The Supreme Court will hear argument on November 29, 2023 in a case that has the potential to fundamentally alter the manner in which the Securities and Exchange Commission resolves its enforcement actions. Specifically, the decision in SEC v. Jarkesy, Jr., No. 22-859 has the potential to fundamentally alter the use of administrative proceedings. The case presents three issues for resolution (as stated by the SEC in its merits brief):

Whether statutory provisions that empower the SEC to initiate and adjudicate administrative enforcement proceedings seeking civil penalties violate the Seventh Amendment.

Whether statutory provisions that authorize the SEC to choose to enforce the securities laws through an agency adjudication instead of filing a district court action violate the nondelegation doctrine.

Whether Congress violated Article II by granting for-cause removal protection to administrative law judges in agencies whose heads enjoy for-cause removal protection.

The opinion of the lower court is available at 34 F. 4th 446 (5th Cir.). The briefs of the parties are briefly summarized below.

Background

Respondent George Jarkesy operated two hedge funds through his investment advisory firm, Patriot28 L.L.C. The funds had 28 investors and about $24 million in assets under management. The charges brought against Petitioner were based primarily on misrepresentations. For example, Respondents told brokers and investors that a prominent accounting firm served as the auditor to the funds. The claim was not correct. They also told investors that a prominent investment bank represented the funds. The claim was incorrect. The investment strategies of the funds were misrepresented. The financial results of the funds were misstated.

A hearing before an ALJ, initiated in 2013, resulted in findings that Mr. Jarkesy had violated provisions of the Securities Act, the Exchange Act and the Advisers Act. Respondents’ claim that the agency adjudication violated the Seventh Amendment was also rejected. Similarly, a claim that the Commission’s authority to choose between judicial and administrative enforcement violated the nondelegation doctrine was also rejected.

The Fifth Circuit subsequently granted the Petition for Review. The court concluded that the Seventh Amendment had been violated since the SEC had been empowered to bring administrative proceedings seeking civil penalties. Key to this point is if the claims arose at common law. Here the questions did not involve public rights since the claims arose at common law.

The Circuit Court also concluded that Congress can only grant regulatory power to another entity if it provides an “intelligible principle” by which the power can be exercised. Here that had not been done. The court concluded by finding that the statutory restrictions on removal of the SEC’s ALJs violated Article II of the Constitution under the Supreme Court’s Free Enterprise Fund ruling.

Petitioner: SEC’s Merits Brief

The Supreme Court’s decision in Atlas Roofing Co. v. Occupational Safety & Health Review Comm’s, 430 U.S. 442, 450 (1977) controls the ruling in this case regarding the Seventh Amendment. There the Court held that Article III permits Congress to assign the adjudication of claims involving so-called “public rights” to non-Article III tribunals. That doctrine permits Congress to create “new statutory obligations,” impose civil penalties for their violation and commit the resolution of issues to an administrative agency. Accordingly, the proceedings were consistent with Article III.

In this matter, the court of appeals simply reached the wrong conclusion. This resulted in part from overreading the Supreme Court’s prior decisions; it also resulted in part from misreading the Court’s prior decisions.

Equally clear is the fact that Congress did not violate the nondelegation doctrine by permitting the SEC to decide the forum in which each case should be brought. When the Commission brings an enforcement action it “exercises only enforcement discretion, a core executive power that stems from the President’s authority” to “take Care that the Laws be faithfully executive,” Citing Article II, Section 3. In this case since the SEC only exercised an enforcement power that is typically administered by agencies it has acted within its discretion. The court of appeals reached the incorrect decision here by failing to properly understand the concept of “legislative power.”

Finally, Congress did not violate Article II in granting tenure protection to the SEC’s ALJs. To the contrary, when Congress vests the appointment of an inferior officer in a department head it can limit and restrict the power of removal as it deems best in the public interest.

Respondents: Jarkesy & Patriot28 LLC Merits Brief

The SEC’s contention that juries are not required when the government seeks penalties for common law fraud claims as here is based on a flawed interpretation of the “public rights” doctrine. The question of if a public right or private right is at issue depends on the nature of the underlying claim.

