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Fifth Circuit Concludes That An SEC FCPA Enforcement Approach Is Unconstitutional

SEC administrative settlements in the FCPA context were rare prior to 2010 largely because the SEC could not impose monetary penalties in such proceedings absent certain exceptions.

However, in the Dodd-Frank Wall Street Reform Act of 2010 Congress granted the SEC authority to impose civil monetary penalties in administrative proceedings in which the SEC staff seeks a cease-and-desist order. Specifically, Section 929P(a) of Dodd-Frank eliminated prior limitations and expanded the SEC’s ability to obtain monetary penalties in administrative proceedings from any person who violates the federal securities laws.

Since 2010, the vast majority of issuer FCPA enforcement actions have been administrative proceedings and in many of these actions the SEC has imposed a monetary penalty. For instance, the SEC’s enforcement action against Goldman Sachs involved an administrative order in which the SEC imposed a $400 million penalty (see here [1]). The SEC’s enforcement action against MTS involved an administrative order in which the SEC imposed a $100 million penalty (see here [2]). The SEC’s enforcement action against Credit Suisse involved an administrative order in which the SEC imposed a $65 million penalty (see here [3]).

Recently, the Fifth Circuit held in Jarkesy v. SEC [4] that the SEC’s practice of imposing civil monetary penalties in administrative proceedings was unconstitutional because Congress delegated its legislative power to the SEC without providing an intelligible principle by which the SEC could exercise the delegated power. Although Jarkesy was not a Foreign Corrupt Practices Act enforcement action, the decision (for the reasons mentioned above) is most certainly FCPA relevant.

The decision, authored by Judge Jennifer Walker Elrod, begins as follows and provides the following relevant background.

“Congress has given the Securities and Exchange Commission substantial power to enforce the nation’s securities laws. It often acts as both prosecutor and judge, and its decisions have broad consequences for personal liberty and property. But the Constitution constrains the SEC’s powers by protecting individual rights and the prerogatives of the other branches of government. This case is about the nature and extent of those constraints in securities fraud cases in which the SEC seeks penalties.

The SEC brought an enforcement action within the agency against Petitioners for securities fraud. An SEC administrative law judge adjudged Petitioners liable and ordered various remedies, and the SEC affirmed on appeal over several constitutional arguments that Petitioners raised. Petitioners raise those same arguments before this court. We hold that: (1) the SEC’s in-house adjudication of Petitioners’ case violated their Seventh Amendment right to a jury trial; (2) Congress unconstitutionally delegated legislative power to the SEC by failing to provide an intelligible principle by which the SEC would exercise the delegated power, in violation of Article I’s vesting of “all” legislative power in Congress; and (3) statutory removal restrictions on SEC ALJs violate the Take Care Clause of Article II. Because the agency proceedings below were unconstitutional, we grant the petition for review, vacate the decision of the SEC, and remand for further proceedings consistent with this opinion.

Petitioner Jarkesy established two hedge funds and selected Petitioner Patriot as the investment adviser. The funds brought in over 100 investors and held about $24 million in assets. In 2011, the SEC launched an investigation into Petitioners’ investing activities, and a couple of years later the SEC chose to bring an action within the agency, alleging that Petitioners (along with some former co-parties) committed fraud under the Securities Act, the Securities Exchange Act, and the Advisers Act. Specifically, the agency charged that Petitioners: (1) misrepresented who served as the prime broker and as the auditor; (2) misrepresented the funds’ investment parameters and safeguards; and (3) overvalued the funds’ assets to increase the fees that they could charge investors.

Petitioners sued in the U.S. District Court for the District of Columbia to enjoin the agency proceedings, arguing that the proceedings infringed on various constitutional rights. But the district court, and later 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 Petitioners had to continue with the agency proceedings and petition the court of appeals to review any adverse final order. 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).

Petitioners’ proceedings moved forward. The ALJ held an evidentiary hearing and concluded that Petitioners committed securities fraud. Petitioners then sought review by the Commission. While their petition for Commission review was pending, the Supreme Court held that SEC ALJs had not been properly appointed under the Constitution. Lucia v. SEC, 138 S. Ct. 2044, 2054–55 (2018). In accordance with that decision, the SEC assigned Petitioners’ proceeding to an ALJ who was properly appointed. But Petitioners chose to waive their right to a new hearing and continued under their original petition to the Commission.

The Commission affirmed that Petitioners committed various forms of securities fraud. It ordered Petitioners to cease and desist from committing further violations and to pay a civil penalty of $300,000, and it ordered Patriot to disgorge nearly $685,000 in ill-gotten gains. The Commission also barred Jarkesy from various securities industry activities: associating with brokers, dealers, and advisers; offering penny stocks; and serving as an officer or director of an advisory board or as an investment adviser.

