14 Wake Forest L. Rev. Online 20

C. Isaac Hopkin


This Note begins with the story of two investment managers. Manager One was an investment manager in Texas who oversaw funds exempt from registration with the Securities and Exchange Commission (“SEC” or the “Commission”).[1] Manager One set up two private investment partnership funds that held about $24 million in assets and had a little over a hundred investors.[2] These funds were described as “hedge-fund like” investments for sophisticated investors.[3] Following the 2008 crash, the funds failed.[4] In 2013, the SEC charged Manager One with fraud.[5] The SEC alleged that Manager One had (1) misrepresented who served as prime broker and as auditor; (2) misrepresented the funds’ investment parameters and safeguards; and (3) overvalued the funds’ assets to generate greater fees.[6] The SEC tried the case in an administrative forum.[7]

In 2014, the SEC administrative law judge (“ALJ”) found Manager One liable.[8] Later, the Commission granted an expedited five-year review before issuing its final order in September 2020.[9] The Commission imposed a monetary penalty of $300,000 on Manager One, ordered his fund to disgorge $685,000 in ill-gotten gains, and barred Manager One from securities activities.[10] Manager One repeatedly requested a jury trial in an Article III court and was repeatedly denied because the SEC, in its sole discretion, chose an administrative proceeding.[11]

Manager Two was also an investment manager in Texas who managed funds exempt from registration.[12] Manager Two set up multiple funds to pursue a hedge-fund-like strategy for sophisticated investors.[13] Following the 2001 crash, the funds collapsed due to a combination of mismanagement and market factors.[14] The SEC charged Manager Two with fraud for overvaluing his funds.[15] The SEC brought the action in federal district court, where the jury found Manager Two liable and imposed a civil penalty of $50,000, a permanent injunction, and a disgorgement of $900,000 of ill-gotten gains.[16]

Why were Manager One and Manager Two treated so differently? The difference is timing. When Manager One was charged, the SEC had to bring all civil enforcement actions against unregistered funds in an Article III court, where the jury right automatically attaches.[17] Unfortunately for Mr. Jarkesy (Manager One), he was charged in 2013 when the SEC had the discretion to choose between an Article III forum or an administrative forum to adjudicate its civil enforcement actions against unregistered funds.[18]

This dramatic shift in the SEC’s power was no accident. In response to the 2008 financial crash, Congress passed the Dodd-Frank Act, giving the SEC sole authority to pursue civil or equitable remedies in either an administrative forum or an Article III court.[19] Nothing limits the SEC’s discretion in this choice.[20] Moreover, the legislative history makes it clear that the SEC’s unbounded discretion was what Congress intended:

This section streamlines the SEC’s existing enforcement authorities by permitting the SEC to seek civil money penalties in cease-and-desist proceedings under Federal securities laws. The section provides appropriate due process protections by making the SEC’s authority in administrative penalty proceedings coextensive with its authority to seek penalties in Federal court. As is the case when a Federal district court imposes a civil penalty in a[n] SEC action, administrative civil money penalties would be subject to review by a Federal appeals court.[21]

As written, this provision puts the Seventh Amendment in the hands of the SEC. The Seventh Amendment protects civil jury trials “in suits at common law.”[22] The Supreme Court has held that when the government is litigating an action in an Article III court that is “analogous to suits at common law,” the Seventh Amendment attaches.[23] So how can the SEC can pursue the same remedies in a district court that requires a jury or in its own administrative courts that do not? The answer lies in the messy public rights exception, which allows the government to litigate in a non-Article III forum and where the Seventh Amendment “poses no independent bar” to non-jury factfinding.[24]

Despite the public rights exception, the SEC’s unfettered discretion is troubling.[25] As the statute stands now, the SEC could theoretically choose to grant one defendant’s Seventh Amendment rights while denying a similar defendant her Seventh Amendment rights.[26] This is the crux of the matter in Jarkesy.[27] When Jarkesy challenged the SEC, saying its discretion was unlawful under the Seventh Amendment, the Fifth Circuit agreed.[28] It found the SEC’s discretion unlawful suffered from two “constitutional defects.”[29] First, the court held that the SEC was not litigating a public right, and thus the Seventh Amendment required a jury trial.[30] Second, the Fifth Circuit held that Congress could not delegate forum choice to the SEC.[31] Both holdings reached the right result, but for the wrong reasons.

This Note analyzes the Fifth Circuit opinion in Jarkesy v. SEC by examining the interplay between administrative adjudication and the Seventh Amendment. Part I first explores the history of the Seventh Amendment and its importance at America’s founding. Next, Part I surveys the evolution of the public rights doctrine, specifically explaining how the public rights doctrine allows Article-III-like fact-finding outside Article III courts. This tension between the Seventh Amendment and public rights serves as the backdrop to the Fifth Circuit’s opinion.

Part II of this Note contends that the Fifth Circuit reached the correct outcome for the wrong reasons. The Fifth Circuit’s first holding was that the SEC’s cause of action was not a public right.[32] But this holding is likely wrong because the cause of action fits well into the Atlas Roofing[33] framework. Second, the Fifth Circuit held that the non-delegation doctrine prevented the SEC from choosing the forum.[34] This second holding defies relevant precedent surrounding the non-delegation doctrine.[35] Even so, the result of Jarkesy was correct. As this Note will explain, the opinion should have focused on how the SEC’s unique power over the forum fails to meet the exclusivity requirement found in Granfinanciera,[36] and thus was not a proper assignment. As a result, Mr. Jarkesy—along with others prosecuted under this statute—should have the right to elect a jury. Put differently, the defendants should control their Seventh Amendment rights, not the SEC. This framework provides an easy out for the Supreme Court, which recently granted certiorari in this case. Indeed, the Granfinanciera exclusive assignment requirement would allow the Court to preserve the administrative adjudication status quo while protecting Seventh Amendment rights. In that world, the Supreme Court could have its cake and eat it too.

I. Background, History, and a Battle of Fundamentals

The Seventh Amendment preserves an individual’s jury right in both common law and statutory civil actions.[37] Even so, when the government brings civil actions, the Seventh Amendment does not attach if the government is litigating a public right in a non-Article III forum.[38] This exception is called the public rights doctrine.[39] When a public right is involved, “the Seventh Amendment poses no independent bar”[40] to a non-Article III adjudication so long as “Congress properly assigns a matter to adjudication in a non-Article III tribunal.”[41] Whether a matter is properly assigned is a two-part inquiry: (1) whether the suit is analogous to one that existed at common law; and if so, (2) whether the government civil action is exempted by the public rights doctrine.[42] If either answer is no, defendants like Jarkesy do not have a Seventh Amendment right in the government’s civil action.

Cases like Jarkesy’s highlight two fundamental but conflicting goals in American law. On one side, the American commitment to a jury trial is as old as the country itself.[43] On the other, our Government prioritizes efficiency by using agencies and other bureaus to provide quick resolutions.[44] Thus, to understand Jarkesy, one must understand the history of the Seventh Amendment and the public rights exception.

A. Juries: The History, the Analysis, and the First Inquiry of Jarkesy
1. The Ancient Origin of Juries

“In Suits at common law . . . the right of trial by jury shall be preserved, and no fact tried by a jury, shall be otherwise re-examined in any court of the United States, than according to the rules of the common law.”[45] This is no small thing. Indeed, the Seventh Amendment was “paid for by thousands of years of slow progress and sacrifice of brave people who stood up for liberty.”[46] The concept of a jury dates back as far as ancient Greece,[47] but it did not evolve into the form contemplated by the Seventh Amendment until eighteenth-century England.[48]

In England, before trial by jury, two primary methods existed in judicial factfinding.[49] One method was trial by combat, where God would bring the truth to light.[50] God would do so during the trial by “giving force to the victor’s arms” while the two litigants fought on foot with a baton.[51] This method soon fell out of favor because trial by combat often lead to the death of noblemen whose life could be “otherwise employed.”[52]

The other, similarly dubious, method came in the form of sworn testimony.[53] With sworn testimony, the litigant presented a witness or witnesses, called compurgators, who swore to the litigant’s innocence or guilt.[54] This method was also problematic because many compurgators were chosen for their willingness to lie in exchange for payment.[55] The structure for factfinding in English law was a mixed bag ripe for reform.

The transformation of the English judicial process began with King Henry II.[56] He established professional judges and authorized “recognitors” or juries.[57] These juries resembled a modern grand jury.[58] The jury’s job was to “accuse” rather than to “try”
the cases.[59] Judge Pope, in his article, explained the process:

“Four persons from a vill, under oath, would report matters of public fame to twelve knights, also under oath. The knights were chosen from a larger area known as the hundred or the wapentake. If the twelve agreed, a presentment was made to the sheriff. After accusation came the trial.”[60]

Those indicted by the accusing jury could still be tried in front of a judge with the accusing jury serving as witnesses rather than triers of fact.[61]

Yet the problem of malicious prosecution remained. As a result, those accused of crimes could go before another jury to show that the charge was “procured out of hate and spite.”[62] If the jury found that the prosecution was false or malicious, the case was over.[63] Soon, the role of the second jury transformed from judging the jury to deciding the case itself.[64]

This process began as early as the thirteenth century.[65] The defendant could bring the same case to a second group “composed of men of a higher rank” called an “attainting jury.”[66] If the second jury disagreed with the first jury, the members of the first jury could be subject to imprisonment, forfeiture of lands, denial of credit, and sometimes death.[67] Out of the “attainting jury” system emerged our system of jurors who judge rather than accuse.[68] The attainting jury would consider what evidence was before the original jury and whether the prior jury accused properly on that evidence.[69] The attainting jury could only consider what was before the prior jury and could not draw any information outside the record.[70]

By the sixteenth century, however, the common law replaced this system, and judges gained the authority to grant a new trial rather than being subject to an attainting jury.[71] To do so, judges now had to hear the evidence along with the jury.[72] The jurors who brought the case had to disclose under oath anything they knew about the facts underlying the case.[73] Rather than jurors being the prosecutor and then the attainment jury determining facts, judges now could usurp the fact-finding function if they found the prosecuting jury’s evidence unsatisfactory.[74]

Perhaps poetically, the “critical moment” for the independent jury as we know it came in a trial against William Penn.[75] Penn, the twenty-six-year-old leader of the Quakers, was charged with “disturbing the King’s peace by preaching nonconformist religious views at an outdoor meeting in London.”[76] After hearing the case, four jurors “refused to convict Penn of the most serious charge.”[77] The judge sent the jury back to reach “the proper verdict,” but the jury again refused.[78] After reaching the wrong verdict again, the court sent the jurors back without “meat, drink, fire, or any other accommodation; they had not so much as a chamber-pot, though desired.”[79] Even in these dreadful conditions, the jurors again returned a verdict for Penn.[80] The court accepted the judgment, but the jurors were fined and jailed for contempt of court.[81] These jurors sued for habeas corpus.[82]

Lord Chief Justice Vaughn, in a monumental opinion, established that juries were entitled to reach their decisions independently.[83] Justice Vaughn observed:

[I]f the Judge having heard the evidence . . . shall tell the jury . . . the law is for the plaintiff, or for the defendant, and you are under the pain of fine and imprisonment to find accordingly, . . . every man sees that the jury is but a troublesome delay . . . and therefore the tryals by them may be better abolish’d than continued; which were a strange new-found conclusion, after a tryal so celebrated for many hundreds of years.[84]

This landmark opinion allowed jurors to be charged with facts, and the judge could no longer override those findings.[85]

Thus, by the eighteenth century, the English court system roughly resembled the forum we know it as today.[86] Judges presided over the trial, and jurors drawn from the community would judge the facts of the case.[87] Jurors were selected because they could determine the facts impartially and attorneys could challenge a juror for cause.[88] Witnesses were subject to open court and gave sworn testimony, and judges ruled on objections.[89] Then, jurors were allowed to privately deliberate until they reached their final verdict.[90] Thus, the common law system produced the modern jury system through the slow drag of time.

2. Juries and the Founding

The new independent jury system became “the grand bulwark of [English] liberties.”[91] Blackstone explained that trial by jury is the glory of the English law and “the most transcendent privilege which any subject can enjoy or wish for, that he cannot be affected, either in his property, his liberty, or his person, but by the unanimous consent of twelve of his neighbors and equals.”[92]

The right to a jury gained equal importance in Colonial America as “[it] was the germ of American freedom–the morning star of that liberty which subsequently revolutionized America.”[93] That is because the jury was one of the few protections against British overreach.[94] The colonists did not get to vote for Parliament, but they could make their grievances against the government known through the local jury.[95] The jury became a vehicle of resistance against British oppression, which in turn led to the British government avoiding jury trials.[96] For example, the Stamp Act cases were tried in admiralty courts in London, depriving many Americans of the local jury.[97] The British government’s manipulation of the system outraged the colonists to the point that the deprivation of their jury rights was a chief grievance in the Declaration of Independence.[98]

The jury protected the community from government overreach and served as a check on judges appointed by British officials.[99] In fact, civil juries were so important that the debate over the Bill of Rights was triggered by a casual comment by George Mason, in which he noted that “no provision was yet made for juries in civil cases.”[100] The Pennsylvania Anti-Federalists nearly prevented ratification of the Constitution because they believed the Federalists were attempting to abolish civil juries.[101] When the Federalists promised the Bill of Rights to assuage the Anti-Federalists concerns, seven of the states proposed amendments including the protection of the civil jury right.[102]

Yet, despite its apparent importance, little is known about the original purpose of the Seventh Amendment.[103] From the contextual history, a general guarantee of the civil jury was widely desired, but there was “no consensus on the precise extent of its power.”[104] For example, during the Constitutional Convention on September 15, 1787, a motion was made by General Thomas Pinckney and Elbridge Gerry to add the following to Article III: “And a trial by jury shall be preserved as usual in civil cases.”[105] Nathaniel Gorham responded to the motion, “The constitution of Juries is different in different States and trial itself is usual in different cases in different states.”[106] The motion was rejected and the convention ended without a guarantee of a civil jury trial.[107]

Even less is known about the debate surrounding the current language of the Seventh Amendment.[108] Madison originally proposed the language from the Virginia ratification convention, “In suits at common law, between man and man, the trial by jury, as one of the best securities to the rights of the people, ought to remain inviolate.”[109] The house committee then revised this language to say, “In suits at common law, the right of the trial by jury shall be preserved.”[110] The house passed the committee version without discussion.[111] The Senate then added, “where consideration exceeds twenty dollars.”[112] The record is sparse after that, but the Seventh Amendment was passed with little debate and ratified later on.[113] This Amendment—that inspired a revolution, that sparked the bill of rights, that was considered “the germ of American freedom–the morning star of that liberty”[114]—provides little light to those invoking it today.

