Publications

(Article from Securities Law Alert, Year in Review 2023) 

For more information, please visit the Securities Law Alert Resource Center

Supreme Court: Constitutional Challenges to Agency Proceedings Can Be Brought Directly in Federal District Court

On April 14, 2023, the Supreme Court issued a unanimous opinion settling a circuit split concerning whether a party to an administrative enforcement action can sue directly in federal district court to challenge the agency’s constitutional authority to proceed, or whether the party must first complete the administrative process before seeking review in a federal court of appeals. Axon Enter. v. FTC, 598 U.S. 175 (2023) (Kagan, J.). Affirming Cochran v. SEC, 20 F.4th 194 (5th Cir. 2021) and reversing Axon Enterprise v. FTC, 986 F.3d 1173 (9th Cir. 2021), the Court held that federal district courts have jurisdiction to hear lawsuits challenging the constitutionality of agency proceedings and to resolve such constitutional challenges. In both cases, the parties challenged the agency’s administrative enforcement action on the theory that the administrative law judges’ dual-layer tenure protection unconstitutionally insulates them from presidential removal.

Justice Kagan, writing for the Court, concluded that “each of the three Thunder Basin factors signals that a district court has jurisdiction to adjudicate [these] sweeping constitutional claims.” In Thunder Basin Coal v. Reich, 510 U.S. 200 (1994), the Court set forth three factors designed to determine whether a claim was “of the type” that Congress intended to be reviewed within a statutory review scheme. A court should consider whether: (i) precluding district court jurisdiction “could foreclose all meaningful judicial review” of the claim; (ii) the claim is “wholly collateral to the statute’s review provisions”; and (iii) the claim is “outside the agency’s expertise.” If the answer to all three questions is yes, it is presumed that Congress did not intend to limit jurisdiction.

Analyzing the first factor, Justice Kagan contrasted situations where an appellate court could undo an agency action (such as by revoking a fine) with situations where a party faces allegedly unconstitutional agency authority that “is impossible to remedy once the proceeding is over, which is when appellate review kicks in.” The Court concluded that “[j]udicial review of [these] structural constitutional claims would come too late to be meaningful.” As to the second factor, the Court concluded that the constitutional claims were “collateral” to any orders or rules from which review might be sought because the constitutional claims have nothing to do with either the enforcement-related matters the Commissions regularly adjudicate or those they would adjudicate in assessing the charges against the parties. Regarding the third factor, the Court determined that the parties’ claims were outside the agencies’ expertise noting that these tenure protection claims “raise standard questions of administrative and constitutional law, detached from considerations of agency policy.” Thus, the claims were not “of the type” that the statutory review schemes reach and a district court could review them.

Supreme Court: Section 11 Requires Purchasers of Shares in a Direct Listing to Plead and Prove That They Purchased Traceable Shares

On June 1, 2023, the Supreme Court issued a unanimous opinion settling a circuit split concerning whether Section 11 of the Securities Act requires a plaintiff who purchased shares through a direct listing to trace his shares to a false or misleading registration statement. Slack Techs. v. Pirani, 598 U.S. 759 (2023) (Gorsuch, J.). The Court held that to state a claim under Section 11 “requires a plaintiff to plead and prove that he purchased shares traceable to the allegedly defective registration statement[.]” The Court remanded the case to the Ninth Circuit to consider whether plaintiff’s pleadings could satisfy Section 11 in light of its decision.[1]

Plaintiff purchased shares on the day the company went public through a direct listing, by filing a registration statement relating to a certain number, but not all, of the shares sold into the market on that date. Following a stock price drop, plaintiff filed a putative class action alleging that the company had violated Sections 11 and 12 of the Securities Act by filing a materially misleading registration statement. The company moved to dismiss arguing that Sections 11 and 12 authorized suit only for those who held shares issued pursuant to a false or misleading registration statement and plaintiff did not allege that he purchased shares traceable to the allegedly misleading registration statement. The district court denied the motion to dismiss but certified its ruling for interlocutory appeal and a divided panel of the Ninth Circuit affirmed. The Supreme Court subsequently granted certiorari.