Critical to this case, the Commission rejected several constitutional arguments Petitioners raised. It determined that: (1) the ALJ was not biased against Petitioners; (2) the Commission did not inappropriately prejudge the case; (3) the Commission did not use unconstitutionally delegated legislative power—or violate Petitioners’ equal protection rights—when it decided to pursue the case within the agency instead of in an Article III court; (4) the removal restrictions on SEC ALJs did not violate Article II and separationof-powers principles; and (5) the proceedings did not violate Petitioners’ Seventh Amendment right to a jury trial. Petitioners then filed a petition for review in this court.”

[5]

After concluding that the SEC’s in-house adjudication of Petitioners’ case violated their Seventh Amendment right to a jury trial, the court next addressed the issue of whether Congress unconstitutionally delegated legislative power to the SEC by failing to provide it with an intelligible principle by which to exercise the delegated power.

This portion of the decision states in full:

“Petitioners next argue that Congress unconstitutionally delegated legislative power to the SEC when it gave the SEC the unfettered authority to choose whether to bring enforcement actions in Article III courts or within the agency. Because Congress gave the SEC a significant legislative power by failing to provide it with an intelligible principle to guide its use of the delegated power, we agree with Petitioners.

“We the People” are the fountainhead of all government power. Through the Constitution, the People delegated some of that power to the federal government so that it would protect rights and promote the common good. See The Federalist No. 10 (James Madison) (explaining that one of the defining features of a republic is “the delegation of the government . . . to a small number of citizens elected by the rest”). But, in keeping with the Founding principles that (1) men are not angels, and (2) “[a]mbition must be made to counteract ambition,” see The Federalist No. 51 (James Madison), the People did not vest all governmental power in one person or entity. It separated the power among the legislative, executive, and judicial branches. See The Federalist No. 47 (James Madison) (“The accumulation of all powers, legislative, executive, and judiciary, in the same hands, whether of one, a few, or many, and whether hereditary, self-appointed, or elective, may justly be pronounced the very definition of tyranny.”). The legislative power is the greatest of these powers, and, of course, it was given to Congress. U.S. Const. art. I, § 1.

The Constitution, in turn, provides strict rules to ensure that Congress exercises the legislative power in a way that comports with the People’s will. Every member of Congress is accountable to his or her constituents through regular popular elections. U.S. Const. art I, §§ 2, 3; id. amend. XVII, cl. 1. And a duly elected Congress may exercise the legislative power only through the assent of two separately constituted chambers (bicameralism) and the approval of the President (presentment). U.S. Const. art. I, § 7. This process, cumbersome though it may often seem to eager onlookers, ensures that the People can be heard and that their representatives have deliberated before the strong hand of the federal government raises to change the rights and responsibilities attendant to our public life. Cf. Rachel E. Barkow, Separation of Powers and the Criminal Law, 58 Stan. L. Rev. 989, 1017 (2006). (“[T]he Framers weighed the need for federal government efficiency against the potential for abuse and came out heavily in favor of limiting federal government power over crime.”).

But that accountability evaporates if a person or entity other than Congress exercises legislative power. See Gundy v. United States, 139 S. Ct. 2116, 2134 (2019) (Gorsuch, J., dissenting) (“[B]y directing that legislating be done only by elected representatives in a public process, the Constitution sought to ensure that the lines of accountability would be clear: The sovereign people would know, without ambiguity, whom to hold accountable for the laws they would have to follow.”). Thus, sequestering that power within the halls of Congress was essential to the Framers. As John Locke—a particularly influential thinker at the Founding—explained, not even the legislative branch itself may give the power away:

The legislative cannot transfer the power of making laws to any other hands; for it being but a delegated power from the people, they who have it cannot pass it over to others. The people alone can appoint the form of the commonwealth, which is by constituting the legislative, and appointing in whose hands that shall be. And when the people have said we will submit to rules, and be governed by laws made by such men, and in such forms, nobody else can say other men shall make laws for them; nor can the people be bound by any laws but such as are enacted by those whom they have chosen and authorised to make laws for them.

Id. at 2133–34 (quoting John Locke, The Second Treatise of Civil Government and a Letter Concerning Toleration § 141, p. 71 (1947)).