3. Seventh Amendment Analysis

In cases like Jarkesy, Seventh Amendment history is an important prong that decides whether the trial can be held in an administrative forum or must be held in an Article III forum.[115] To determine whether a plaintiff is entitled to a jury, a court first evaluates whether the litigant has a Seventh Amendment right per Tull v. United States.[116]

To determine whether the Seventh Amendment applies, courts examine if the cause of action is “analogous to suits at common law” as existed at the time of the Seventh Amendment.[117] In Tull, the Court determined whether the Seventh Amendment applied against the government when it imposed a civil fine for violating the Clean Water Act.[118] The Supreme Court held that Tull was entitled to a jury trial because the action was analogous to the common law action of debt brought before juries in England.[119] In reaching its holding, the Court reasoned that common law extended not only to common-law actions—such as torts, contracts, or fraud—but also to claims created by congressional action.[120]

Following Tull, courts evaluate (1) the nature of the action and (2) the remedy sought.[121] If the nature of the statute and its remedy are analogous to actions and remedies that existed in eighteenth century England, then the Seventh Amendment attaches.[122] That said, in making this analysis, courts prioritize the nature of relief over the cause of action itself.[123] Thus, if the remedy is similar to one that at the time of the ratification of the Seventh Amendment would have been sought in a court of law rather than a court of equity, then the action is subject to a jury.[124]

4. Jarkesy’s Seventh Amendment Rights

Jarkesy is not William Penn, but his desire to pursue his right to an independent jury is understandable. It is even more understandable when a litigant sees the SEC’s astonishing win rate in administrative proceedings. According to the Wall Street Journal, the SEC won ninety percent of contested cases before an administrative law judge, compared to its sixty-nine percent success rate in federal court over the same time frame.[125]

This disparity is especially relevant because the SEC uses the administrative forum much more often than Article III courts.[126] A litigant such as Jarkesy faces three potential SEC actions: (1) actions against brokers, (2) actions for reporting or accounting, or (3) actions against investment advisors. The SEC brought ninety percent of actions against brokers, eighty-four percent of actions for reporting or accounting, and seventy-four percent of actions against investment advisors in an administrative forum rather than an Article III court.[127] Anyone subject to the SEC’s enforcement could understandably feel like a litigant in Eighteenth century England where “every man sees that the jury is but a troublesome delay” rather than a “new-found conclusion, after a tryal so celebrated for hundreds of years.”[128]

B. The Public Rights Doctrine: History, Confusion, and the Second Inquiry of Jarkesy

In cases such as Jarkesy’s, the public rights doctrine is the greatest difference between an Article III forum, which carries a Seventh Amendment right, or an administrative proceeding, which is exempt from many Article III procedures. A public right is a government action related to an executive or legislative power.[129] In essence, public rights allow the government to litigate civil matters because it is enforcing them on behalf of the public. Consider securities laws. In response to the Great Depression and the stock market crash that precipitated it, Congress passed laws that allowed the government to initiate civil actions against bad actors.[130] Unlike every-day common law actions where the SEC initiates an enforcement action under securities law, the SEC is not validating the rights of a particular individual or itself, rather the SEC litigates on behalf of the public.[131] In those cases, the SEC is enforcing a public right. So long as a matter is a public right, Congress may properly assign it to a non-Article III forum, exempt from the Seventh Amendment.[132]

The public rights exception emerged before the twentieth century.[133] Yet since the founding, the executive and legislative branches have grown in both size—through new agencies—and scope—by said agencies enforcing civil penalties.[134] Accordingly, the public rights doctrine has had to adapt and change along with those branches to reflect the values that existed at the founding while also recognizing the new reality of a larger and broader federal government. Here, the Note explores the emergence of the public rights doctrine, the transformation into its modern form, and what makes a right public and thus exempt from jury trials.

1. Emergence of the Public Rights Doctrine

The public rights doctrine is supported by two different constitutional rationales: separation of powers and sovereign immunity.[135] Under the separation of powers theory, a public right may be tried in a non-Article III court because those causes of action are an exercise of executive or legislative powers, not judicial power.[136] The broad constitutional grants of power to the legislative and executive branches in Articles I and II of the Constitution necessitate some form of dispute resolution when that power is exercised.[137] When such dispute resolution is required, the public rights doctrine determines whether those branches can create their own fora, or whether such dispute resolutions are subject to the same restrictions constitutionally imposed on the judiciary.[138] Put another way, the public rights doctrine clarifies which actions stemming from Article I and II must be resolved by Article III courts and which actions are legislative or executive in their function and thus exempt from mandatory Article III court procedures.[139] As a result, the cause of action has no place in an Article III branch because the judiciary cannot exercise legislative nor executive power.[140]

The sovereign immunity rational for the public rights doctrine stems from the common law tradition. At common law, an individual was barred from suing the sovereign without its permission and the sovereign rarely (if ever) brought civil suits.[141] But the Article III language implicates many government actions: “All cases . . .[and] controversies to which the United States shall be a Party” are subject to Article III.[142] Thus public rights resolve the incongruence between when Article III applies to the sovereign, Thus, the public rights doctrine resolves the contradiction. If the cause of action is not a public right the sovereign would be subject to Article III litigation; when the cause of action is a public right the sovereign is shielded from Article III courts by the common law tradition of sovereign immunity.[143] Under this rationale, if Article III waives sovereign immunity, then Seventh Amendment protections attach.[144] Otherwise, the common law allows the government to form its own forum of dispute resolution, such as proceedings in front of an administrative law judge. Regardless of the underlying theory, the public rights exception allows the government to litigate on behalf of the public in a civil setting.

The first case to recognize the public rights doctrine was Murray’s Lessee v. Hoboken Land & Improvement Co. (Murray’s Lessee).[145] There, a dispute arose over property ownership where one party took lineal title while the other was a bona fide purchaser from the United States.[146] At issue was a statute that allowed the Treasury Department to issue a lien before it made findings in federal court.[147] The lineal title claimant challenged the statute, arguing that only Article III courts had the power to issue a lien and the Treasury-Department lien on his land was therefore invalid.[148]

The Court disagreed using the sovereign immunity rationale:

[T]here are matters, involving public rights, which may be presented in such form that the judicial power is capable of acting on them, and which are susceptible of judicial determination, but which Congress may or may not bring within the cognizance of the courts of the United States, as it may deem proper.[149]

Put differently, if the government is the owner of the land, it must consent to suit in an Article III court; otherwise, Congress may allow an executive department to grant relief.[150]

Public rights extended as the administrative state grew. In Crowell v. Benson,[151] a commissioner found Benson liable for injuries sustained by one of Benson’s employees as part of the Longshoremen’s and Harbor Workers’ Compensation Act.[152] The employee brought the action in an administrative forum as authorized by the statute, instead of the typical judicial forum, where the commissioner found him liable.[153] Benson challenged the act, arguing that the statute authorizing private suit violated inter alia “provisions of article 3 with respect to the judicial power of the United States.” [154]

The Supreme Court agreed using the public rights rationale. The Court explained that Congress may establish “legislative courts” for matters that “arise between the Government and persons subject to its authority in connection with the performance of the constitutional functions of the executive or legislative departments.”[155] But when matters arise between two private persons “to enforce constitutional rights[,]” Congress’s power to assign the matter is “an untenable assumption.”[156] Put another way, the separation of powers requires that the executive and legislative branches be exempt from Article III restrictions when using their powers because “functions of the executive or legislative departments” are not judicial powers. By comparison, when the matters relate to a judicial power, here maritime jurisdiction, such a matter cannot be assigned outside of Article III courts.

2. The Expansion of Public Rights to Reflect the Modern Administrative State

The drafters of the Seventh Amendment and Article III did not contemplate a world in which the government would try common law actions.[157] At the founding, litigation between citizens and the State was rare outside of criminal matters.[158] In the civil context, government actions brought in common law courts were mostly contractual disputes.[159] Thus, the language of the Seventh Amendment and Article III do not contemplate actions like Jarkesy where the government brings an action analogous to a common law fraud claim.[160]

The Court addressed the increasing divergence between historic practices and the modern government in Atlas Roofing Co. v. Occupational Safety & Health Review Commission.[161] In Atlas Roofing, the company challenged the administrative proceeding against it, arguing that conducting the action in an administrative forum deprived the company of its Seventh Amendment right because the proceeding involved a common-law claim.[162] The Court rejected this argument, explaining that OSHA had litigated a public right and therefore did not require a jury trial.[163] The Court held that when Congress creates a new statutory public right, Congress may assign the adjudication of that right to an administrative agency.[164] “The distinction is between cases of private right and those which arise between the government and persons subject to its authority in connection with the performance of the constitutional functions of the executive or legislative function.”[165] The Court’s holding consolidated both the separation of powers and sovereign immunity rationales by requiring the government to be a named party and Congress to create “a new cause of action unknown to the common law” for the public right doctrine to apply.

But in later holdings, the Court held that the first condition of Atlas Roofing, which required that the government be a party to the suit, was no longer necessary for a right to be deemed a public right. In Thomas v. Union Carbide Agricultural Products Co.,[166] the Court examined “whether Article III of the Constitution prohibit[ed] Congress from selecting binding arbitration . . . as the mechanism for resolving disputes among participates in FIFRA’s pesticide registration scheme.”[167] The Court found that it did not because the matter was a public right and thus exempt from Article III.[168] The majority explained that Congress may choose “quasi-judicial methods of resolving matters” when those matters concern “an integral part of a [Congressional] program.”[169] Put differently, the focus is on substance rather than form.[170] This case returned the Court to the separation of powers rationale where a matter became a public right when it was an exercise of Congressional power.[171] Thus, as the doctrine stands today, a matter becomes a public right when it concerns an exercise of legislative or executive power; when the matter becomes a public right, the matter can be assigned to a non-Article III forum.

In sum, the distinction between a public right and a private right is whether the right is “integrally related to a particular federal government action.”[172] If it relates to an executive or legislative function, then the right is public.[173] If a party is litigating a public right, then the Seventh Amendment “poses no independent bar to the adjudication of that action by a nonjury factfinder.”[174] Simple, right?

Yet scholars and courts agree that determining what a public right is creates a procedural and judicial mess.[175] This mess is apparent in Jarkesy.[176] On one hand, the action involves the government acting in its sovereign capacity to enforce securities law.[177] On the other hand, this action is eerily similar to the action in Tull where an administrative agency was enforcing a civil penalty based on a common law cause of action.[178] This tension is at the heart of both the public rights doctrine and Jarkesy itself.

3. Separation of Powers Analysis and Jarkesy

Typically, administrative adjudication does not trigger the Seventh Amendment because it enforces public rights assigned to non-Article III forums.[179] Accordingly, when Congress properly assigns such a matter to an agency, then no jury right attaches.[180] Congress may properly assign the matter when no Article III powers are implicated.[181] Agency adjudications do not exercise Article III powers and are thus properly assigned in three instances:

(1) those where there is no deprivation of life, liberty, or property; (2) those deprivations that nonetheless satisfy due process such as in Murray’s Lessee; and (3) those where the agency exercises no power at all, because it serves as a judicial adjunct.[182]

Under the first type of case where there is not a deprivation, non-Article III adjudication is permissible because there is no due process concern. For example, when the government issues a benefit and then revokes that benefit, such an action would not—absent unusual circumstances—be subject to a to an Article III court because there is no deprivation involved.[183] The Fifth Circuit found that this type of exemption is not the type in Jarkesy’s suit because he was subject to a civil penalty—i.e., a deprivation of property.[184]

The second framework is permitted even in cases of deprivation where due process and fair procedures are present.[185] For example, in Murray’s Lessee, the litigant was only subject to a temporary lien that he could later contest in court.[186] Congress could properly allow the executive to issue a lien because it was temporary “until a decision should be made by the court.”[187] Consequently, any deprivation in life, liberty, and property without adjudication in the courts was minimal. By contrast, Jarkesy is not concerned with mere temporary deprivation. In fact, Jarkesy was barred from his chosen profession of securities trading for years until the final adjudication took place.[188] The deprivation, while potentially subject to review, has been far too punitive for far too long to qualify for the Murray’s Lessee exception.

The third category—the one that likely fits best in Jarkesy—allows non-Article III adjudication when the agency is not responsible for the exercise of judicial or executive powers.[189] For example, in Crowell, administrative agencies could participate in factfinding because the source of the power was “determin[ing] various matters arising between the government and others, which from their nature do not require judicial determination.”[190] When the government is bringing a case analogous to common law fraud, this power has been called a “replacement right.”[191] A “replacement right” refers to when Congress substitutes an existing common law remedy with an administrative one and assigns the right’s adjudication to a non-Article III forum.[192]

This description best fits with Jarkesy because the SEC’s action against him was subject to Article III authority until the Dodd-Frank Act.[193] Following the Dodd-Frank Act, the SEC now has the power to exercise its replacement right selectively,[194] so the jury right attaches only when the SEC chooses to bring the action in an Article III court.[195] Therefore, like in Crowell, it is a public right because the SEC is vindicating the public interest.

Yet replacement rights create separation of powers issues because Congress is supplanting existing judicial authority.[196] Indeed, to do so, the legislation must be an exercise of legislative or executive power. This is especially unique in a case such as Jarkesy, in which the SEC sometimes chooses to bring the case within Article III powers and other times exercises its own adjudication powers. This is where the heart of the matter lies in Jarkesy—what power is the SEC exercising when trying the suit in its own forum?

