Much virtual ink has been spilled in the weeks and months since the Supreme Court issued its opinion in Securities and Exchange Commission v. Jarkesy—much attesting to that the decision was the death knell for in-house enforcement by federal agencies broadly. But on closer inspection, Jarkesy presents a narrow holding, standing for the proposition that the SEC must bring only one specific type of enforcement action in federal court: an action claiming securities fraud while seeking civil penalties. While the SEC may have lost a single tool in its arsenal of enforcement mechanisms, it maintains a full suite of enforcement options to investigate and enforce violations of its rules.
Meanwhile, lurking in the waters of the federal court system are Jarkesy-like challenges to the authority of other entities that play a role in regulating or policing securities industry participants. This has led us to ask: what does Jarkesy mean for in-house enforcement more broadly?
Jarkesy-like challenges against SROs
Since its congressional inception, the SEC has effectively outsourced enforcement of slivers of its mandate to self-regulatory organizations or “SROs.” SROs, like FINRA, the MSRB, and the Chicago Board of Options Exchange, among other national security exchanges, take on much of the regulatory load regarding various players in the financial industry. This load often extends to exercising enforcement power over members of the organizations.
SROs share space and functions with the SEC, but SROs are private entities which at least in theory wield no governmental power. They are mere private corporations responsible for regulating securities industry participants.
There are escalating complaints that, despite their ostensibly private status, SROs exercise government authority. The distinction is particularly hard to see when it comes to their ability to investigate, charge, and adjudicate violations. For this blurring of the line between government and private enterprise, SROs have been subject to criticism.
Alpine Securities Corporation achieved a stay of FINRA’s expedited enforcement proceedings against it while pursuing constitutional challenges to FINRA’s system of in-house adjudication against FINRA members. In 2023, the D.C. Circuit Court of Appeals concluded that Alpine Securities was likely to succeed on the merits. It therefore overturned a lower court ruling that Alpine Securities was not entitled to an injunction.
Building on the momentum of Jarkesy and Alpine Securities, two recent suits are targeting the Public Company Accounting Oversight Board’s (“PCAOB”) in-house enforcement practices.
Jarkesy-like challenges against the PCAOB
These challenges object to the PCAOB’s use of its in-house adjudication system to enforce its rules and punish violators on constitutional grounds. The PCAOB is technically not an SRO, but a nonprofit created under the 2002 Sarbanes-Oxley Act tasked with overseeing public company auditors in the wake of the fall of Enron; its budget is controlled by the SEC. The PCAOB also has an enforcement function; its staff investigates violations of its rules and regulations. Typically, the targets of such investigations will choose to settle with the PCAOB, yet other times the allegations are effectively litigated—sent to adjudication before adjudicative staff within the PCAOB.
In March 2024, in John Doe v. PCAOB, an anonymous individual alleged that the PCAOB’s in-house adjudication system robs enforcement targets of several core constitutional protections. And in John Doe Corporation v. PCAOB, also brought in March of 2024, an unnamed corporation alleged similar constitutional concerns. More specifically, John Doe Corporation alleges that: the PCAOB’s Chief Hearing Officer acts as an “inferior constitutional officer” despite not being appointed as one; its Chief Hearing Officer is unconstitutionally protected from presidential removal; its in-house hearings are improperly conducted without a jury; and its in-house hearings do not comply with Sarbanes-Oxley’s “fair procedures” standard or the Fifth Amendment’s due process standard.
What we are thinking about.
The DC Circuit is sympathetic to the arguments in Alpine Securities. Based on Alpine Securities’ success in that case, we think it is reasonable to predict that John Doe Corporation will likely encounter some degree of success as well.
While federal courts have been reigning in these in-house adjudications, the rulings on these issues have consistently been relatively narrow. As seen in Jarkesy, the Supreme Court is willing to address constitutional questions about how financial regulators exercise their authority, but they don’t seem interested in painting with broad strokes.
It is clear that when the SEC pursues fraud claims, such claims have a home in federal courts under Jarkesy. What is not immediately clear, however, is whether enforcement actions like those pursued by the PCAOB or SROs are similarly well situated in federal court. Therefore, if the present challenges prevail in challenging in-house enforcement, there is a real question of what form enforcement proceedings against security industry participants will take.
Finally, if you are being pursued by any securities industry regulator, or even if you are just a witness to an enforcement inquiry, you will need competent counsel. When defending an investigation that is subject to in-house proceedings, whether at the hands of FINRA, the PCAOB, or the SEC, you’re not defending it on an equal footing. Enlisting experienced and competent counsel to guide you through this process is the most important step you can take when you receive notice that you are subject to such an investigation, not when you figure out that you must fight a regulator on their own turf.
