Supreme Court Decision Calls into Question Financial Regulatory Enforcement

When must the federal government respect your constitutional rights? “Always,” said the U.S. Supreme Court, or at least when it comes to a person’s right to a jury trial under the Seventh Amendment. In Securities and Exchange Commission v. Jarkesy, 603 U.S. 109 (2024), the Supreme Court affirmed a decision of the U.S. Circuit Court of Appeals for the Fifth Circuit vacating a Securities and Exchange Commission order imposing civil penalties for securities fraud. The appellate court determined that the Seventh Amendment right to a jury trial applied to the federal agency’s enforcement action, and the SEC did not provide the individual, Jarkesy, the right to a jury trial before fining him. The high Court affirmed that people don’t lose this critical constitutional guarantee merely because the government (in that case, the SEC) uses agency hearings instead of federal Article III courts to enforce its rules.

Jarkesy tells us that the SEC can’t use its in-house administrative tribunals to levy monetary sanctions for violations of its rules. But what does that mean for organizations over which the SEC has authority?

What is FINRA?

For generations, federal law has entrusted industry participants with much of the responsibility for regulating the securities industry. For example, most brokers and other entities involved in trading stocks, bonds, etc., are members of the Financial Industry Regulatory Authority (FINRA). FINRA is a non-governmental “self-regulatory organization” (SRO), legally authorized by the SEC to govern its members’ activity in the financial markets. One cannot act as a securities broker without joining FINRA.

As a result, FINRA has the authority to discipline its members for violating federal laws or FINRA’s rules through various penalties, including financial sanctions and expulsion from FINRA membership (which effectively expels the member from the industry). The SEC oversees FINRA’s governance, reviewing its rules and enforcement actions. Thus, much of the securities industry primarily governs itself through SROs like FINRA, but the SEC, per Congress, maintains ultimate authority over the industry.

What are administrative tribunals?

Many federal agencies use some kind of in-house proceedings that resemble courts. They generally feature two sides (typically the government and a private individual or company) and allow each side an opportunity to present evidence and confront the other side’s evidence. They feature a decision-maker who has some degree of independence from the parties to the proceeding. Frequently, this decisionmaker is a “hearing officer” or “administrative law judge” who is an employee of the relevant agency but was not a part of the enforcement action or case at issue.

Significantly, while many of these elements resemble the characteristics of courtroom proceedings, agency tribunals differ substantially from Article III trial courts. First, Article III judges are independent from federal agencies and federal prosecutors. Furthermore, parties to court proceedings can often have their claims decided by juries. Finally, federal courts follow the Federal Rules of Civil Procedure and the Federal Rules of Evidence, which ensure that parties can discover all relevant information before trial and that the judge and jury only rely on reliable information to make their decisions.

Myriad other elements distinguish district courts and agency proceedings, and generally, these additional procedures serve to protect the parties’ constitutional rights. Agencies often use their in-house tribunals to avoid the significant time, expense, and uncertainty that district court procedures add to government enforcement actions. But employing proceedings that lack procedures designed to protect individuals’ constitutional rights runs the risk of violating those constitutional rights. The Jarkesy decision stands as an example of the Supreme Court telling a federal agency that it has gone too far.

How could Jarkesy impact FINRA’s authority?

In Jarkesy, the Supreme Court decided that the SEC can’t use non-jury administrative proceedings to impose financial penalties. But what about those SROs, like FINRA, that derive their enforcement authority from the SEC? That is, if the Seventh Amendment prohibits the SEC from using its in-house tribunals to impose monetary sanctions, can FINRA, which derives its authority from the SEC, use its in-house proceedings to likewise impose fines without violating the Constitution?

Moreover, does the Jarkesy ruling call into question other procedural differences between agency hearings and federal district courts? For example, if agency proceedings do not afford an individual a right to fully confront adverse witnesses, follow the Federal Rules of Evidence, or allow for comprehensive discovery, do they violate the Constitution’s guarantee of due process?

And, if the Court decides that agency hearings must provide additional procedural protections, do those requirements trickle down to all the SROs, like FINRA, under the agency’s purview?

Additional litigation will be required to answer these questions and others establishing the scope of the Constitution’s application to agency and non-governmental administrative adjudications.

Please contact CullenLaw attorneys for more information about constitutional issues in agency and other hearings.