II. How the Supreme Court Can Have Its Cake and Eat It Too: The Fifth Circuit Was Right in Jarkesy but for the Wrong Reasons

Jarkesy’s reasoning “cuts against [] Supreme Court precedent on the applicability of the Seventh Amendment to agency proceedings involving ‘public rights.’”[197] The question presented to the panel was whether Jarkesy had the right to a jury trial in the SEC’s proceeding against him.[198] The Fifth Circuit held that Jarkesy was entitled to a jury because the SEC was not litigating a public right, or, alternatively, Congress had violated the non-delegation doctrine by allowing the SEC to choose its forum.[199]

The opinion focused on whether the statutory cause of action was a public right.[200]This inquiry assessed “whether Congress may assign” the matter to a non-Article III forum.[201] As explained below, [202] Congress could assign it to the SEC because it likely was a public right. Instead, the panel should have focused on the other aspect of Granfinanciera which asks “whether Congress . . . has assigned resolution of the relevant claim to a non-Article III adjudicative body.”[203]

Despite the cause of action implicating a public right, Congress did not properly assign it to the SEC. Under Granfinanciera, “[u]nless Congress may and has permissibly withdrawn jurisdiction over that action by courts of law and assigned it exclusively to non-Article III tribunals sitting without juries, the Seventh Amendment guarantees petitioners a jury trial upon request.”[204] By allowing the SEC discretion to pick a forum with or without a jury, Congress has not satisfied Granfinanciera because it has not exclusively assigned the action to a non-article III tribunal. Consequently, without proper assignment, the action is subject to Article III protections.[205]

This sets up a simple solution for the Supreme Court. At minimum, a defendant should have the same right to invoke Article III as the SEC. Granfinanciera provides the way. By finding that Jarkesy is entitled to a jury because the action was not “exclusively assigned,” the Court can allow Jarkesy his Seventh Amendment rights without undermining the entirety of administrative adjudication. Rather, administrative adjudication would maintain its status quo because Atlas Roofing and Granfinanciera remain unchanged. By this narrow ruling, the Court can have its cake, maintaining a complex administrative structure, and eat it too, strengthening Seventh Amendment rights.

A. The Jarkesy Framework

In this Subpart, the Note explains what the Fifth Circuit’s relevant holdings were and why they were not right in light of Granfinanciera, Atlas Roofing, etc. This Subpart is split into the two major portions of the opinion: first the public rights framework and second the non-delegation framework. These portions of the opinion were alternative holdings about Jarkesy’s right to a jury trial.

1. Public Rights Framework: Part I of the Opinion

The first holding in the Fifth Circuit Opinion was that the SEC was not litigating a public right and thus Jarkesy was entitled to a jury.[206] Courts answer two questions to determine whether an administrative litigant is entitled to a jury: first whether the cause of action existed at common law under the Seventh Amendment, and second whether the cause of action is a public right.[207] In this case, it is not disputed that the first inquiry is met. The SEC’s civil penalty is just like the civil penalty evaluated in Tull––an action at debt.[208] For the second inquiry, determination of whether public rights are implicated, the court considers: (1) whether “Congress ‘creat[ed] a new cause of action, and remedies therefor[e], unknown to the common law,’ because traditional rights and remedies were inadequate to cope with a manifest public problem;” and (2) whether jury trials would “go far to impede swift resolution of the matter.”[209]

The Fifth Circuit’s analysis under the first prong is questionable given current caselaw. The panel held that the SEC was not litigating a public right because the action was analogous to common law fraud.[210] But this contradicts Atlas Roofing, which found that a tort like action without damages is “unknown to the common law.”[211] To distinguish Atlas Roofing, the majority explained that “OSHA empowered the government to pursue civil penalties and abatement orders whether or not any employees were ‘actually injured’ . . . .”[212] The court continued, “The government’s right to relief was exclusively a creature of statute and therefore was distinctly public in nature.”[213] The majority then analogized the SEC’s cause of action to common law fraud.[214]

This point is puzzling because the panel proves the SEC’s point. The SEC argued that its fraud claims are unique because the agency need not demonstrate loss.[215] In fact, just like in Atlas Roofing, the SEC’s analogous action lacks the damages component.[216] Proving actual damages is vital to common law fraud.[217] Here, the statute Congress passed creates a new action different from the common law because, even though it mirrors the most of the elements of common law fraud, the SEC need not demonstrate damages.[218] In this way, the statute is nearly identical to the statute at issue in Atlas Roofing, which also mirrored a common-law claim lacking damages. Thus, the Fifth Circuit’s attempt to differentiate Atlas Roofing fails because the panel’s focus was misplaced. What makes an action “unknown to the common law” is not a lack of similar elements, here misrepresentation.[219] Similarity is inevitable. Rather, an action is “unknown to the common law” when it lacks one of the common elements, here damages.[220]

The panel also tried to reason that Atlas Roofing was unique because it asked “factfinders to undertake detailed assessments of workplace safety condition and to make unsafe-conditions findings even if no injury occurred.”[221] But again on this point, the SEC’s power is similar in that it investigates securities fraud actions, makes findings on whether fraud occurs, and brings actions even if no damages have occurred.[222] For this reason, analogy to common law is not enough to overcome the public rights exception outlined in Atlas Roofing because fraud without damages is “unknown to the common law.”[223]

For the other element of the Atlas Roofing test, whether jury trials go far to “impede swift resolution” of the action, the Fifth Circuit’s reasoning has more support.[224] To begin with, the current litigation took seven years.[225] Seven years is not considered a swift resolution, even in judicial-time.[226] And the SEC still brings similar actions in district court which cuts against the argument that jury trials impede swift resolution.[227] Requiring an Article III trial would not “impede swift resolution” because even the SEC agrees that Article III courts can handle these claims.[228]

In sum, the opinion ignored the comparison between the cause of action in Atlas Roofing by OSHA and the cause of action brought by the SEC. Consequently, under current case law, it is likely that the action brought by the SEC is a public right and thus exempt from the Seventh Amendment requirements.

2. The Non-Delegation Non-Starter: Part II of the Opinion

The Jarkesy court was “almost certainly wrong” in the non-delegation part of its opinion.[229] In that portion, the panel held that even if the Commission’s cause of action were enforcing a public right, Congress improperly delegated a legislative power to the SEC.[230]

The majority observed that the language of Article I provides that all legislative powers must be vested in the Congress.[231] The Court also reasoned that forum selection is a legislative power.[232] It is a legislative power because “assigning disputes to agency adjudication”[233] “alter[s] the legal rights of, duties, and relations of persons . . . outside the legislative branch.”[234] In addition, “the mode of determining which cases are assigned to administrative tribunals ‘is completely within congressional control.’”[235] Thus, because forum selection is a legislative power, Congress must articulate “an intelligible principle” to control the exercise of that power if delegating it to an agency.[236] The Jarkesy court reasoned that Congress did not give an intelligible principle when delegating forum selection to the SEC and it was thus an unconstitutional delegation.[237]

The non-delegation requirement has only been applied “when Congress has delegated power directly to the President—never when Congress has delegated power to agency officials.”[238] Although some Justices have signaled this may change, that reception has only been in dissents and concurrences.[239] In fact, the Fifth Circuit rejected Congress’s delegation to an administrative agency by citing those dissents instead of any majority opinions.[240] In essence, the Jarkesy court tenuously relied on the expansion of an already disputed doctrine.

The court was, in my opinion, correctly wary of the SEC’s complete discretion over forum. But its holding misconstrued existing case law and relied on non-delegation, which has not applied to this sort of action before. Alternatively, the Fifth Circuit could have held that Congress did not exclusively assign the action to the SEC, allowing Jarkesy to invoke an Article III forum. This is directly supported by the case law, particularly Granfinanciera.

B. Did Congress Assign the Action? The Exclusivity Principle: A Way Out for the Court?

This Note agrees with the Fifth Circuit: the SEC should not have complete discretion over forum. Congress should choose the forum and the SEC must follow. Yet, the Fifth Circuit’s holding ventured far beyond the caselaw to reach this result. Rather than base its holding on broad (and novel) interpretations of the caselaw, the Fifth Circuit instead should have issued a narrow opinion based on Granfinanciera. In doing so, the court could have reached the same result—a jury right for Jarkesy—without relying on a Supreme Court dissenting opinion for its rule.[241]

Granfinanciera answers when the Seventh Amendment prevents non-Article III adjudication.[242] The test is whether Congress “may and has assigned resolution of the relevant claim to a non-Article III adjudicative body that does not use a jury as a factfinder.”[243] Congress may assign any action that is a public right.[244] Under Granfinanciera, it is likely that the SEC was litigating a public right against Jarkesy because the action is unknown to the common law.[245] Thus, Congress may assign it. The question then is whether Congress has assigned it. Under Granfinanciera, the answer is no.

Congress has not assigned a public right unless adjudication of that right is given “exclusively to non-article III tribunals sitting without juries.”[246] Otherwise, “the Seventh Amendment guarantees petitioners a jury trial upon request.”[247] Thus, to assign means to exclusively assign. Without exclusive assignment, the Seventh Amendment requires a jury trial upon a defendant’s request.[248]

The requirement for exclusive assignment is found in many of the Court’s public rights precedents. In Atlas Roofing the Court stated, “Congress has often created new statutory obligations, provided for civil penalties for their violation and committed exclusively to an administrative agency the function of deciding whether a violation has in fact occurred.”[249] In Ex parte Bakelite Corp.,[250] the Court stated, “Congress may reserve to itself the power to decide, may delegate that power to executive officers, or may commit it to judicial tribunals.”[251] The Court stated in Thomas that “the public rights doctrine reflects simply a pragmatic understanding that when Congress selects a quasi-judicial method of resolving matters that ‘could be conclusively determined by the Executive and Legislative Branches,’ the danger of encroaching on the judicial powers is less than when private rights.”[252] In sum, exclusivity ensures actual assignment, which in turn secures the rights of the parties before litigation ever starts.

Here, unlike other public rights cases, the relevant statute did not exclusively assign the matter outside of Article III courts. In fact, the statute gives the SEC complete autonomy to litigate in an Article II forum, its own administrative court, or an Article III forum.[253] The SEC’s autonomy violates the exclusivity requirement found in Granfinanciera and other public rights cases. Whether the Seventh Amendment applies “turns not solely on the nature of the issue to be resolved, but also the forum in which it is resolved.”[254] In Jarkesy, the SEC chooses the forum and thus had complete control over Jarkesy’s Seventh Amendment right. Granfinanciera does not tolerate this level of agency autonomy. Indeed, by requiring exclusive assignment, a court ensures that control over the Seventh Amendment is not left to an agency’s whims. Instead, Congress may both create a new right and define the parameters of that right.

Thus, the Fifth Circuit improperly based its opinion on non-delegation rather than proper assignment. When the matter is not exclusively assigned, the Seventh Amendment steps in and assures the litigant has a jury right if they so elect. This holding would have resulted in the same outcome, a jury trial for Jarkesy, without going against Atlas Roofing’s precedent, or alternatively relying on a theoretical doctrine not adopted in any controlling precedent.

C. Proposal

The exclusivity requirement opens an easy path for the Supreme Court to follow. One of the concerns consistently expressed by the Justices is how finding for Jarkesy could upend agency adjudication.[255] Yet another consistent concern is how easily Congress could deprive anyone of a jury right if they wanted to.[256]

In responding to these concerns, Granfinanciera gives the Supreme Court a chance to have its cake and eat it too. Rather than upending practically all administrative adjudications or further weakening the Seventh Amendment, exclusive assignment allows the Justices to take a small step in preserving both. The Supreme Court could reject the Fifth Circuit’s opinion under Atlas Roofing and still hold that Granfinanciera requires exclusive assignment. Under that rule, Jarkesy and anyone else similarly prosecuted may elect for a jury trial or consent to an SEC trial because Granfinanciera requires it.[257] Thus, the Supreme Court can have its cake and eat it too.

Alternatively, the SEC could moot this issue today by giving litigants the option to choose Article II or Article III forum.[258] The SEC can accomplish this without Congress, as it will simply be an administrative procedure which is exempt from notice and comment rulemaking.[259] By selecting a forum through notice and comment procedures, the SEC would protect its interest in efficiency while preserving a litigant’s Seventh Amendment rights. Either way, the resolution need not upend all agency adjudication. Rather, any solution could be tailored to preserve SEC efficiency and the Seventh Amendment rights.


In sum, juries are an ancient and an important right, though not an untouchable one. Juries may be abrogated when the action is not one “at common law” or when the right being litigated is a public right. Public rights are those rights which are closely intertwined with an executive or legislative scheme. Even so, just because an action may be a public right in theory, it still must be assigned to be litigated in a non-Article III forum. Without exclusive assignment to a non-jury forum, the Seventh Amendment attaches. In Jarkesy, the SEC brought a case in an administrative forum for civil penalties. The majority opinion held that this was unconstitutional because the SEC was not litigating a public right. Even still, this action reflects other actions brought by administrative agencies. It sounds in common law but is a new action because it lacks one of the vital elements of common-law claims, damages. But unlike other public rights, the SEC has the power to bring the action in one forum with a jury right and one without a jury right. This violates the exclusivity principle as explained in Granfinanciera. Exclusivity provides an easy way out for the Court and even the SEC itself. So long as the SEC has this right, the defendant ought to maintain it too. By doing so, the Court, the SEC, and other parties may protect the legislative scheme, the administrative state, and also the Seventh Amendment.

C. Isaac Hopkin[260]*

  1. . Brief of Phillip Goldstein et al. as Amici Curiae in Support of Petitioners, Jarkesy v. SEC, 34 F.4th 446 (5th Cir. 2022) (No. 20-61007), 2021 WL 1856946, at *6 [hereinafter Cuban Brief]; Brief of the New Civil Liberties Alliance as Amicus Curiae in Support of Petitioners, Jarkesy, 34 F.4th 446 (No. 20-61007), 2021 WL 1856951, at *3 [hereinafter NCLU Brief].

  2. . Jarkesy v. SEC, 34 F.4th 446, 450 (5th Cir. 2022), cert. granted, 143 S. Ct. 2688 (2023).

  3. . Brief for the Cato Institute as Amicus Curiae in Support of Petitioners, Jarkesy, 34 F.4th 446 (5th Cir. 2022) (No. 20-61007), 2021 WL 1149884, at *2 [hereinafter Cato Brief].

  4. . NCLU Brief, supra note 1, at *3.

  5. . Jarkesy, 34 F.4th at 450.

  6. . Id.

  7. . Id. at 449.

  8. . NCLU Brief, supra note 1, at *3.

  9. . Id.

  10. . Jarkesy, 34 F.4th at 450.

  11. . See, e.g., Jarkesy v. SEC, 803 F.3d 9, 30 (D.C. Cir. 2015) (denying Manager 1 his jury request because the court lacked subject-matter jurisdiction for the case).

  12. . SEC v. Seghers, 298 F.App’x 319, 323 n.2 (5th Cir. 2008).

  13. . Id. at 322.

  14. . Id.

  15. . Id. at 323.

  16. . Id.

  17. . Thomas Glassman, Ice Skating up Hill: Constitutional Challenges to SEC Administrative Proceedings, 16 J. Bus. & Sec. L. 47, 68 (2015).

  18. . Id.

  19. . 15 U.S.C. § 78u(d) (authorizing the SEC to seek monetary penalties); id. § 78u-3 (authorizing the SEC to choose the forum).

  20. . Jarkesy v. SEC, 34 F.4th 446, 450 (5th Cir. 2022), cert. granted, 143 S. Ct. 2688 (2023).

