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US Securities and Exchange Commission

Right to Remove: SEC Administrative Enforcement Opt-out Gets Fresh Look as Supreme Court Ruling Looms

Bill Flook  Editor, Accounting and Compliance Alert

· 6 minute read

Bill Flook  Editor, Accounting and Compliance Alert

· 6 minute read

The Supreme Court’s looming decision in SEC v. Jarkesy has reignited discussion over “right to remove,” a decades-old concept in which the targets of SEC administrative enforcement actions could opt to move their case to federal court. Advocates say the fix could solve constitutional questions while preserving the commission’s more efficient in-house enforcement track.

In Jarkesyargued in November 2023, the court is slated to weigh in on the SEC’s use of administrative law judges (ALJs) to hear cases that would otherwise be brought in US district court. Two years ago, the Fifth Circuit deemed the tribunals unconstitutional and vacated a commission judgment against hedge fund manager George Jarkesy and investment adviser Patriot28 LLC.

Critics – who include auditors suing the SEC to halt administrative actions against them – believe the proceedings are procedurally tilted in favor of the SEC, which boasts a lopsided win-rate. Respondents have no right to a jury; face certain limits related to discovery; and are subject to different rules of evidence compared to a federal courtroom, without the latter’s restrictions on hearsay evidence.

Nevertheless, some respondents may still prefer the administrative route.

“I think a lot of sophisticated businesses, big businesses would rather be before the agency,” University of Michigan Law Professor Chris Walker told Thomson Reuters, noting the speed and confidentiality advantages, as well as those businesses’ possible reluctance to undertake a jury trial.

Walker and David Zaring, a professor at the Wharton School, coauthored The Right to Remove in Agency Adjudication, published recently in the Ohio State Law Journal. In the essay, they made the case for either the SEC, Congress, or even the Supreme Court itself to establish an opt-out system that “solves the tension between an Article III ‘gold standard’ sort of adjudication and the reasonable desire, in many cases, to resolve agency enforcement matters cheaply, quickly, and efficiently.” Article III is the provision of the US Constitution establishing and empowering the federal judiciary.

In the essay, the authors assume the Supreme Court “will strike down SEC adjudication on at least one constitutional ground.” A right-to-remove regime, they argue, could be implemented by the commission via a procedural rule, not requiring a notice-and-comment rulemaking, even prior to a ruling in Jarkesy.

The basic right-to-remove premise is not new. Walker and Zaring note such proposals advocated by an American Bar Association (ABA) task force in the early 1990s and the US Chamber of Commerce in 2015, as well as the 2022 inclusion of the Administrative Enforcement Fairness Act as part of the Senate GOP’s JOBS Act 4.0 package that would prescribe such a system, with some exceptions.

Jarkesy’s disruptive potential for agency adjudication has recently prompted a fresh look at right to remove. The House Financial Services Committee’s Capital Markets subcommittee has placed a bill on the agenda for its May 7 hearing, H.R. 6695, the Due Process Restoration Act of 2023, under which any person facing an SEC proceeding under a securities law with the potential for a cease-and-desist order and penalties could require the commission to terminate that proceeding and instead launch it in district court. That person would have 20 days after receiving notice of the proceeding to take that action.

In her majority opinion two years ago, Fifth Circuit Judge Jennifer Walker Elrod concluded that Jarkesy and Patriot28 had a right to a jury trial under the Seventh Amendment for actions where the SEC seeks monetary penalties; that Congress failed to articulate an “intelligible principle” when it delegated the power to the commission to choose whether it brings cases before its own ALJs or in district court; and removal restrictions on ALJs violate Article II of the Constitution, which dictates the president must “take care that the laws be faithfully executed.” During argument last year at the Supreme Court, conservative justices zeroed in on the first holding, in particular, and expressed skepticism at the government’s stance on why the Seventh Amendment doesn’t apply to agency adjudication.

Amid the constitutional uncertainty, the SEC already tends to bring its major litigated enforcement cases in district court and often relies on its in-house proceedings for settled matters. But litigated proceedings have still come through the pipeline, including separate actions against two Marcum LLP partners for alleged audit failures, both of whom are suing in the Southern District of New York (SDNY) to halt the proceedings using arguments similar to the Fifth Circuit holdings in Jarkesy. Those administrative actions, as well as the parallel district court matters, have been stayed until after a Jarkesy ruling.

Under the right-to-remove regime envisioned by Walker and Zaring, a respondent notified by the SEC of possible civil penalties would be able to, within a set time limit, file with the commission a notice to remove to federal court. The SEC would then either stay or dismiss the proceedings and file a district court complaint. While ultimately up to the commission or Congress, they suggest a time limit to seek that venue change that runs “between when the SEC issues notice of potential civil penalties and the date of the hearing on those penalties.” Otherwise, the two sides move forward in a consent-based adjudication.

A Democrat-led Senate has so far stood as a significant obstacle to passing right-to-remove legislation, having shown no appetite for reviving the JOBS Act 4.0 package or the standalone version of the Administrative Enforcement Fairness Act. In a March 2023 written statement for an SEC Investor Advisory Committee (IAC) panel, Faith Anderson, chief of Registration and Regulatory Affairs in the Securities Division of the Washington Department of Financial Institutions, attached a North American Securities Administrators Association (NASAA) report warning the bill would “invariably slow the SEC enforcement process, add to the caseload of an already overburdened federal judiciary, and drive up taxpayer costs,” as well as potentially preclude the commission from obtaining relief such as certain industry bars.

But if the Supreme Court forces the SEC to shift the proceedings to federal court, Walker predicts “our proposal is going to get a lot of legs” in Congress.

“But quite frankly, Congress doesn’t have to do it. The SEC should do it tomorrow,” Walker said. “The day that decision comes down, the SEC should issue a rule saying ‘we now recognize the right to remove and here’s how it works.’ If you don’t ask to remove you are expressly consenting to the ALJ deciding your case.”

This story was updated on May 3, 2024 to clarify that opposition to the Administrative Enforcement Fairness Act was part of a NASAA report.


This article originally appeared in the May 3, 2024, edition of Accounting & Compliance Alert, available on Checkpoint.

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