Here the SEC initiated a fraud action for penalties seeking to deprive the target of that action of a “core” right – private property. Such questions should be resolved by a jury. This is consistent with the earliest interpretations of the right to a jury. It is also consistent with the Fifth Circuit’s conclusion that Congress’ delegation of the unfettered power to the agency to assign the enforcement action to either forum violates the separation of powers doctrine. The proper remedy for this violation is thus setting aside the decision.

Atlas Roofing is not to the contrary. There the Court considered a claim under OSHA.

After analyzing the statute, and considering a case being prosecuted by the government, the Court found that the rights at issue were public. The attributes considered by the Atlas Roofing court however – the claims were unknown at common law, they were new, the remedies were new and the administrative forum would provide a speeding remedy – should not apply here. There it was the novelty of the statutory claims that guided the result. That concept does not apply here.

Decision

The decision in the case is due by June 30, 2024.

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In a shortened work week punctuated by the Thanksgiving holiday and Black Friday the Commission filed two new actions. One centered on the failure of an advisory to comply with the custody rule. The second involved two firms collectively known as Kraken to register their trading platform.

Be careful, be safe this week.

SEC Enforcement – Filed and Settled Actions

Statistics: This week the Commission filed 2 new civil injunctive action and no new administrative proceeding, excluding tag-along actions and those that present a conflict for the author.

Accounting fraud: SEC v. SAExploration Holdings, Inc., Civil Action No. 20-CV-08423 (S.D.N.Y.) is a previously filed action that centered on the recording of about $100 million in revenue from a company that did not have the ability to make the payments. The result was the falsification of the financial statements. Defendant Brian A. Beatty settled the action based on his multi-year participation in the scheme. He consented to the entry of permanent injunctions based on Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)A, 13(b)(2)(B) and related rules as well as Section 304 of SOX. The judgment orders Mr. Beatty to pay disgorgement in the amount of $219,940, prejudgment interest of $41,763 and orders the reimbursement of SAE in the amount of $441,995 under SOX. The Court entered the judgment. See Lit. Rel. No. 25902 (November 22, 2023).

False statements – EB-5: SEC v. Ahmed, Civil Action No. 1:23-cv-10210 (S.D.N.Y. Filed November 21, 2023) is an action which names as defendants: Nadim Ahmed, Mehreen Shas, Mona Shah, Nuride Transportation Group, LLC, NYC Green Transportation Group, LLC, Med Trans EB-5 Fund, LLC, NYCEV Mobility LLC, Gravitas NYC Regional Center, LLC, and Mona Shah & Associates, PLLC. Defendant Ahmed is the Executive Chairman of NuRide while Defendant Shah is an attorney licensed in New York and the UK. The action centers on soliciting individuals to supposedly participate in the EB-5 program which grants a permanent green card to foreign nationals who create a certain number of jobs in the United States for individuals seeking permanent residence in this country. In this action Defendants have raised over $66 million from over 100 investors since 2014 based on representations that a permanent green card could be obtained permitting residence in the U.S. by investors. Misrepresentations were made to investors regarding the use of their funds which were supposed to be used for the program. To date none of the participants has received a green card. The stock offerings being made by Defendants were not registered with the Commission. The complaint alleges violations of Securities Act Sections 5(a), 5(c), 17(a) and 10(b). The case in in litigation. See Lit. Rel. No. 25897 (November 21, 2023).

Muni bonds: SEC v. Breland, Civil Action No. 3:22-cv-01467 (W.D. La.) is a previously filed action which names as defendant Vern A. Breland. The complaint centered on a municipal bond offering in 2017 and 2018 for the town of Sterlington, Louisiana. The financial statements involved were based on false financial projections. In addition, Defendant directed that portions of the offering proceeds be diverted to him. Mr. Breland resolved the matter, consenting to the entry of permanent injunctions based on Securities Act Section 17(a) and Exchange Act Section 10(b). He also agreed to pay at $35,000 civil penalty. See Lit. Rel. No. 25901 (November 21, 2023).