  21. . H.R. Rep. No. 111-687, pt. 1, at 78 (2010).

  22. . U.S. Const. amend. VII.

  23. . Tull v. United States, 481 U.S. 412, 417 (1987).

  24. . Granfinanciera, S.A. v. Nordberg, 492 U.S. 33, 53 (1989).

  25. . See NCLU Brief, supra note 1, at *14; Jarkesy, 34 F.4th at 462.

  26. . See Cuban Brief, supra note 1, at *6.

  27. . 34 F.4th 446 (5th Cir. 2022), cert. granted, 143 S. Ct. 2688 (2023).

  28. . Id. at 459, 462.

  29. . Id.

  30. . Id. at 457.

  31. . Id. at 462–63.

  32. . Id. at 451–60.

  33. . 430 U.S. 442 (1977).

  34. . Tull v. United States, 481 U.S. 412, 425 (1987).

  35. . See infra pp. 34–35.

  36. . Granfinanciera, S.A. v. Nordberg, 492 U.S. 33, 49 (1989).

  37. . Tull, 481 U.S. at 417.

  38. . See William Baude, Adjudication Outside Article III, 133 Harv. L. Rev. 1511, 1570–71 (2020).

  39. . Thomas v. Union Carbide Agric. Prods. Co., 473 U.S. 568, 589 (1985).

  40. . Granfinanciera, 492 U.S. at 53–54.

  41. . Oil States Energy Servs., LLC v. Green’s Energy Grp., LLC, 138 S. Ct. 1365, 1379 (2018) (quoting Granfinanciera, 492 U.S. at 53–54).

  42. . Jarkesy v. SEC, 34 F.4th 446, 453 (5th Cir. 2022), cert. granted, 143 S. Ct. 2688 (2023).

  43. . See The Declaration of Independence para. 20 (U.S. 1776) (“He has combined with others to subject us to a jurisdiction foreign to our constitution, and unacknowledged by our laws; giving his Assent to their Acts of pretended Legislation: . . . For depriving us in many cases, of the benefits of Trial by Jury.”).

  44. . See Paul R. Verkuil, The Emerging Concept of Administrative Procedure, 78 Colum. L. Rev. 258, 279 (1978) (“It is equally important . . . to provide mechanisms that will not delay or frustrate substantive regulatory programs.”). Efficiency is the one of the SEC’s justifications for use of the administrative forum over district courts. “From the standpoint of deterrence and investor protection, I think we can all agree that it is better to have rulings earlier than later.” Andrew Ceresney, Director, SEC Div. of Enforcement, Remarks to the American Bar Association’s Business Law Section Fall Meeting (Nov. 21, 2014) (transcript available at http://perma.cc/C9HU-FB9V).

  45. . U.S Const. amend. VII.

  46. . Jennifer Walker Elrod, Is the Jury Still Out?: A Case for the Continued Viability of the American Jury, 44 Tex. Tech L. Rev. 303, 310 (2012). Judge Jennifer Walker Elrod was the Judge who authored the Jarkesy opinion. Jarkesy v. SEC, 34 F.4th 446 (5th Cir. 2022), cert. granted, 143 S. Ct. 2688 (2023).

  47. . Elrod, supra note 46, at 310.

  48. . Id. at 314.

  49. . See id. at 311.

  50. . Id.

  51. . Edward L. Rubin, Trial by Battle. Trial by Argument., 56 Ark. L. Rev. 261, 263 (2003).

  52. . Elrod, supra note 46, at 268–69.

  53. . See id. at 311.

  54. . Id.

  55. . Id.

  56. . Jack Pope, The Jury, 39 Tex. L. Rev. 426, 431 (1961). The reform process was not for some noble purpose, instead it was to keep revenue in the King’s Court rather than going to local tribunals. See id.

  57. . Id. at 432.

  58. . See id. at 431–39.

  59. . Id. at 434.

  60. . Id.

  61. . Id. at 435.

  62. . Pope, supra note 56, at 434.

  63. . Id. at 434–35.

  64. . Id. at 435.

  65. . Id. at 441.

  66. . Id.

  67. . Elrod, supra note 46, at 313.

  68. . Pope, supra note 56, at 441–42.

  69. . Id. at 442.

  70. . Id.

  71. . Id.

  72. . Id. at 442–43.

  73. . Pope, supra note 56, at 445.

  74. . Id.

  75. . Elrod, supra note 46, at 313.

  76. . Id.

  77. . Id.

  78. . Id.

  79. . Id. (quoting 6 Cobbett’s Complete Collection of State Trials and Proceedings for High Treason and Other Crimes and Misdemeanors from the Earliest Period to the Present Time 964 (1810)).

  80. . Id.

  81. . Elrod, supra note 46, at 313.

  82. . Id.

  83. . Id. at 313–14.

  84. . Bushell’s Case, 124 Eng. Rep. 1006, 1010 (C.P. 1670).

  85. . Pope, supra note 56, at 443.

  86. . See id. at 444

  87. . Id.

  88. . Id.

  89. . Id.

  90. . Id.

  91. . 4 William Blackstone, Commentaries *342.

  92. . Id. at *379.

  93. . Elrod, supra note 46, at 314–15.

  94. . Id. at 315.

  95. . Akhil Reed Amar, A Tale of Three Wars: Tinker in Constitutional Context¸ 48 Drake L. Rev. 507, 514 (2000).

  96. . Rachel E. Barkow, Recharging the Jury: The Criminal Jury’s Constitutional Role in an Era of Mandatory Sentencing, 152 U. Pa. L. Rev. 33, 52–53 (2003).

  97. . Id. at 53.

  98. . The Declaration of Independence para. 20 (U.S. 1776) (“He has combined with others to subject us to a jurisdiction foreign to our constitution, and unacknowledged by our laws; giving his Assent to their Acts of pretended Legislation: . . . For depriving us in many cases, of the benefits of Trial by Jury.”).

  99. . Akhil Reed Amar, The Bill of Rights as a Constitution, 100 Yale L.J. 1131, 1183 (1991).

  100. . Id.

  101. . Kenneth S. Klein, The Validity of the Public Rights Doctrine in Light of the Historical Rationale of the Seventh Amendment, 21 Hastings Const. L.Q. 1013, 1018 (1994).

  102. . Id. at 1019.

  103. . Edith Build Henderson, The Background of the Seventh Amendment, 80 Harv. L. Rev. 289, 291–92 (1966).

  104. . Id. at 299.

  105. . Id. at 293–94.

  106. . Id. at 294.

  107. . Id. at 294–95.

  108. . See Charles W. Wolfram, The Constitutional History of the Seventh Amendment, 57 Minn. L. Rev. 639, 730 (1973).

  109. . Id. at 728.

  110. . Id. at 729.

  111. . Id.

  112. . Id. at 730.

  113. . Id.

  114. . Julius J. Marke, Peter Zenger’s Trial, 6 Litig. 41, 55 (1980).

  115. . Atlas Roofing Co. v. Occupational Safety & Health Rev. Comm’n, 430 U.S. 442, 460–61 (1977).

  116. . 481 U.S. 412 (1987).

  117. . Id. at 417 (internal quotation omitted).

  118. . Id. at 414.

  119. . Id. at 418.

  120. . Id. at 417 (citing Curtis v. Loether, 415 U.S. 189, 193 (1974)).

  121. . Id.

  122. . Tull v. United States, 481 U.S. 412, 417 (1987).

  123. . Id. at 420.

  124. . Id. at 423.

  125. . Jean Eaglesham, SEC Wins with In-House Judges, Wall St. J. (May 6, 2015, 10:30 PM), https://www.wsj.com/articles/sec-wins-with-in-house-judges-1430965803.

  126. . See SEC, Addendum to Division of Enforcement Press Release Fiscal Year 2022 (2022), https://www.sec.gov/files/fy22-enforcement-statistics.pdf.

  127. . Id.

  128. . Bushell’s Case, 124 Eng. Rep. 1006, 1010 (C.P. 1670).

  129. . Stern v. Marshall, 564 U.S. 462, 490–91 (2011).

  130. . See Glassman, supra note 17, at 50.

  131. . Id.

  132. . Oil States Energy Servs., LLC v. Green’s Energy Grp., LLC, 138 S. Ct. 1365, 1379 (2018).

  133. . See Den v. Hoboken Land & Improvement Co. (Murray’s Lessee), 59 U.S. (18 How.) 272, 284 (1855).

  134. . See Ellen E. Sward, Legislative Courts, Article III, and the Seventh Amendment, 77 N.C. L. Rev. 1037, 1064, 1103 (1999).

  135. . Klein, supra note 101, at 1023.

  136. . Baude, supra note 38, at 1577.

  137. . Klein, supra note 101, at 1023–24.

  138. . Id. at 1024–25.

  139. . Id. at 1024.

  140. . See id.; see also Oceanic Steam Navigation Co. v. Stranahan, 214 U.S. 320, 339 (1909) (Congress could “impose appropriate obligations and sanctions their enforcement by reasonable money penalties, giving executive officers the power to enforce such penalties without the necessity of invoking judicial power.”).

  141. . See Sward, supra note 134, at 1064.

  142. . Klein, supra note 101, at 1024.

  143. . Id.

  144. . Id. at 1024, 1031–32.

  145. . 59 U.S. (18 How.) 272 (1855).

  146. . Id. at 284–85.

  147. . Id. at 274.

  148. . Id. at 275.

  149. . Id. at 284.

  150. . Klein, supra note 101, at 1025.

  151. . 285 U.S. 22 (1932).

  152. . Id. at 36–37.

  153. . Id.

  154. . Id. at 37.

  155. . Id. at 50.

  156. . Id. at 60–61.

  157. . See Sward, supra note 134, at 1064, 1103.

  158. . Id.

  159. . Id.

  160. . See Jarkesy v. SEC, 34 F.4th 446, 454 (5th Cir. 2022), cert. granted, 143 S. Ct. 2688 (2023) (describing the SEC’s action as akin to common law fraud).

  161. . 430 U.S. 442 (1977).

  162. . Id. at 448–49.

  163. . Id. at 460.

  164. . Id. at 455.

  165. . Id. at 452 (quoting Crowell v. Benson, 285 U.S. 22, 50–51 (1932)).

  166. . 473 U.S. 586 (1985).

  167. . Id. at 571. FIFRA’s pesticide registration scheme is a matter for another law review article. For a summation of its process, see id. at 572–75 and Ruckelshaus v. Monsanto Co., 467 U.S. 986, 991–97 (1984).

  168. . Thomas, 473 U.S. at 593–94.

  169. . Id. at 589.

  170. . Id. at 587.

  171. . See id. at 589–93.

  172. . Stern v. Marshall, 564 U.S. 462, 490–91 (2011).

  173. . Id.

  174. . Granfinanciera, S.A. v. Nordberg, 492 U.S. 33, 53 (1989) (citing Atlas Roofing Co. v. Occupational Safety & Health Rev. Comm’n, 430 U.S. 442, 453–55 (1977)).

  175. . Baude, supra note 38, at 1520, 1542, 1547; Robert L. Glicksman & Richard E. Levy, The New Separation of Powers Formalism and Administrative Adjudication, 90 Geo. Wash. L. Rev. 1088, 1138 (2022) (“[T]he current doctrine concerning administrative adjudication is confusing and poorly defined.”). Efforts by judges to define public rights is equally confused. See Stern v. Marshall, 564 U.S. 462, 488 (2011) ([O]ur discussion of the public rights exception since that time has not been entirely consistent . . . .”); see also Transcript of Oral Argument at 6, SEC v. Jarkesy, 143 S. Ct. 2688 (2023) (No. 22-859) (“The court has never fully plumbed its outer perimeters.”).

  176. . 34 F.4th 446 (5th Cir. 2022), cert. granted, 143 S. Ct. 2688 (2023).

  177. . Id. at 467 (Davis, J. dissenting).

  178. . Id. at 454 (majority opinion) (citing Tull v. United States, 481 U.S. 412, 481 (1987)).

  179. . William F. Funk, Sidney A. Shapiro, & Russell L. Weaver, Administrative Procedure and Practice 558 (6th ed. 2019).

  180. . Oil States Energy Servs., LLC v. Green’s Energy Grp., LLC, 138 S. Ct. 1365, 1379 (2018) (emphasis added) (quoting Granfinanciera, S.A. v. Nordberg, 492 U.S. 33, 53–54 (1989)).

  181. . Baude, supra note 38, at 1577.

  182. . Id. Of course, this is not a perfect diagram that explains all the Court’s relevant holdings. Some cases are public rights because they embody a little bit of each category. See id. at 1578.

  183. . See, e.g., Matthews v. Eldridge, 424 U.S. 319 (1976) (rejecting court-like procedures in an administrative forum, because the plaintiff had adequate notice).

  184. . Jarkesy v. SEC, 34 F.4th 446, 453 (5th Cir. 2022), cert. granted, 143 S. Ct. 2688 (2023).

  185. . Baude, supra note 38, at 1578.

  186. . Id. at 1552–53.

  187. . Murray’s Lessee, 59 U.S. (18 How.) 272, 285 (1855).

  188. . NCLU Brief, supra note 1, at *3–4.

  189. . Baude, supra note 38, at 1578.

  190. . Crowell v. Benson, 285 U.S. 22, 50 (1932).

  191. . See Sward, supra note 134, at 1079.

  192. . Id.

  193. . Glassman, supra note 17, at 68.

  194. . Id.

  195. . Id.

  196. . Sward, supra note 134, at 1080.

  197. . Jonathan H. Adler, The Good, the Bad, and the Ugly of Jarkesy v. SEC, Volokh Conspiracy (Aug. 17, 2022, 6:10 p.m.) https://reason.com/volokh/2022/08/17/the-good-the-bad-and-the-ugly-of-jarkesy-v-sec/; see id. (“[T]he Fifth Circuit’s arguments that Atlas Roofing has been abrogated . . . [is] thoroughly unconvincing.”).

  198. . Jarkesy v. SEC, 34 F.4th 446, 450 (5th Cir. 2022), cert. granted, 143 S. Ct. 2688 (2023).

  199. . Id. at 451, 465.

  200. . Id. at 451.

  201. . See Granfinanciera, S.A. v. Nordberg, 492 U.S. 33, 42 (1989) (emphasis added).

  202. . See discussion infra Section II.A.1.

  203. . Granfinanciera, 492 U.S. at 42 (emphasis added).

  204. . Id. at 49 (emphasis added).

  205. . Id.

  206. . Jarkesy v. SEC, 34 F.4th 446, 451 (5th Cir. 2022), cert. granted, 143 S. Ct. 2688 (2023).