Writing for the Court, Justice Gorsuch explained that Section 11 authorizes an individual to sue for a material misstatement or omission in a registration statement when he has acquired “such security.” Viewing this as a matter of statutory interpretation, the Court focused its analysis on the meaning of the term “such security” in Section 11. Noting that there is no clear referent in Section 11 to indicate what “such” means in the phrase “such security” the Court looked to other sections of the Securities Act for context. In particular, the Court observed that “the statute repeatedly uses the word ‘such’ to narrow the law’s focus.” The Court reasoned that as to “‘such security,’ the statute is limited to a security registered under the particular registration statement alleged to contain a falsehood or misleading omission.” The Court also noted that Section 11(e) caps damages against an underwriter at the total price at which the securities were offered to the public, thereby tying the maximum available recovery to the value of the registered shares alone. The Court observed that this provision would make “little sense” under plaintiff’s interpretation because if Section 11 liability “extended beyond registered shares then presumably available damages would too.” The Court concluded that “[c]ollectively, these contextual clues persuade us that [the company’s] reading of the law is the better one.”

Supreme Court: The Court Hears Oral Argument on Whether the SEC’s In-House Courts Are Unconstitutional 

On November 29, 2023, the Supreme Court heard oral argument concerning whether statutory provisions that empower the SEC to initiate and adjudicate administrative enforcement proceedings seeking civil penalties in its own in-house courts violate the Seventh Amendment right to a jury trial. SEC v. Jarkesy, No. 22-859. In the case, the SEC brought an administrative proceeding against a hedge fund owner and his advisory firm for allegedly making misrepresentations to investors. After an SEC administrative law judge determined that respondents had violated the Securities Act, Exchange Act, and Advisers Act, a divided panel of the Fifth Circuit vacated and remanded. In its petition for a writ of certiorari, the SEC asserted that the Fifth Circuit’s holdings were “incorrect” and “highly consequential.”  

During oral argument, the attorney appearing on behalf of the SEC emphasized that in-house adjudications are a “longstanding and entrenched practice” and asserted that the Supreme Court’s decision in Atlas Roofing v. Occupat’l Safety & Health Rev. Comm'n, 430 U.S. 442 (1977) considered many of the same arguments and “reaffirmed that Congress does not violate the Seventh Amendment when it authorizes an agency to impose civil penalties in administrative proceedings to enforce a federal statute.” In Atlas Roofing, the Court stated “in cases in which ‘public rights’ are being litigated - e.g., cases in which the Government sues in its sovereign capacity to enforce public rights created by statutes within the power of Congress to enact - the Seventh Amendment does not prohibit Congress from assigning the factfinding function and initial adjudication to an administrative forum with which the jury would be incompatible.”

Justice Thomas asked if the rights being litigated were categorized as private rights rather than public rights if that would determine whether the case should be adjudicated before an Article III court. Justice Sotomayor noted that Justice Thomas’s writings have broadly defined a private right as any right that involves property, life, or liberty. The SEC attorney acknowledged that the definition of public rights is contested but pointed out that when an agency is enforcing a federal statute in exercise of its sovereign powers, that it is a matter involving public rights under Atlas Roofing, even if private property was involved. The SEC attorney asserted that this case involves public rights because the SEC is seeking to vindicate is the public’s right to fair and honest markets.

Justice Gorsuch commented that the SEC has changed over the years and stated that “Congress has a lot more problems on its plate today than it -- than it did a hundred years ago or even 50 years ago. But that doesn't mean that the constraints of the Constitution somehow evaporate[.]” Similarly, Chief Justice Roberts noted that “the extent of impact of government agencies on daily life today is enormously more significant than it was 50 years ago.” Chief Justice Roberts further pointed out that when an administrative agency can decide whether to proceed against a defendant before its own in-house court or in federal court, that “it does seem to me to be curious that and unlike most constitutional rights that you have that right until the government decides that they don't want you to have it. That doesn't seem to me the way the Constitution normally works.”

Addressing respondents’ counsel, Justice Kagan pointed out that Atlas Roofing stated that “the Seventh Amendment is no bar to the creation of new rights or to their enforcement outside the regular courts of law.” Comparing the statutory scheme at issue with the OSH Act at issue in Atlas Roofing, Justice Kagan stated that both served a prophylactic purpose allowing the government to take action before harm occurs. Respondents’ counsel countered that a new statutory public right had not been created here because the elements of a 10b-5 action are “substantially the same and certainly serve the same essential function as a traditional common law fraud claim.” Respondents’ counsel continued that if a common law claim or something “approximating” such a claim is thrown into a statutory scheme that it still requires the right to trial by jury.

The Court’s decision in this case is highly anticipated as its outcome may affect how the SEC litigates certain cases.