Home Hedge Funds SEC Seeks Review of Ruling That Cast ‘Cloud’ Over Enforcement

SEC Seeks Review of Ruling That Cast ‘Cloud’ Over Enforcement

Bloomberg Law

The Securities and Exchange Commission asked the full Fifth Circuit to review a decision finding the agency’s administrative proceedings unconstitutional, arguing the ruling created uncertainty over federal agencies’ use of in-house judges to hear cases.

In May, a divided panel for the US Court of Appeals for the Fifth Circuit vacated a SEC decision that hedge-fund manager George Jarkesy Jr. committed securities fraud. The panel found, in part, that restrictions on removing SEC administrative law judges only for cause violated the separation of powers.

The ruling conflicts with a 2021 Ninth Circuit ruling, Decker Coal v. Pehringer, which upheld the same removal restrictions for administrative law judges in the Labor Department, the SEC wrote in a Friday petition. The 2-1 decision calls into question adjudications by the SEC and other agencies, the commission said in asking for an en banc review.

“The majority’s decision thus leaves uncertain how the Commission can proceed on remand if it were to use an ALJ” and “casts a cloud of uncertainty over the adjudications of all independent agencies that use ALJs,” the petition said.

Jarkesy and his advisory firm, Patriot28 LLC, established two hedge funds with around $24 million in assets. Following an in-house enforcement proceeding, the SEC decided Jarkesy violated securities laws by making misrepresentations about how the funds were managed, audited, and valued.

The Fifth Circuit panel also held the proceeding violated Jarkesy’s Seventh Amendment right to a jury trial. Additionally, it said the SEC’s decision to initiate an administrative proceeding, rather than filing a lawsuit in district court, was an unconstitutional exercise of legislative authority.

The Seventh Amendment doesn’t apply because securities laws are “public rights” that can be adjudicated by an administrative tribunal, the SEC said in Friday’s petition.

It has always been understood that officials in the executive branch “decide what violations to assert, what penalties to seek, and in what forum to proceed” when enforcing laws, the SEC said.

“While those charging decisions may affect whether a party ‘receive[s] certain legal processes,’ they are executive, not legislative, actions,” the SEC said.

S. Michael McColloch and Karen Cook represent Jarkesy and Patriot28.

The case is Jarkesy v. SEC, 5th Cir., No. 20-61007, rehearing petition filed 7/1/22.

—With assistance from Jennifer Bennett.

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