  207. . Granfinanciera, S.A. v. Nordberg, 492 U.S. 33, 53–54 (1977).

  208. . Jarkesy, 34 F.4th at 454.

  209. . Granfinanciera, 492 U.S. at 60–63 (quoting Atlas Roofing Co. v. Occupational Safety & Health Rev. Comm’n, 430 U.S. 442, 461 (1977)).

  210. . Jarkesy, 34 F.4th at 454–57.

  211. . Atlas Roofing, 430 U.S. at 453.

  212. . Jarkesy, 34 F.4th at 458 (citing Atlas Roofing, 430 U.S. at 445).

  213. . Id.

  214. . Id.

  215. . Oral Argument at 25:50, Jarkesy 34 F.4th 446 (No. 20–61007), https://www.courtlistener.com/audio/77971/jarkesy-v-sec/.

  216. . 15 U.S.C. § 78. Several of the Justices seemed to find this analogy fitting. See Transcript of Oral Argument at 100, 115, 146, SEC v. Jarkesy, 143 S. Ct. 2688 (2023) (No. 22-859).

  217. . See Jarkesy, 34 F. 4th at 455 (“The traditional elements of common-law fraud are (1) a knowing or reckless material misrepresentation, (2) that the tortfeasor intended to act on and (3) that harmed the plaintiff.” (quoting In re Deepwater Horizon, 857 F.3d 246, 249 (5th Cir. 2017)) (emphasis added)).

  218. . Jarkesy, 34 F. 4th at 472 (Davis, J., dissenting).

  219. . Id.

  220. . Id. at n.47.

  221. . Id. at 456 (majority opinion) (citing Atlas Roofing v. Occupational Safety & Health Rev. Comm’n, 430 U.S. 442, 445 (1977)).

  222. . See 15 U.S.C § 78u-2.

  223. . Atlas Roofing, 430 U.S. 442, 453 (1977).

  224. . Granfinanciera, S.A. v. Nordberg, 492 U.S. 33, 60–63 (1977).

  225. . Jarkesy, 34 F.4th at 456.

  226. . See id.

  227. . Id. at 455–56.

  228. . Id. at 456.

  229. . See Adler, supra note 197.

  230. . Jarkesy, 34 F.4th at 459.

  231. . Id. at 460.

  232. . Id. at 461 (quoting Crowell v. Benson, 285 U.S. 22, 50 (1992)).

  233. . See Oceanic Steam Navigation Co. v. Stranahan, 214 U.S. 320, 339 (1909).

  234. . Jarkesy, 34 F.4th at 461 (quoting INS v. Chadha, 462 U.S. 919 (1983)).

  235. . Crowell v. Benson, 285 U.S. 22, 50 (quoting Ex parte Bakelite Corp., 279 U.S. 438, 451 (1929)).

  236. . Mistretta v. United States, 488 U.S. 361, 372 (1989).

  237. . Jarkesy, 34 F.4th at 462.

  238. . Elena Kagan, Presidential Administration, 114 Harv. L. Rev. 2245, 2364 (2001).

  239. . See Brandon J. Johnson, The Accountability–Accessibility Disconnect, 58 Wake Forest L. Rev. 65, 74–80 (2023).

  240. . See Jarkesy, 34 F.4th at 460 (citing Gundy v. United States, 139 S. Ct. 2116, 2134 (2019) (Gorsuch, J., dissenting)).

  241. . Id.

  242. . See Granfinanciera, S.A., v. Nordberg, 492 U.S 33, 51 (1989).

  243. . Id. at 42.

  244. . Id. at n.4.

  245. . See discussion supra Part II.A.2.

  246. . Granfinanciera, 492 U.S. at 49.

  247. . Id.

  248. . Id.

  249. . Atlas Roofing Co. v. Occupational Safety & Health Rev. Comm’n, 430 U.S. 442, 450 (1977) (emphasis added).

  250. . 279 U.S. 438 (1929).

  251. . Id. at 451.

  252. . Id. at 589 (quoting N. Pipeline Constr. Co. v. Marathon Pipeline Co., 458 U.S. 50, 68 (1982) (plurality opinion)).

  253. . See Jarkesy v. SEC, 34 F.4th 446, 461 (5th Cir. 2022), cert. granted, 143 S. Ct. 2688 (2023).

  254. . Granfinanciera, S.A. v. Nordberg, 492 U.S. 33, 49 (1989).

  255. . See, e.g., Transcript of Oral Argument at 119–20, SEC v. Jarkesy, 143 S. Ct. 2688 (2023) (No. 22-859) (Justice Sotomayor expressing concern that finding for Jarkesy could nullify all agency adjudication).

  256. . See, e.g., Transcript of Oral Argument at 27, SEC v. Jarkesy, 143 S. Ct. 2688 (2023) (No. 22-859) (Justice Kavanaugh expressing concern that the government throws a different label on a suit and can deprive litigants of jury trials and other due process rights in civil litigation).

  257. . Consent overcomes any assignment problems. “The entitlement to an Article III adjudicator is a ‘personal right’ and thus ordinarily ‘subject to waiver.’” Wellness Int’l Network, Ltd. v. Sharif, 575 U.S. 665, 678 (2015) (quoting Commodity Futures Trading Comm’n v. Schor, 478 U.S. 833, 848 (1986)).

  258. . Transcript of Oral Argument at 135–36, Jarkesy, 143 S. Ct. 2688 (No. 22-859); see also Christopher J. Walker & David Zaring, The Right to Remove in Agency Adjudication, 84 Ohio St. L.J. (forthcoming 2024) (manuscript at 33), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4644940.

  259. . 5 U.S.C. § 553.

  260. *. J.D. Candidate 2024 Wake Forest University School of Law; B.S. Finance Brigham Young University; incoming associate at Morris Nichols Arsht & Tunnell. The biggest thank you goes to my wife Brooke, and our kids Scott, Liam, and Sonya (Sunny), their love and support means more than I can express here. Also thank you to Christian Schweitzer who has been a mentor to me since my 1L year and provided so much help and support as editor of the note. For helpful feedback and discussion, I would like to thank Professors Christine Coughlin, Lee-ford Tritt, and Sidney Shapiro. Finally, a huge thank you for the Law Review team, specifically Keegan Hicks, Dylan Ellis, and Haley Hurst, each of them made my note much clearer.

Maya Pillai

Trust, but verify. This is a common methodology in the audit world and was even mentioned by the SEC Acting Chief Accountant Paul Munter in his statement on “The Auditor’s Responsibility for Fraud Detection.” [1]  He commented, “[T]he mindset of ‘trust but verify’ may represent potential bias if it is anchored in the belief that management is honest and has integrity.” Well, that is bold. We all want to believe that management has nothing but the purest intentions. But, what happens when this spotlight turns on the investor? Does the same principle exist?

Section 3(a)(11) of the Securities Act, known as the “intrastate offerings exemption,” provides small businesses with options to procure financing. [2]  Rule 147, the “safe harbor” rule under § 3(a)(11), lists objective criteria with which companies must comply. [3]  The newly loosened exemption, Rule 147A, permits issuers to make offers to out-of-state residents, as long as sales are only made to in-state residents and allows for a company to be incorporated out-of-state when its principal place of business remains in-state. [4]  (The limited framework of the SEC’s interpretation of § 3(a)(11) precludes issuers under Rule 147A from offering securities to out-of-state residents.) [5]  Deregulation is good, right? Well, it depends. Based on my study of these changes—and the caution given by Munter— the provision permitting issuers to rely on representations by investors to display their in-state status should be reconsidered.

This criterion removes a key due diligence requirement for issuers. That isn’t really that important, right? Let’s look at current events. One of the many reasons for the downfall of Silicon Valley Bank (“SVB”) was the loosening of regulatory requirements. Had SVB still been subject to regular stress tests, portfolio misrepresentation would likely have been noted much earlier. Relying only on an investor’s representation to satisfy the in-state requirement shows the issuer conducts no additional “test” to verify residency. As such, the issuer is more likely to fail. Therefore, additional measures should be put in place under Rule 147A for issuers to confirm the veracity of a purchaser’s residency. Once again, trust, but verify.

Why is due diligence necessary? Especially in the financial sector, institutions can “uncover any potential risk … of doing business with a specific organization or individual by analyzing information from a variety of sources.” [6]  Due diligence takes on many forms and consists of a wide range of processes. Knowing the individual or organization from whom you receive money helps ensure every party complies with the applicable rules and regulations to avoid exposure to liability, such as imprisonment and fines. There is also a non-tangible consequence: reputational risk. Financial institutions, like law firms, rely heavily on their name and reputation. Public perception holds a significant amount of weight (notice who the sponsors are at the next golf tournament or non-profit fundraiser you attend). If a financial institution receives a fine or shuts down for non-compliance, that makes headlines around the world. (And, of course, reactions are evident in the stock markets.) Nonetheless, the big institutions (e.g., Wells Fargo, Bank of America, Charles Schwab, etc.) manage to stay afloat, despite bad press. Maybe the banks took a page from Kanye West when he said, “Bad publicity is still publicity.”

There should be preventative measures from the issuer to prevent investors from making false representations about their in-state status.

Rule 147A’s language currently reads,

Sales of securities pursuant to this section shall be made only to residents of the state or territory in which the issuer is resident, as determined pursuant to paragraph (c) of this section, or who the issuer reasonably believes, at the time of sale, are residents of the state or territory in which the issuer is resident. [7]

There is the word, “reasonably.” Does the SEC provide further guidance on the rule? Yes, at the end of paragraph (d), a note states, “Obtaining a written representation from purchasers of in-state residency status will not, without more, be sufficient to establish a reasonable belief that such purchasers are in-state residents.” [8] 

Once again, with the term “reasonable,” but now we gain a clearer picture. While the investor’s written representation is expected to be truthful, this is not always guaranteed. Perhaps the SEC should revise the guidance note for paragraph (d) to read, “Obtaining a written and truthful representation from purchasers of in-state residency status will not, without more, be sufficient to establish a reasonable belief that such purchasers are in-state residents.”

This feels a little better. However, these changes introduce a new uncertainty when evaluating a generally recognized valid measure to confirm a truthful representation from an investor. Remember, “trust, but verify!” A residency affidavit (which must be notarized) would certainly suffice,

“It has been verified that on the ___ day of _____, 202_, John Smith’s principal residence is at 123 Main St, Charlotte, NC 28204. The following documents have been presented to corroborate John Smith’s residency: [.]”

In addition to one’s driver’s license containing an investor’s current address, the following documents should also be considered in verifying an investor’s principal residence: (1) most recent mortgage statement or lease agreement; (2) most recent utility statement; (3) vehicle insurance card from your most current policy; and (4) most recent property tax receipt. An investor’s most recent credit card statement may not be the best because the statement could be addressed to your billing address, which may differ from your principal residence address. Even a W2 or 1099 from the most recent tax year could list a different address if you moved after those tax documents were created and provided to you.

Although partial to the suggestions above, I would be remiss if I did not also question whether the reasonable belief standard is best suited for the securities industry. [9]  From tort law, a reasonable belief is the belief that an ordinary person would hold under like circumstances as those faced by the person in question. It is worth noting that the SEC does not explicitly define “reasonable belief.” (For this essay, I assume the SEC adopted the tort law definition of this term.) In Rule 147A, reasonable belief is merely supported by obtaining a written representation from the investor regarding their residency. [10]  The individuals at these financial institutions tasked with reviewing the representations from purchasers are not your average teller or loan officer at Chase or Wells Fargo. These due diligence/compliance employees are held to a higher standard by their employers because of their expected understanding of the applicable rules and regulations for intrastate offerings. The fate of an entire company rests in the hands of those tasked with reviewing the necessary documents. If a single investor is not an in-state resident, then the entire offering is no longer in compliance with the exemption under Rule 147A.  [11]

In his concluding remarks, Munter reiterated, “[T]he value of the audit and the related benefits to investors, including investor protections, are diminished if the audit is conducted without the appropriate levels of due professional care and professional skepticism.” [12]  It is clear that the entire offering depends upon the accuracy of the audit. With such high stakes, this should be a more defined process. Trust, but verify.


[1] Paul Munter, The Auditor’s Responsibility for Fraud Detection, SEC (Oct. 11, 2022), https://www.sec.gov/news/statement/munter-statement-fraud-detection-101122.

[2] Intrastate offerings, SEC (Apr. 6, 2023), https://www.sec.gov/education/smallbusiness/exemptofferings/intrastateofferings.

[3] Id.

[4] Id.

[5] Joe Green, SEC Adopts New Rules to Facilitate Intrastate Crowdfunding, LinkedIn (Oct. 28, 2016), https://www.linkedin.com/pulse/sec-adopts-new-rules-facilitate-intrastate-joe-green/.

[6] What is Customer Due Diligence (CDD)?, SWIFT, https://www.swift.com/your-needs/financial-crime-cyber-security/know-your-customer-kyc/customer-due-diligence-cdd (last visited Aug. 7, 2023).

[7] Intrastate sales exemption, 17 C.F.R. § 230.147(A) (2021).

[8] Id.

[9] Amanda M. Rose, The “Reasonable Investor” of Federal Securities Law: Insights from Tort Law’s “Reasonable Person” & Suggested Reforms, 43 Iowa 77, 79 (2017) .

[10] Covington & Burling LLP, SEC Enhances Exemptions for Local Offerings, Covington (Dec. 1, 2016), https://www.cov.com/-/media/files/corporate/publications/2016/12/sec_enhances_exemptions_for_local_offerings.pdf.

[11] Alan Palmiter, Securities Regulation, (8th ed. 2021).

[12] Munter, supra note 1.


Securities and Exchange Logo

Securities and Exchange Commission Logo

13 Wake Forest L. Rev. Online 1

Mark T. Wilhelm[*] & Michael T. Byrne[**]

Publicly traded companies in the United States are required to disclose a significant amount of information to the public in order to comply with applicable securities laws.[1] While at times those disclosure requirements are rather rigid, there are many circumstances in which these companies retain latitude to keep secrets out of the public eye—and notably, out of the reach of their competitors.

Public companies are required to file disclosure documents with the U.S. Securities and Exchange Commission (“SEC”), which are made available to the public pursuant to the Freedom of Information Act (“FOIA”).[2] In particular, Item 601(b)(10) of Regulation S-K requires public companies to file as an exhibit to their disclosure documents copies of certain material contracts into which the company has entered.[3] These exhibits often include sensitive information that companies prefer to keep confidential for competitive or other reasons.