Custody Rule: SEC v. Brite Advisors USA, Inc., Civil Action No. 23 Civ. 10212 (S.D.N.Y. Filed November 21, 2023) is an action which names as defendant the registered investment adviser. Since 2019 Defendant has failed to comply with the requirements of the Custody Rule which dictated that it obtain or receive from Brit Australia an annual internal control report from an outside auditor for assets for which it has custody as required. In addition, Brite USA has received millions of dollars in operational funding arranged by its parent company, Brite Advisory Group Ltd. These arrangements created a conflict of interest which should have been disclosed but was not. The complaint alleges violations of Advisers Act Section 206(a) and 206(4). See Lit. Rel. No. 25900 (November 21, 2023).

Breach of duty: SEC v. Shustek, Civil Action No. 2:21-cv-01416 (D. Nev.) is a previously file action which named as defendant Michael Shustek and his advisory firm, Vestin Mortgage LLC. The complaint alleged that since 2012 Defendant has drained about $29 million from the advisory firm to another he controlled. This was done by repeatedly buying and selling the same buildings. The complaint alleges violations of Securities Act Sections 17(a)(2) & (3) and Advisors Act Section 206(2). To resolve the matter defendant consented to the entry of permanent injunctions based on the Sections cited in the complaint. In addition, Defendant agreed to pay a civil penalty of $300,000. See Lit. Rel. No. 25899 (November 21, 2023).

False statements: SEC v. Rio Tinto Ltd., Civil Action No. 25898 (S.D.N.Y.) is a previously filed action which named as defendants the mining firm and its former CEO Thomas Albanese. The complaint alleges that the firm’s filings contained misleading statements about the value of the firm’s assets. To resolve the matter the company consented to the entry of permanent injunctions based on Exchange Act Sections 13(a) and 13(b)(2)(A) and agreed to pay a penalty of $28 million. Mr. Albanese consented to the entry of a permanent injunction based on Exchange Act Section 13(b)(5). He will pay a penalty in the amount of $50,000. See Lit. Rel. No. 25898 (November 21, 2023).

Failure to register: SEC v. Payward, Inc. and Payward Ventures, Inc., Civil Action No. 3:23-cv-06003 (N.D. Ca. Filed November 20, 2023). Defendants are two entities based in San Francisco known as Kraken. Since 2013 Kraken has operated an online trading platform. Customers can purchase and sell crypto assets on the trading platform. Many are viewed by the SEC as investment contracts. Nevertheless, no registration is held by Kraken. To the contrary, the firm simultaneously acts as broker, dealer, exchange and clearing agency. The business practices of Kraken create risks for investors which may not be readily apparent. Not only does the firm operate without any registration, even where the crypto asset may be a security, internal controls and recordkeeping are deficient. The firm also frequently comingles customer crypto assets with its own. Its auditors identified this practice as one that creates a “significant risk” for customers. In addition, Kraken comingles customer cash with its own. At times Kraken has paid operational expenses directly from bank account that contain customer cash. And, its recordkeeping for customer assets resulted in material errors in 2020 and 2021. The firm’s deficient practices are the result of putting its own financial interests ahead of those of its customers, according to the complaint. This practice creates substantial risks for customers. The complaint alleges violations of Securities Act Sections 5, 15(a) and 17A(b). The case is in litigation. See Lit. Rel. No. 25896 (November 21, 2023).

Australia

Consultation: The Australian Securities and Investment Commission is consulting and soliciting feedback from the investment management industry on a proposal to remake Order CO 13/72 which extended certain relieve to facilitate the quotation of exchange traded funds on the ASX market. The agency is considering broadening the relief, according to the November 24, 2023 release (here).

BaFin

Discussion: Birgit Rodolphe, Chief Executive Director of Resolution and Prevention of Money Laundering, recently discussed the most important aspects of regulating decentralized financial and BaFin’s approach in a publication released on November 3, 2023 (here).

Hong Kong

Announcement: The Securities and Futures Commission of Hong Kong recently announced that it will launch China treasury bond futures in a release dated November 24, 2023 (here).

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