June 2022 Business Litigation Update

Last month, the US Court of Appeals for the Fifth Circuit issued an opinion in Jarkesy v. SEC that could have some interesting and significant implications for the future of the SEC.

The case involves a hedge fund manager, George Jarkesy, who was accused of deceiving investors to raise $24 million. The matter was initially heard by an Administrative Law Judge (ALJ) with the SEC, who determined Jarkesy did commit securities fraud.   Jarkesy appealed the decision to the Fifth Circuit, claiming that he was denied his constitutional right to a jury trial.  The Fifth Circuit agreed with Jarkesy and vacated the SEC’s decision.

But importantly the Fifth Circuit went beyond the “right to jury trial” issue and also ruled that the SEC’s current power to even decide to bring an action before an ALJ (rather than in federal court) is unconstitutional.  Such a decision, according to the Fifth Circuit, is a “legislative action” but Congress failed to provide the SEC with any “intelligible principle” upon which to make that determination.  An “intelligible principle” from Congress is required whenever it delegates authority to a federal agency.

As a result, according to the Fifth Circuit, Congress improperly delegated its authority to the SEC (thereby violating the “nondelegation doctrine”), which is unconstitutional (but has not been judicially invoked for 87 years).

While this may seem like a narrow, technical issue (it is!), commentators have noted that the underlying principle used by the Fifth Circuit (the nondelegation doctrine) has the potential to be significant.  Taken to its logical extreme, the Fifth Circuit is really challenging the SEC’s power to make rules – like the recent ones concerning climate change disclosures for public companies.  Under the nondelegation doctrine, these may be held unconstitutional as well.

As Matt Levine of Bloomberg.com noted:

“But the [Fifth Circuit] is making a broader point here….  The point is that the SEC’s actual legislative actions — writing rules about stock buybacks or swaps disclosure or climate change — are now in danger. It used to be accepted as a routine matter that the SEC could make rules under a very broad grant of power from Congress to regulate securities markets in the public interest.  I am not sure that is true anymore….  I think the Fifth Circuit went out of its way to find a nondelegation problem….  I think this might be a sign of where things are going….  Because now there is a live possibility that federal courts might say it is unconstitutional for the SEC to make any rules about anything.”

The SEC has not announced whether it will seek further review of the decision from the full Fifth Circuit or from the U.S. Supreme Court.  Given the high stakes involved, we are closely monitoring this case and as developments arise, we will continue to provide updates moving forward.