Accordingly, under Rule 406 of the Securities Act of 1933[4] and Rule 24b-2 of the Securities Exchange Act of 1934,[5] the SEC permits public companies to request confidential treatment of certain information contained in these exhibits—meaning a company may redact the sensitive information and shield it from public view. FOIA permits the SEC to grant such requests if the redacted information falls into one of FOIA’s specified exemptions. The most commonly cited FOIA exemption in this context is found in Section 552(b)(4), which protects “trade secrets and commercial or financial information obtained from a person and privileged or confidential.”[6]

Historically, at the time that public companies redacted information from these exhibits, they were required to submit along with the exhibit a formal, hard copy confidential treatment request (“CTR”) with the SEC.[7] Submitting a CTR was a relatively arduous process that involved preparing and mailing a particularly formatted application to the SEC that specified (i) the justifications for redacting each piece of information, (ii) which FOIA exemption applied to each piece of information, and (iii) other pertinent details. The CTR also needed to include an unredacted copy of the exhibit that was the subject of the request. Upon receipt of a CTR, the SEC issued a confidential treatment order (“CT Order”) either granting or denying the CTR.[8] If denied, the company had to publicly refile the exhibit without the proposed redactions.

On March 20, 2019, the SEC announced it had modernized and simplified its rules related to, among other things, confidential treatment of information in filed exhibits.[9] The changes, which went into effect in May 2019, were aimed at bringing the SEC’s disclosure requirements into compliance with the Fixing America’s Surface Transportation Act (“FAST Act”).[10] Initially, following the rule changes, a public company could forgo submitting a formal CTR application if the redacted information was not material and would be competitively harmful if publicly disclosed.[11] However, on November 2, 2020, the SEC adopted amendments to eliminate the competitive harm requirement of CTRs in response to the Supreme Court’s clarification of the definition of “confidential” in Food Marketing Institute v. Argus Leader Media,[12] which stated: “[a]t least where commercial or financial information is both customarily and actually treated as private by its owner and provided to the government under an assurance of privacy, the information is ‘confidential’ within the meaning of [FOIA Section 552(b)(4)].”[13]

Thus, currently, if a public company redacts portions of a filed exhibit without submitting a formal CTR, the company must:

(i) mark the exhibit index to indicate that portions of the exhibit or exhibits have been redacted;

(ii) include a prominent statement on the first page of the redacted exhibit that certain information has been excluded from the exhibit because it is both (1) not material and (2) the type that the company treats as private or confidential; and

(iii) include brackets indicating where the information has been redacted from the filed version of the exhibit.[14]

Notably, public companies retain the option to submit formal CTRs to the SEC, and even after the rule changes, a very limited number of public companies have continued to do so.[15] This continued practice is likely a result of such companies (i) simply being unaware of the rule changes, (ii) failing to adjust their practices to conform with the new, relaxed rules, or (iii) taking what could be aggressive positions on what information is confidential, and proactively seeking SEC guidance on whether such confidential treatment would be granted.

As part of the same rule changes, the SEC also reduced the quantity of materials that public companies must file as exhibits.[16] Previously, and among other things, public companies were required to file as exhibits each material contract (i) entered within the preceding two years, or (ii) which was to be performed in whole or in part at or after the filing of the disclosure document.[17] Following the rule changes, the two-year lookback applies only to newly reporting companies—this means that most public companies must file material contracts meeting only the second requirement above.[18]

And finally, the rule changes also made clear that certain types of personally identifiable information (“PII”) such as social security numbers, home addresses, etc., could be redacted outside of the CTR process.[19] Anecdotally, prior to this rule change, certain practitioners would file CTRs to redact these types of personally identifiable information, while other practitioners would redact the information outside of the CTR process on the basis that it was obviously confidential and that the likelihood of the SEC objecting would be very small.[20]

A. SEC’s Standard of Review of Redacted Information

The SEC has stated it “intend[s] to review registrant filings for compliance with the new rules” as part of its regular filing review process.[21] However, the SEC only selectively reviews filings,[22] which means that some (if not many) redacted exhibits will not undergo a formal review. During the rulemaking process related to the applicable Regulation S-K changes, the SEC admitted that “[o]ne potential cost of the amendments is that information may be redacted that would not otherwise be afforded confidential treatment by the [SEC] staff.”[23] However, the SEC felt that the impact of this potential shortcoming was mitigated by the fact that the SEC very rarely denies CTRs. In fact, from 2014 to 2018, the SEC formally denied only one CTR, and an additional 1% of CTRs were withdrawn by filers after the SEC determined the information in the exhibits was too material to redact.[24] But the SEC also noted that 11% of CTRs from those years were granted only after the SEC required the filer to reduce or modify the requested redactions.[25] Thus, while an overwhelming majority of CTRs were granted as-is, the rule changes will likely result in at least some redacted information that would have been revealed in a traditional CTR review remaining hidden from the public.

Nevertheless, it is important to emphasize that while the SEC’s review process has changed, the standard for what information actually qualifies for confidential treatment remains largely the same (aside from some changes in what verbiage should appear in the filings to mark the redactions and the clarification of the treatment of personally identifiable information).[26] Public companies therefore must still ensure they disclose all material information and redact no more information than necessary. If a public company does redact questionably protectable information and the SEC identifies it, the SEC may require that the company provide additional explanation or documentation regarding why the redacted information should qualify for confidential treatment, as well as unredacted copies of the relevant exhibits—essentially replicating the effort and cost of a traditional CTR.[27] If the explanation and documentation do not sufficiently justify the redactions, the SEC will require the company to publicly file an unredacted copy of the exhibit, which could result in negative publicity for the company.

B. Major Increase in Filing of Redacted Exhibits

This Study utilized the Intelligize® database to search SEC filings and estimate the number of exhibits for which confidential treatment was sought from January 1 to December 31 of each year from 2012 through 2022. Searches were intended to uncover the total number of exhibits seeking confidential treatment during each calendar year, rather than the total number of CT Orders issued by the SEC each year, because the SEC often issues a single CT Order to grant confidential treatment of multiple exhibits for the same public company. Search terms reflected common verbiage used by public companies seeking confidential treatment in each respective year analyzed.[28] For example, since the 2019 rule changes, almost all redacted exhibits use the phrase “not material” in their prominent statements marking the redactions; this phrase was not commonly used prior to the rule changes. Search terms additionally accounted for some companies using outdated verbiage in their prominent statements marking the redactions, likely as a result of failing to recognize or comply with the rule changes.

As shown below in Figure 1, an estimated 4,247 redacted exhibits were filed with the SEC in 2022. This represents an increase of approximately 61% above the estimated average number of redacted exhibits filed in the years analyzed prior to the 2019 changes (an average of 2,635 redacted exhibits per year from 2012-2018). Note that while a vast majority of redacted exhibits are filed as an “Exhibit 10” pursuant to Item 601(b)(10) of Regulation S-K (including over 91% of redacted exhibits filed in 2018),[29] the results of this search include other types of redacted exhibits as well.

Figure 1

When considering these results in light of the SEC’s (i) removal of the two-year lookback period for filing material contracts—which presumably reduced the total number of material contracts required to be filed as exhibits following the rule change, and (ii) clarification of the treatment of personally identifiable information, the increase in redacted exhibits is even more significant than it first appears. In fact, as shown below in Figure 2, the estimated number of aggregate annual Exhibit 10 and Exhibit 2 filings—which constitute the overwhelming majority of redacted exhibits—shows a downward trajectory from 2012 to 2022, despite a temporary spike in Exhibit 10 and Exhibit 2 filings in 2021 and early 2022 that was likely the result of increased merger and acquisition activity in the midst of the COVID-19 pandemic, including a short boom in the use of Special Purpose Acquisition Company (“SPAC”) vehicles.[30]

Figure 2

Despite the unique market factors present in 2021, the rate at which the number of redacted exhibits filed per year has increased following the 2019 rule changes has consistently—and significantly—outpaced the growth in the number of Exhibit 10 and Exhibit 2 filings. This suggests that in addition to filing more total redacted exhibits per year since the rule changes, public companies are also redacting information from a larger percentage of the material contract exhibits they file. The estimates below in Figure 3, which were calculated by dividing the total number of redacted exhibits by the total number of combined Exhibit 10 and Exhibit 2 filings per year, support this conclusion.

Figure 3

Moreover, the increase in redacted exhibits takes on added magnitude when considering the reduction of the number of public companies over the analyzed time period. To estimate the number of public companies per year, this Study again utilized the Intelligize® database to find the total number of required annual reports filed with the SEC—specifically forms 10-K, 10-KT, 1-K, and 20-F—in each year.[31]

As shown below in Figure 4, the total number of public companies gradually decreased from 2012 to 2020, but then jumped back up in 2021 and 2022. The recent rise is (at least in part) a likely result of the aforementioned SPAC boom. Because SPACs are public companies with no business operations, until they go through a de-SPAC process their filings do not typically contain the type of sensitive information that would warrant redactions in their SEC filings. Thus, to allow a clearer picture of how often public companies with actual business operations are redacting portions of their exhibits, Figure 4 also includes the estimated total number of public companies per year when SPACs are removed from the presentation. After removing SPACs, there is a much more consistent downward trend in the number of public companies over the studied period, from an estimated 8,361 in 2012 to an estimated 7,671 in 2022—a decrease of approximately 8%.[32]

Figure 4

The intersection of the generally declining number of public companies and the increase in redacted exhibits following the 2019 rule changes suggests that public companies are now submitting a higher number of redacted exhibits per year. The estimates below in Figure 5A—calculated by dividing the total number of redacted exhibits by the total number of public companies in each respective year—support this inference, as the number of redacted exhibits filed per company has soared since the rule changes. As shown in Figure 5B, the growth in the number of redacted exhibits filed per company becomes slightly more pronounced when excluding SPACs from both data points.

Figure 5A

Figure 5B

Notably, the SPAC expansion also presumably played a major role in the influx of Exhibit 10 (and to a lesser extent, Exhibit 2) filings in 2021 and 2022. Again, when considering that SPAC exhibits are less likely to contain materially sensitive information because SPACs have no business operations prior to undergoing the de-SPACing process, the dramatic increase in the number of redacted exhibits filed per public company following the rule changes becomes all the more noteworthy.

An additional partial explanation of this phenomena may be the corresponding increase in the average size of public companies in recent years.[33] As public companies grow in size, it stands to reason that they may be party to more material contracts that warrant requesting confidential treatment.

More obviously, a significant portion of the increase in redacted exhibits may be attributable to companies seeking cost savings.[34] Public companies (especially smaller companies) that could not afford to or did not feel strongly about redacting certain immaterial information may have previously forgone the CTR process to avoid the expense of doing so.

But in addition to cost savings, it is no secret that public companies generally want to keep as much information private as they are legally allowed, and it appears that many are now testing the limits. In light of what appears to be a de-emphasis from the SEC on the administrative checks surrounding CTR redactions, public companies may be taking more aggressive stances on what information they redact in publicly filed exhibits.

C. Implications

The SEC’s modernization and simplification of its confidential treatment rules in 2019 made it drastically easier for public companies to redact information from their material contract exhibits. The results shown in this report reveal that public companies have already begun redacting information more often—and are thus keeping more sensitive (or purportedly sensitive) information away from their competitors—than before the rule changes. Overall, the rule changes appear to be a positive development for most public companies, as well as the SEC, primarily due to the associated cost savings and relieving administrative burden.

When looking at the impact of these changes on the market as a whole, the analysis of the increase in confidential treatment redactions is more mixed. The SEC’s loosened CTR application standards will undoubtedly increase the amount of redacted information that is actually material—and thus should have been disclosed to the public. The question is, to what degree? Measuring just how much material information is improperly redacted will be all but impossible to quantify, especially in light of the redactions obviously not being made public for study. But if the redactions are more extensive than expected, this could negatively impact competitive activity in a way the rule changes could not have intended. Conceivably, the SEC could further deter public companies from over-redacting by imposing serious penalties for clear violations of the new rules, but this has not yet occurred and does not seem likely.

In the end, assuming the SEC maintains a strong level of oversight, it seems unlikely that the increased volume of redacted exhibits will dramatically affect the investing public or the market in general. Public companies should remain diligent about disclosing all material information and complying with the updated rules to avoid unnecessary costs and compliance and enforcement risks.


* Associate, Corporate & Securities, Troutman Pepper Hamilton Sanders LLP, Philadelphia, Pennsylvania; J.D., Villanova University Charles Widger School of Law; B.A., University of Michigan. The views expressed in this Study are only those of the Authors and do not reflect the views of Troutman Pepper Hamilton Sanders LLP or its clients.

** Associate, Corporate & Securities, Troutman Pepper Hamilton Sanders LLP, Berwyn, Pennsylvania; J.D., Villanova University Charles Widger School of Law; B.A., Villanova University. The views expressed in this Study are only those of the Authors and do not reflect the views of Troutman Pepper Hamilton Sanders LLP or its clients.

  1. See Rules and Regulations for the Securities and Exchange Commission and Major Securities Law, U.S. Sec. & Exch. Comm’n, https://www.sec.gov/about/laws/secrulesregs (last visited Apr. 3, 2023).

  2.  5 U.S.C. § 552 (2018).

  3.  17 C.F.R. § 229.601(b)(10) (2022).

  4.  17 C.F.R. § 230.406 (2022).

  5.  17 C.F.R. § 240.24b-2 (2022).

  6.  5 U.S.C. § 552(b)(4) (2018). See FAST Act Modernization and Simplification of Regulation S-K, 84 Fed. Reg. 12,674, 12,680 n.45 (Apr. 2, 2019).

  7. See generally, Securities and Exchange Commission Confidential Treatment Procedure Under Rule 83, U.S. Sec. & Exch. Comm’n, https://www.sec.gov/foia/conftreat (last visited Apr. 3, 2023).

  8. For an example of an order denying confidential treatment, see Order Denying Applications by New York Stock Exchange, LLC, Release No. 34-83760 (Aug 1, 2008), available at https://www.sec.gov/rules/other/2018/34-83760.pdf.

  9.  Press Release, SEC Adopts Rules to Implement FAST Act Mandate to Modernize and Simplify Disclosure, U.S. Sec. & Exch. Comm’n (Mar. 20, 2019), https://www.sec.gov/news/press-release/2019-38.

  10.  Fixing America’s Surface Transportation Act, Pub. L. No. 114-94, § 72002–72003, 129 Stat. 1312 (2015).

  11.  FAST Act Modernization and Simplification of Regulation S-K, 84 Fed. Reg. at 12,680.

  12.  139 S. Ct. 2356 (2019).