Article I of the Constitution thus provides that “[a]ll legislative Powers herein granted shall be vested in a Congress of the United States.” U.S. Const. art. I, § 1 (emphasis added). In keeping with Founding conceptions of separation of powers, the Supreme Court has made clear that Congress cannot “delegate to the Courts, or to any other tribunals, powers which are strictly and exclusively legislative.” Wayman v. Southard, 23 U.S. (10 Wheat.) 1, 42 (1825); see also A.L.A. Schechter Poultry Corp. v. United States, 295 U.S. 495, 529 (1935) (“Congress is not permitted to abdicate or to transfer to others the essential legislative functions with which it is thus vested.”). According to the Supreme Court’s more recent formulations of that longstanding rule, Congress may grant regulatory power to another entity only if it provides an “intelligible principle” by which the recipient of the power can exercise it. Mistretta v. United States, 488 U.S. 361, 372 (1989) (quoting J.W. Hampton, Jr., & Co. v. United States, 276 U.S. 394, 409 (1928)). The two questions we must address, then, are (1) whether Congress has delegated power to the agency that would be legislative power but-for an intelligible principle to guide its use and, if it has, (2) whether it has provided an intelligible principle such that the agency exercises only executive power.

We first conclude that Congress has delegated to the SEC what would be legislative power absent a guiding intelligible principle. Government actions are “legislative” if they have “the purpose and effect of altering the legal rights, duties and relations of persons . . . outside the legislative branch.” INS v. Chadha, 462 U.S. 919, 952 (1983). The Supreme Court has noted that the power to assign disputes to agency adjudication is “peculiarly within the authority of the legislative department.” Oceanic Steam Navigation Co. v. Stranahan, 214 U.S. 320, 339 (1909). And, as discussed above, in some special circumstances Congress has the power to assign to agency adjudication matters traditionally at home in Article III courts. Atlas Roofing, 430 U.S. at 455. Through Dodd–Frank § 929P(a), Congress gave the SEC the power to bring securities fraud actions for monetary penalties within the agency instead of in an Article III court whenever the SEC in its unfettered discretion decides to do so. See 15 U.S.C. § 78u-2(a). Thus, it gave the SEC the ability to determine which subjects of its enforcement actions are entitled to Article III proceedings with a jury trial, and which are not. That was a delegation of legislative power. As the Court said in Crowell v. Benson, “the mode of determining” which cases are assigned to administrative tribunals “is completely within congressional control.” 285 U.S. 22, 50 (1932) (quoting Ex parte Bakelite Corp., 279 U.S. at 451).

The SEC argues that by choosing whether to bring an action in an agency tribunal instead of in an Article III court it merely exercises a form of prosecutorial discretion—an executive, not legislative, power. That position reflects a misunderstanding of the nature of the delegated power. Congress did not, for example, merely give the SEC the power to decide whether to bring enforcement actions in the first place, or to choose where to bring a case among those district courts that might have proper jurisdiction. It instead effectively gave the SEC the power to decide which defendants should receive certain legal processes (those accompanying Article III proceedings) and which should not. Such a decision—to assign certain actions to agency adjudication—is a power that Congress uniquely possesses. See id.

Next, Congress did not provide the SEC with an intelligible principle by which to exercise that power. We recognize that the Supreme Court has not in the past several decades held that Congress failed to provide a requisite intelligible principle. Cf. Whitman v. Am. Trucking Ass’ns, Inc., 531 U.S. 457, 474–75 (2001) (cataloguing the various congressional directives that the Court has found to be “intelligible principle[s]”). But neither in the last eighty years has the Supreme Court considered the issue when Congress offered no guidance whatsoever. The last time it did consider such an open-ended delegation of legislative power, it concluded that Congress had acted unconstitutionally: In Panama Refining Co. v. Ryan, 293 U.S. 388, 405–06 (1935), the Court considered a statutory provision granting the President the authority to prohibit the transportation in interstate commerce of petroleum and related products. The Court scoured the statute for directives to guide the President’s use of that authority, but it found none. Id. at 414–20. It therefore explained:

[I]n every case in which the question has been raised, the Court has recognized that there are limits of delegation which there is no constitutional authority to transcend. We think that section 9(c) goes beyond those limits. As to the transportation of oil production in excess of state permission, the Congress has declared no policy, has established no standard, has laid down no rule.

Id. at 430.

Congress’s grant of authority to the SEC here is similarly open-ended. Even the SEC agrees that Congress has given it exclusive authority and absolute discretion to decide whether to bring securities fraud enforcement actions within the agency instead of in an Article III court. Congress has said nothing at all indicating how the SEC should make that call in any given case. If the intelligible principle standard means anything, it must mean that a total absence of guidance is impermissible under the Constitution. See Gundy, 139 S. Ct. at 2123 (Kagan, J., plurality op.) (noting that “we would face a nondelegation question” if the statutory provision at issue had “grant[ed] the Attorney General plenary power to determine SORNA’s applicability to pre-Act offenders—to require them to register, or not, as she sees fit, and to change her policy for any reason and at any time” (emphasis added)). We therefore vacate the SEC’s judgment on this ground as well.”

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