring the accused. FCIC requires the accused to undertake a debarment proceeding before they may seek judicial review from a federal court. 7 C.F.R. § 400.453.

Considering the court’s decision in Jarkesy, a person may also attempt to challenge FCIC’s debarment procedures. FCIC’s debarment procedures may also be challenged. Someone facing a debarment action may file a lawsuit against FCIC in federal court and argue that Congress’s delegation of power that provides FCIC full discretion to implement regulations that require an internal administrative review for debarment claims is unconstitutional. Essentially, Congress permits FCIC to establish regulations to carry out the provisions of the FCIA (7 U.S.C. § 1506(o)), but this does not provide FCIC much guidance on which procedures the agency must initiate to bring debarment actions. A judge hearing this argument may, relying on the Fifth Circuit’s ruling in Jarkesy, determine that Congress delegated legislative authority to FCIC without a guiding intelligible principle, and FCIC’s ability to establish its own regulations that implements an administrative proceeding for debarment actions is an unconstitutional delegation of authority.

Scope of EPA Authority

The Jarkesy decision from the Fifth Circuit comes at a time when the scope of agency authority is once again being revisited by the United States Supreme Court. Recently, the Supreme Court heard arguments in West Virginia v. U.S. Envt’l Protection Agency, No. 20-1530 (2022), a lawsuit involving the Clean Air Act (“CAA”) and the authority of the Environmental Protection Agency (“EPA”). In that case, the plaintiffs argue that EPA exceeded the authority granted to it by Congress when it issued a rule that the plaintiffs claim is a “wholesale transformation of the U.S. energy system.” While in Jarkesy, the Fifth Circuit focused on whether Congress should have granted the SEC authority to decide where a dispute is heard, and in West Virginia the Supreme Court will decide whether EPA exceeded the authority granted to it by Congress, both cases concern the scope of agency authority. If the Supreme Court rules in favor of the plaintiffs in West Virginia, the ruling would follow the trend set by the Fifth Circuit in Jarkesy in narrowing the scope of authority granted to federal agencies. To read more about the West Virginia case, click here.

Conclusion

While the Fifth Circuit’s decision in Jarkesy involves SEC’s administrative procedures, this decision may have an impact on the administrative actions of other federal agencies, such as FCIC and EPA. It is possible, however, that SEC will appeal the Fifth Circuit’s decision to the U.S. Supreme Court. If the Supreme Court accepts to review the case, the Court could affirm or reject all or some of the Fifth Circuit’s ruling.

 

To read the Fifth Circuit’s ruling, click here.

To read NALC resources on administrative law, click here.

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