  13.  Id. at 2366; Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets, 86 Fed. Reg. 3496, 3530 (Jan. 14, 2021).

  14. Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets, 86 Fed. Reg. at 3530. In addition, confidential treatment secured under the new rules is indefinite rather than having a fixed lifespan as it did in the past. See Div. Corp. Fin, U.S. Sec. & Exch. Comm’n, CF Disclosure Guidance: Topic No. 7, Confidential Treatment Applications Submitted Pursuant to Rules 406 and 24b-2 (Dec. 19, 2019, as amended March 9, 2021), https://www.sec.gov/corpfin/confidential-treatment-applications#options. This means that under the new rules, public companies no longer need to file requests to extend confidential treatment. However, public companies that secured confidential treatment of exhibits prior to the rule changes should confirm the SEC’s instructions for how to handle extensions going forward. Id.

  15. Search for Confidential Treatment Orders, U.S. Sec. & Exch. Comm’n, https://www.sec.gov/edgar/searchedgar/ctorders.htm (last visited December 31, 2022).

  16. FAST Act Modernization and Simplification of Regulation S-K, 84 Fed. Reg. at 12,692.

  17. Id.

  18. Id.

  19. Id. at 12,719.

  20. Id. at 12,691 (“As a matter of practice, the staff generally does not object where a registrant omits PII from exhibits without also submitting a confidential treatment request under Rule 406 or Rule 24b-2. To codify this current staff practice, the Commission proposed new Item 601(a)(6) to allow registrants to omit PII from their required Item 601 exhibits without submitting a confidential treatment request for the information.”).

  21. New Rules and Procedures for Exhibits Containing Immaterial, Competitively Harmful Information, U.S. Sec. & Exch. Comm’n (Apr. 1, 2019), https://www.sec.gov/corpfin/announcement/new-rules-and-procedures-exhibits-containing-immaterial.

  22. See Filing Review Process, U.S. Sec. & Exch. Comm’n, https://www.sec.gov/divisions/corpfin/cffilingreview.htm (last visited December 31, 2022).

  23. FAST Act Modernization and Simplification of Regulation S–K, 84 Fed. Reg. at 12,705–06.

  24. Id.

  25. Id.

  26. See 17 C.F.R. § 229.601(b)(10)(iv) (2022).

  27. See New Rules and Procedures for Exhibits Containing Immaterial, Competitively Harmful Information, supra note 23.

  28. For exhibits filed from 2012-2018 (prior to 2019 rule changes), the following search terms were used: ((omit* OR redact* OR omission*) w/40 (“filed separately” OR “separately filed”)) OR “confidential treatment has been requested”.

    For exhibits filed from 2019-2022 (to account for the 2019 rule changes), the following search terms were used: (((omitted OR omits OR omission* OR redacted OR redacts OR redaction*) w/40 “not material”) OR (“has been excluded” w/20 “not material”)) OR (((omit* OR redact* OR omission*) w/40 (“filed separately” OR “separately filed”)) OR “confidential treatment has been requested”).

  29. FAST Act Modernization and Simplification of Regulation S-K, 84 Fed. Reg. at 12,682 n.69.

  30. See Christine Dobridge, Rebecca John & Berardino Palazzo, The Post-COVID Stock Listing Boom, Bd. Governors Fed. Rsrv. Sys.: FED Notes (June 17, 2022), https://www.federalreserve.gov/econres/notes/feds-notes/the-post-covid-stock-listing-boom-20220617.html#:~:text=Using%20data%20for%20the%20three,increase%20of%20about%2028%20percent; Kristin Broughton, M&A Likely to Remain Strong in 2022 as Covid-19 Looms Over Business Plans, Wall St. J. (Dec. 23, 2021 5:30 AM), https://www.wsj.com/articles/m-a-likely-to-remain-strong-in-2022-as-covid-19-looms-over-business-plans-11640255406. A SPAC is a type of blank check company “with no operations that offers securities for cash and places substantially all the offering proceeds into a trust or escrow account for future use in the acquisition of one or more private operating companies. Following its initial public offering . . . the SPAC will identify acquisition candidates and attempt to complete one or more business combination transactions after which the company will continue the operations of the acquired company or companies . . . as a public company.” Div. Corp. Fin, U.S. Sec. & Exch. Comm’n, CF Disclosure Guidance: Topic No. 11, Special Purpose Acquisition Companies (Dec. 22, 2020), https://www.sec.gov/corpfin/disclosure-special-purpose-acquisition-companies.

  31. The search excluded amended filings, such as 10-K/A, 10-KT/A, 1-K/A, and 20-F/A forms, to avoid duplication.

  32. The decline in the number of public companies extends all the way back to the 1990s. Heightened regulation of public companies, especially via the Sarbanes-Oxley Act of 2002, has incentivized companies to stay private or go private. See Jason M. Thomas, Where Have All the Public Companies Gone?, Wall St. J. (Nov. 16, 2017, 7:10 PM), https://www.wsj.com/articles/where-have-all-the-public-companies-gone-1510869125. The expansion of private equity and venture capital are other driving forces in this movement. See Spencer Israel, The Number Of Companies Publicly Traded In The US Is Shrinking—Or Is It?, MarketWatch (Oct. 30, 2020, 8:53 AM), https://www.marketwatch.com/story/the-number-of-companies-publicly-traded-in-the-us-is-shrinkingor-is-it-2020-10-30?mod=investing.

  33. Where Have All the Public Companies Gone?, Bloomberg (Apr. 9, 2018, 7:00 AM), https://www.bloomberg.com/opinion/articles/2018-04-09/where-have-all-the-u-s-public-companies-gone.

  34. FAST Act Modernization and Simplification of Regulation S-K, 84 Fed. Reg. at 12,705.

By Ben Woessner 

The last few decades have seen significant debate surrounding the generous compensation of the top executives of publicly-held corporations.  While some view the current system of pay as functional and driven by market forces like scarce executive talent,[1] many watch the upward trajectory of an increasingly disproportionate gap between executive pay and the average American’s salary with equally growing dismay.[2]

Some commentators point to the fact that executive compensation packages have increasingly utilized stock-based compensation to account for the trending upward spiral of executive pay, which may pose a threat to a company by potentially misaligning the interests of its directors with those of its shareholders.[3]  For example, while stock-based compensation attempts to award executives based on stock performance, thereby motivating higher returns to shareholders, it can also incentivize hedging transactions that permit directors to shield themselves from stock declines while still benefiting from compensation.[4]

In response to concerns regarding corporate transparency in the wake of the Financial Crisis of 2008, Congress instituted disclosure reforms through the Dodd-Frank Act of 2010, which, among other measures, included provisions for “clawback” recovery of incentive-based pay awarded on the basis of erroneous accounting reports.[5]  The implementation of a provision of the Act requiring a clawback of executive pay based on inaccurate reports regardless of whether the errors are “due to fraud, error, or any other factor” was delayed until recently.[6]

On Wednesday, October 26, the Securities and Exchange Commission (“SEC”) voted 3-2 in favor of a provision of the Dodd-Frank Act requiring publicly held companies to implement clawback policies to recover erroneously awarded incentive-based compensation paid to directors, even where the director had no responsibility over the inaccurate accounting statement.[7]  The new rule will require exchanges to “prohibit the listing of issuers that do not develop and implement policies to recover erroneously awarded incentive-based compensation.”[8]  These policies will be triggered whenever companies are forced to issue financial restatements for later-discovered accounting errors and will apply to compensation awarded up to three years from the policy’s implementation.[9]

The SEC intends the rule to “return erroneously awarded compensation to the issuer and its shareholders.”[10]  In so doing, the Commission hopes to realign the interests of executives and shareholders by increasing corporate accountability regarding the distorted incentives potentially created by stock-related forms of incentive-based compensation.[11]

However, the clawback rule may suffer from overbroad definitions that potentially undercut its goals to align executive and shareholder interest.  The first of these definitions concerns what qualifies as an accounting restatement that would trigger a recovery of incentive-based compensation.  Under the original proposal of the rule, only “Big R” restatements, or those that are “material to previously issued financial statements,” would trigger a clawback.[12]  However, the newly adopted rule also requires recovery of pay after so-called “little r” restatements—those that correct nonmaterial errors that could constitute material errors if left unreported.[13]

While the SEC hopes that including both material and immaterial restatements will incentivize executives to assert more control over accounting, thereby reducing instances of accounting error and allowing shareholders to put greater trust in the financial reporting of a company,[14] the rule contains another expansive definition that potentially undermines this goal.  The rule’s definition of “executive officer” not only includes the President, CFO, and principal accounting officer, but also “any other officer who performs a policymaking function.”[15]  As a result, even individuals who may have no actual control over the company’s compliance with accounting rules, and therefore no practical way to ensure greater accountability, are at risk of a compensation clawback.[16]

Furthermore, the clawback rule includes an expansive definition of what qualifies as incentive-based compensation that is subject to recovery if a company issues a financial restatement, including “any compensation that is granted, earned, or vested based wholly or in part upon the attainment of any financial reporting measure.”[17]  Therefore, at-risk compensation could include not only bonuses and equity-based compensation, but also nonqualified deferred compensation and long-term incentive compensation, so long as it is granted at least in part on the attainment of a financial reporting measure.[18]

Accordingly, critics of the rule argue that companies are likely to significantly decrease the amount of at-risk incentive compensation offered to executives, who will instead elect for a compensation restructuring to retain executive talent with higher salaries or increased discretionary bonuses unrelated to performance goals.[19]  Such restructuring would tend to go against the very heart of the clawback rule’s purpose—while clawbacks hope to align executive and shareholder interests through increased accountability, a shift away from performance-based compensation altogether may untie executive incentives from stock performance to the shareholder’s detriment.

When the rule goes into effect in about one year, the increasing trend toward shareholder activism may serve to keep potentially detrimental compensation restructuring in check.[20]  In fact, at least one study has shown that clawback policies required by the new rule are popular with shareholders as demonstrated by positive stock returns for companies following the initial 2015 announcement of the newly adopted clawback rule.[21] Nevertheless, in addition to being “burdensome to administer,” the rule may increase the divide between executive and shareholder interests as a result of its sweeping definitions, raising doubts as to whether its proposed benefit will outweigh its costs.[22]

[1] See generally Randall S. Thomas, Explaining the International CEO Pay Gap: Board Capture or Market Driven?, 57 Vand. L. Rev. 1171 (2004).

[2] Josh Bivens & Jori Kandra, Economic Policy Institute, CEO Pay Has Skyrocketed 1,460% Since 1978 (2022), https://www.epi.org/publication/ceo-pay-in-2021/.

[3] Luis A. Aguilar, Aligning the Interests of Company Executives and Directors with Shareholders, Harv. L. Sch. F. on Corp. Governance (Feb. 16, 2015), https://corpgov.law.harvard.edu/2015/02/16/aligning-the-interests-of-company-executives-and-directors-with-shareholders/.

[4] Id.

[5] Gary Gensler, Statement by Chair Gensler on Final Rules Regarding Clawbacks of Erroneously Awarded Compensation, Harv. L. Sch. F. on Corp. Governance (Oct. 30, 2022), https://corpgov.law.harvard.edu/2022/10/30/statement-by-chair-gensler-on-final-rules-regarding-clawbacks-of-erroneously-awarded-compensation/.

[6] Id.

[7] Paul Kiernan, Accounting Errors to Cost Executives Their Bonuses Under SEC Rule, Wall St. J. (Oct. 26, 2022), https://www.wsj.com/articles/sec-to-vote-on-rule-to-claw-back-executive-pay-11666792822.

[8] Sec. & Exch. Comm’n, Listing Standards for Recovery of Erroneously Awarded Compensation 125 (2022), https://www.sec.gov/rules/final/2022/33-11126.pdf.

[9] Id. at 86.

[10] Id. at 80.

[11] Id.

[12] Id. at 28.

[13] Meredith O’Leary et al., What SEC Bonus Clawback Rule Means For Public Cos., Law360 (Nov. 1, 2022, 4:52 PM), https://plus.lexis.com/newsstand#/law360/article/1545558?crid=719884c7-8ae5-4c53-95a7-cbe621d17e6d.

[14] Id.

[15] Id.

[16] O’Leary et al., supra note 13.

[17] Sec. & Exch. Comm’n, supra note 8, at 57.

[18] O’Leary et al., supra note 13.

[19] Kiernan, supra note 7.

[20] Id.

[21] Id.

[22] O’Leary et al., supra note 13.

By Michael J. Riedl


Shaquille O’Neal.  Patrick Mahomes.  Serena Williams.  Alex Rodriguez.  No, this is not a reading of the guest list at the 2021 ESPY Awards,[1] but rather a list of athletes on the management or advisory boards of various Special Purpose Acquisition Companies (“SPACs”).[2]  SPACs, far from a novel financial vehicle,[3] grew to prominence over the past few years as record numbers of SPACs listed on exchanges across the globe.[4]  The capital flooding into SPACs reached a high watermark when investor William Ackman raised $4 billion for his fund, Pershing Square Tontine Holdings (“PSTH”), in July 2020.[5]  However, issuance[6] dramatically slowed towards the end of 2020,[7] and the valuation of SPACs both pre- and post-business combination fell precipitously.[8]

In a nutshell, SPACs are capital vehicles for purchasing equity ownership in a private company and then bringing that company public through a business combination.[9]  SPACs raise money through a fairly traditional Initial Public Offering (“IPO”), with a few key differences.[10]  Unlike a traditional IPO, in which the company uses the proceeds from the issuance for further growth or expansion, SPAC IPO proceeds are held in a trust account until a merger with a private company occurs.[11]  Additionally, most SPACs issue warrants (the right to purchase shares of the SPAC at a certain price)[12] at the time of the IPO to investors and SPAC sponsors.[13]  Lastly, because SPAC IPOs are not taking an existing company public at the time of IPO, reporting and regulatory requirements are significantly lessened.[14]

In the early stages of the SPAC resurgence, both issuance and post-business combination valuation remained healthy.[15]  For example, after combining with VectoIQ Acquisition Corp.,[16] the hydrogen vehicle start-up Nikola soared to a market capitalization of $34 billion—on almost no revenue.[17]  However, investors soon learned that Nikola’s groundbreaking hydrogen truck was rolling downhill in a demonstration and not moving on its own power.[18]  Nikola’s CEO at the time, Trevor Milton, was subsequently indicted for securities and wire fraud.[19]  In addition, the “SPAC King,” Chamath Palihapitiya, who has led ten SPAC IPOs,[20] ran into significant investor pushback after the Securities and Exchange Commission (“SEC”) launched an investigation into one of his SPAC combinations.[21]

Outside of the concern about the quality of the companies that SPACs are bringing public,[22] the decline in SPAC activity may result from a change in guidance from the SEC,[23] recent investor behavior,[24] and an uptick in shareholder litigation.[25] On April 12, 2021, the SEC issued guidance that the warrants issued by a vast majority of SPACs should be classified as liabilities on financial statements, not as equity instruments.[26]  This guidance was based on the consideration that, when sponsor warrants are transferred by sponsors to non-sponsors, their settlement price changes in ways not indexed to the SPAC’s underlying price.[27]  This change in guidance led to a rush of SPACs to file Form 8-Ks to update their previous filings.[28]

More recently, SPACs have been hit by a wave of redemptions prior to business combination.[29]  SPACs are required to offer shareholders the ability to redeem their shares before the official merger between the entities for a pro-rata share of the money in the trust account.[30]  This requirement has been said to make SPACs a relatively low-risk investment, at least before business combination.[31]  For example, a shareholder who purchased ten shares of a SPAC IPO priced at ten dollars per share can redeem their shares for one hundred dollars pre-combination.  However, in recent months, redemption rates have skyrocketed, with some SPACs seeing redemption rates over 50 percent, and Sandbridge Acquisition Corp. (“SBG”) having a redemption rate of 86 percent.[32]  Curiously, these redemptions are happening after shareholders—many of whom will later redeem—approve the business combination.[33]  One can only assume that investors want to get their money out of the SPAC as quickly, and at as high of a price, as possible.

