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By Yin Wilczek
Aug. 20 — As the Securities and Exchange Commission continues to ramp up the use of its administrative forum, the U.S. Court of Appeals for the District of Columbia may have a chance to weigh in on whether that forum is inherently unfair.
Houston hedge-fund manager George Jarkesy Jr. Aug. 12 asked the D.C. Circuit to review a district court decision declining to bar the SEC from going forward with an administrative action against him over allegations that he steered bloated fees to the John Thomas Financial Inc. brokerage.
In asking the district court to issue preliminary and permanent injunctions, Jarkesy argued that his constitutional rights would be violated if the action proceeded because the commission has “stripped” the administrative proceeding (AP) process of “minimum standards of fairness.”
The D.C. Circuit directed Jarkesy to file his initial submissions by Sept. 11. Jarkesy's attorney—Mark Bierbower, Hunton & Williams LLP, Washington—did not respond to a request for comment.
The SEC's increasing use of its administrative venue over the last few years was spurred by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act.
The financial reform statute enhanced the SEC's enforcement powers in several respects, including giving it the authority to obtain monetary penalties in APs against all individuals, not just those associated with regulated entities. The legislation also increased the amount of fines that the SEC can seek in administrative cases.
Defense attorneys have long expressed concern over the SEC's intent to proceed administratively rather than in federal court, noting that among other procedural disadvantages for respondents, discovery is sharply limited and administrative law judge findings are reviewed by the commission itself.
In June, SEC Enforcement Director Andrew Ceresney said the commission intends to bring more insider trading actions in its administrative forum. At the time, Ceresney—when asked whether he was concerned about increasing court scrutiny given the SEC's procedural leg-up in APs—responded that the commission is on “pretty solid ground on the constitutionality” of ALJ rulings.
In anticipation of more administrative actions, the SEC recently added two new ALJs, bringing its total complement to five.
Jarkesy highlighted the commission's procedural advantages in his complaint to the district court.
“By charging Plaintiffs in an AP instead of federal court, the SEC has treated Plaintiffs differently—to their detriment—from others similarly situated,” Jarkesy and John Thomas Capital Management LLC—now known as Patriot28 LLC—argued in the complaint. “This different treatment has forced Plaintiffs to defend themselves in the truncated AP proceeding with an extremely high volume of evidence, virtually no discovery, no protection of the Federal Rules of Civil Procedure, no counterclaims, no Federal Rules of Evidence (or any discernible standard governing evidence), no jury, and no Article III judge, when others in the same situation have been afforded all of those protections in federal court.”
In declining to issue an injunction, the district court found that it had no jurisdiction to hear the case because under the review scheme set out in the 1934 Securities Exchange Act, a commission final order must be appealed to a federal court of appeals. In this case, the district court noted, there was no final order entered by the SEC.
After the district court's decision, ALJ Carol Fox Foelak held a 12-day hearing in Jarkesy's administrative case.
In the latest update, the SEC Aug. 13—one day after Jarkesy filed his appeal to the D.C. Circuit—extended to Oct. 17 the date by which the ALJ must file an initial decision.
Meanwhile, there is a similar case pending before the U.S. District Court for the Southern District of New York questioning the fairness of the SEC's administrative forum. The case was filed by investment adviser Harding Advisory LLC and its chief executive officer Wing F. Chau to stop the commission from proceeding administratively against them over alleged violations involving a 2006 collateralized debt obligation.
After the district court declined to issue a preliminary restraining order to stop the commission from proceeding with its administrative case, ALJ Cameron Elliot held a 17-day hearing between March and April. Elliot's initial decision is due Sept. 14, but Chief ALJ Brenda Murray has asked the commission to extend the deadline for another 120 days.
Meanwhile, Russell Ryan, a Washington-based partner at King & Spalding LLC, told Bloomberg BNA Aug. 20 that Jarkesy likely will have an uphill battle before the D.C. Circuit.
Most courts that have heard similar cases so far have not been receptive to this type of challenge before the administrative process has run its course, Ryan said. However, given that this is a constitutional issue, Jarkesy could get some traction before the D.C. Circuit by arguing that he would suffer irreparable harm if he had to wait until his case was fully adjudicated by the SEC, Ryan added.
“The practical irreparable harm for most people is that if you have to go through a two-year administrative proceeding before you get your final order, a lot of respondents are bankrupted by then,” he said. “They have no money to go to the courts afterwards.”
In the meantime, SEC respondents are starting to raise the constitutional issues in their AP briefs to preserve the arguments should they lose at the SEC level, Ryan said. “Those cases will play out over the next year or two but eventually some of them will get to a court of appeals,” he said. At that time, ripeness and subject-matter jurisdiction will not be barriers and “a court like the D.C. Circuit will eventually grapple with this.”
Ryan wrote an Aug. 4 opinion piece in the Wall Street Journal questioning the constitutionality of the SEC AP process.
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The D.C. Circuit's scheduling order is available at http://www.bloomberglaw.com/public/document/George_Jarkesy_Jr_et_al_v_SEC_Docket_No_1405196_DC_Cir_Aug_12_201.
The district court's memorandum opinion is available at http://www.bloomberglaw.com/public/document/JARKESY_et_al_v_UNITED_STATES_SECURITIES_AND_EXCHANGE_COMMISSION_/2.
The SEC's extension order in the In re John Thomas Capital Mgmt. Grp. LLC case is available at http://www.sec.gov/litigation/opinions/2014/33-9631.pdf.
Murray's extension motion is available at http://www.sec.gov/alj/aljorders/2014/ap-1690.pdf.
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