Besides the apparent effects on investor sentiment, one consequence of the high redemption rate is that the amount of money held in trust by some SPACs have fallen below the minimum capital requirement set by the SPAC.[34]  Because investors can redeem their shares for the cash held in trust prior to business combination, a minimum capital requirement is typically structured into SPAC mergers to allow the target company an “out” when the capital they were expecting to get no longer exists.[35] For example, SBG, with its 86 percent redemption rate,[36] was $125 million short of its minimum capital requirement.[37]  However, the company they merged with, Owlet Baby Care, Inc., waived the capital requirement  in order to consummate the deal.[38]  For investors that did not redeem, this meant they were left owning equity in a company with significantly less capital to grow their business.[39]  Should the high redemption trend continue, it might further be a headwind on new SPAC issuance, since investors may lack confidence in SPACs and private companies may see SPAC mergers as increasingly risky.

Lastly, and perhaps most importantly, shareholders are beginning to bring derivative suits against SPACs.[40]  Most actions have been brought regarding falling share prices, where investors allege that the company mislead investors.[41]  However, after Mr. Ackman’s fund, PSTH, failed to acquire an equity stake in Universal Music Group due to the likelihood of violating SEC regulations,[42] an investor brought suit alleging the fund was an “Investment Company.”[43]  Such a lawsuit, according to Mr. Ackman, will “have a chilling effect on the ability of other SPACs to consummate merger transactions or to engage in IPOs until the litigation is resolved.”[44]

At the heart of the suit is whether Mr. Ackman’s fund, and SPACs writ large, is an Investment Company as classified by the Investment Company Act of 1940, 15 U.S.C. §§ 80a-1 to 64.[45]  The plaintiff’s lawyers allege that PSTH invested in short-term U.S. Treasuries which qualifies them as an Investment Company.[46]  If so, the sponsor warrants and other compensation structures that are ubiquitous in the SPAC industry could be found to violate the Investment Company Act.[47]  In a rebuke to this assertion, fifty-eight of the largest law firms in the world signed a joint statement stating that they “view the assertion that SPACs are investment companies as without factual or legal basis.”[48]  It is the view of the collective firms that SPACs are “engaged primarily in identifying and consummating a business transaction,” not a company that is “primarily, in the business of investing, reinvesting or trading in securities.”[49]

Regardless of how the merits of the lawsuit turn out, it has already affected Mr. Ackman’s SPAC, as he plans to return the $4 billion that he raised.[50]  However, Mr. Ackman is already looking to create another capital vehicle called a Special Purpose Acquisition Rights Company (“SPARC”).[51]  Unlike a SPAC, which requires investors to purchase shares at an IPO, a SPARC does not require such an investment.[52]  A SPARC issues warrants which grant rights, but not obligations, for warrant holders to purchase shares in a proposed future business combination.[53]  This has the benefit of allowing investors to put their capital to work in other investments while the SPARC seeks a merger target.[54]  Whether or not this new capital vehicle gets approved is ultimately up to the SEC and the New York Stock Exchange.[55]  However, one thing is clear, even if the SPAC boom has officially faded, sophisticated investors will continue to financially engineer capital vehicles to pursue business combinations.

[1]See Press Release, Isabelle Lopez, ESPN, Nominees Announced for The 2021 ESPYS Presented by Capital One as Fan Voting Begins, (June 16, 2021) https://espnpressroom.com/us/press-releases/2021/06/nominees-announced-for-the-2021-espys-presented-by-capital-one-as-fan-voting-begins/.

[2] Amrith Ramkumar, The Celebrities From Serena Williams to A-Rod Fueling the SPAC Boom, Wall St. J. (Mar. 17, 2021, 5:32 AM), https://www.wsj.com/articles/the-celebrities-from-serena-williams-to-a-rod-fueling-the-spac-boom-11615973578.

[3] See Devin Sullivan, A Look at SPACs: From the 90s to Covid-19, IR Magazine (Aug. 11, 2020), https://www.irmagazine.com/small-cap/look-spacs-90s-covid-19.

[4] Id.

[5] Tomi Kilgore, Billionaire Bill Ackman Has a $4 Billion ‘Blank Check’ to Buy a Company, but He Hasn’t Said Which One, MarketWatch (July 23, 2020, 7:40 AM), https://www.marketwatch.com/story/billionaire-bill-ackman-has-a-4-billion-blank-check-to-buy-a-company-but-he-hasnt-said-which-one-2020-07-22.

[6] Adam Hayes, Issue, Investopedia, https://www.investopedia.com/terms/i/issue.asp (Aug. 30, 2021).

[7] See Ben Scent, Wall Street’s $100 Billion SPAC Boom Upends the League Tables, Bloomberg, https://www.bloomberg.com/news/articles/2021-04-01/wall-street-s-100-billion-spac-boom-is-resetting-the-rankings (Apr. 1, 2021, 4:10 PM).

[8] Yun Li, SPACs are becoming less of a sure thing as the deals get stranger, shares roll over, CNBC, https://www.cnbc.com/2021/03/04/spacs-are-becoming-less-of-a-sure-thing-as-the-deals-get-stranger-shares-roll-over.html (Mar. 4, 2021).

[9] Ramey Layne & Brenda Lenahan, Special Purpose Acquisition Companies: An Introduction, Harv. L. Sch. Forum on Corp. Governance (July 6, 2018), https://corpgov.law.harvard.edu/2018/07/06/special-purpose-acquisition-companies-an-introduction/.

[10] Id.

[11] Id.

[12] James Chen, Warrant, Investopedia, https://www.investopedia.com/terms/w/warrant.asp (Aug. 8, 2021).

[13] Joel L. Rubenstein et al., Clarity Emerges in the Aftermath of the SEC Statement on SPAC Warrant Accounting: A Roadmap for the Changes to Permit Equity Classification, White & Case LLP (June 1, 2021), https://www.whitecase.com/publications/alert/clarity-emerges-aftermath-sec-statement-spac-warrant-accounting-roadmap-changes.

[14] Layne & Lenahan, supra note 9.

[15] See Nicholas Jasinski, Why Nikola Decided to Merge With a SPAC. And Why More Such Deals Are Coming., Barron’s (Aug. 2, 2020, 8:00 AM), https://www.barrons.com/articles/after-the-sept-11-attacks-how-barrons-helped-investors-navigate-a-changed-world-51630604795.

[16] Press Release, Nikola Corporation, Nikola and VectoIQ Acquisition Corp. Announce Closing of Business Combination (June 2, 2020), https://nikolamotor.com/press_releases/nikola-and-vectoiq-acquisition-corp-announce-closing-of-business-combination-77.

[17] Edward Ludlow & Craig Trudell, Nikola May Not Be Next Tesla, But Its Valuation Is More Extreme, Bloomberg, https://www.bloomberg.com/news/articles/2020-06-09/meet-nikola-a-26-billion-electric-truck-maker-with-no-revenue (June 10, 2020, 11:15 PM).

[18] Timothy B. Lee, Nikola Admits Prototype Was Rolling Downhill in Promotional Video, Ars Technica (Sept. 14, 2020, 1:58 PM), https://arstechnica.com/cars/2020/09/nikola-admits-prototype-was-rolling-downhill-in-promotional-video/; see also Nikola: How to Parlay An Ocean of Lies Into a Partnership with the Largest Auto OEM in America, Hindenburg Rsch. (Sep. 10, 2020), https://hindenburgresearch.com/nikola/.

[19] Michael Wayland, Grand Jury Indicts Trevor Milton, Founder of Electric Carmaker Nikola, on Three Counts of Fraud, CNBC, https://www.cnbc.com/2021/07/29/us-prosecutors-charge-trevor-milton-founder-of-electric-carmaker-nikola-with-three-counts-of-fraud.html (July 29, 2021, 4:16 PM).

[20] David Pogemiller, Chamath and Social Capital’s 4 New SPACs IPO Today, TheStreet, https://www.thestreet.com/boardroomalpha/spac/chamath-spac-king-dnaa-dnab-dnac-dnad-ipo (June 30, 2021) (NASDAQ: DNAA, DNAB, DNAC, DNAD; NYSE: IPOA, IPOB, IPOC, IPOE, IPOD, IPOF).

[21] See Zeke Faux, The SPAC King Is Doing Just Fine Even as the Bubble Starts to Burst, Bloomberg Businessweek (Mar. 13, 2021, 5:00AM), https://www.bloomberg.com/news/features/2021-05-13/spac-king-chamath-palihapitiya-hopes-his-hype-will-keep-mesmerizing-you.

[22] Li, supra note 8.

[23] Yun Li, SPAC Transactions Come to a Halt Amid SEC Crackdown, Cooling Retail Investor Interest, CNBC, https://www.cnbc.com/2021/04/21/spac-transactions-come-to-a-halt-amid-sec-crackdown-cooling-retail-investor-interest.html (Apr. 22, 2021, 9:35 AM).

[24] See infra note 29 and accompanying text.

[25] See infra note 40 and accompanying text.

[26] John Coates & Paul Munter, Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies (“SPACs”), SEC (Apr. 12, 2021), https://www.sec.gov/news/public-statement/accounting-reporting-warrants-issued-spacs.

[27] Rubenstein et al., supra note 13.

[28] See Coates & Munter, supra note 26.

[29] David Pogemiller, A SPAC Risk Exposed?, TheStreet (July 16, 2021), https://www.thestreet.com/boardroomalpha/spac/spac-risk-exposed-redemptions-sponsor-promote.

[30] Layne & Lenahan, supra note 9.

[31] See Pogemiller, supra note 29.

[32] Id.

[33] David Drapkin, Spring Valley / AeroFarms Need More Capital, TheStreet (Aug. 30, 2021), https://www.thestreet.com/boardroomalpha/spac/spacs-sv-snooze-september.

[34] Pogemiller, supra note 29.

[35] See Pamela Marcogliese et al., 20 Key Considerations for Private Companies Evaluating Whether to Be Acquired by a SPAC, Freshfields Bruckhaus Deringer LLP (July 27, 2020), https://blog.freshfields.us/post/102gcbg/20-key-considerations-for-private-companies-evaluating-whether-to-be-acquired-by.

[36] See Pogemiller, supra note 29.

[37] See Sandbridge Acquisition Corp., Current Report (Form 10-K, Item 8.01) (July 14, 2021) (At a special meeting of stockholders, 19,758,773 shares of common stock were presented for redemption, which left $15 million of “Available Sandbridge Cash.” The agreement with Owlet Baby Care, Inc., provided Owlet the option to leave the deal if, after redemption, Sandbridge did not have $140 million in cash.).

[38] See Sandbridge Acquisition Corp., Current Report (Form 10-K, Exhibit 99.1) (July 14, 2021), https://sec.report/Document/0001140361-21-024354/brhc10026886_ex99-1.htm.

[39] See Pogemiller, supra note 29.

[40] Jean Eaglesham, SPACs Are Having Their Day—in Court, Wall St. J. (Aug. 25, 2021, 7:00 AM), https://www.wsj.com/articles/spacs-are-having-their-dayin-court-11629889200.

[41] Id.

[42] Thomas Seal & Nishant Kumar, Ackman Abandons Universal Music SPAC Deal After SEC Backlash, Bloomberg, https://www.bloomberg.com/news/articles/2021-07-19/pershing-square-decides-not-to-proceed-with-universal-music-deal (July 19, 2021, 8:49 AM).

[43] Complaint at 6, Assad v. Pershing Square Tontine Holdings, Ltd., No. 1:21-cv-06907 (S.D.N.Y.  Aug. 17, 2019), ECF No. 1.

[44] Press Release, William A. Ackman, CEO, Pershing Square Tontine Holdings, Ltd., Pershing Square Tontine Holdings, Ltd. Releases Letter to Shareholders (Aug. 19, 2021), https://pstontine.com/wp-content/uploads/2021/08/8.19.2021-Press-Release-PSTH-Letter-to-Shareholders.pdf.

[45] Assad, supra note 31, at 6.

[46] Id. at 10–11.

[47] Id. at 43, 47.

[48] Press Release, Sidley Austin LLP, Over 55 of the Nation’s Leading Law Firms Respond to Investment Company Act Lawsuits Targeting the SPAC Industry (Aug. 30, 2021), https://www.sidley.com/-/media/update-pdfs/2021/08/joint-statement.pdf?la=en.

[49] Id.

[50]Ackman, supra note 44, at 2.

[51] Andrew Ross Sorkin et al., Bill Ackman’s SPAC Deal Gets Messier, N.Y. Times, https://www.nytimes.com/2021/08/20/business/dealbook/bill-ackman-spac-sparc.html (Aug. 20, 2021).

[52] Id.

[53] See, e.g., Press Release, Pershing Square Tontine Holdings, Ltd., Pershing Square Tontine Holdings, Ltd. (“PSTH”) to Acquire 10% of the Ordinary Shares of Universal Music Group (“UMG”) from Vivendi S.E. for Approximately $4 Billion, Representing an Enterprise Value of €35 Billion (June 20, 2021), https://pstontine.com/wp-content/uploads/2021/06/Final-Announcement-Press-Release-6.20.2021.pdf.

[54] Id. at 5.

[55] Sorkin et al., supra note 51.

Post image by Ken Teegardin on Flickr