By: James W. Kraus
October 6, 2015
Anyone finding him or herself on the receiving end of an SEC administrative enforcement action must wait until that one is over before seeking to raise judicial challenges, even those based on the U.S. Constitution, to the Commission’s proceeding. At least that was the conclusion reached by a panel of the DC Circuit on Tuesday in the case of Jarkesy v. Securities and Exchange Commission, No. 14-5196 (D.C. Cir. Sept. 29, 2015). In that case, the Court affirmed the district court’s dismissal, based on lack of subject-matter jurisdiction, of George Jarkesy, Jr.’s claim for injunctive relief to terminate administrative proceedings pending in front of the SEC.
The SEC’s Administrative Action Against Jarkesy and Others
Jarkesy was the manager of Patriot28, LLC, an unregistered investment advisor and general partner of two hedge funds. The SEC instituted administrative and cease and desist proceedings against Jarkesy, Patriot28 and two other respondents, seeking disgorgement of fees, civil penalties, a cease-and-desist order against all respondents, as well as securities industry and officer-and-director bars against Jarkesy. The SEC alleged that Mr. Jarkesy and Patriot28 (collectively “Jarkesy”) had committed securities fraud in connection with the offer, purchase and sale of securities, and that the other two respondents, John Thomas Financial, Inc. (a broker-dealer) and Anastasios Belesis (the founder and CEO of John Thomas Financial) had aided and abetted.
Prior to the passage of Dodd-Frank in 2010, the SEC could not seek penalties from an unregistered individual like Jarkesy in an administrative proceeding. It could only have brought an administrative proceeding against “regulated persons” or companies. With the changes brought on by Dodd-Frank, the SEC now has the option to decide whether to bring enforcement actions against unregistered individuals in federal court or in an administrative proceeding. The problem cited by many in the position of Jarkesy is that this new playing field is not level, with the tilt in the administrative forum decidedly in favor of the Commission’s enforcement arm.
Before the SEC’s case against all of the respondents came to administrative hearing, John Thomas Financial and Belesis settled with the Commission, and the Commission issued an order approving the settlement that included findings that also discussed the fraudulent conduct of the “manager” and the “advisor” of the hedge funds – references to Jarkesy. The Commission’s order noted, however, that its findings were not binding on any other person or entity in any other proceedings.
Jarkesy’s Challenge to the Commission’s Proceeding
Following the Commission’s order of settlement regarding the other respondents, Jarkesy filed a Petition for Interlocutory Review with the Commission, seeking to disqualify the Commissioners and obtain a dismissal of the administrative proceeding on the ground that the Commission had “conclusively prejudiced the case” against Jarkesy. In addition, just days before Jarkesy’s hearing before the ALJ was set to begin, Jarkesy filed the subject action in the district court seeking an injunction to prevent the SEC from proceeding with the administrative action that in Jarkesy’s view had violated and would continue to violate his fundamental constitutional rights.
The constitutional claims by Jarkesy included allegations that (1) the Commission violated his Fifth Amendment due process rights by pre-judging the charges; (2) the Commission’s institution of an administrative proceeding violated his rights under the Equal Protection Clause by denying his fundamental right to a jury trial; (3) the Commission had essentially created a “class-of-one,” in that while it had taken similarly situated individuals to court, the decision to charge Jarkesy in an agency proceeding was motivated by animus; (4) there were improper ex partecommunications between the SEC Enforcement Division and the Commissioners regarding their co-respondent’s settlement; and (5) the Commission violated their right to due process by failing to comply with its Brady obligations.
Court Rejects Jurisdiction for “Separation of Powers” Challenge to Dodd-Frank
As a threshold matter the Court found that even if Jarkesy’s claims in the district court constituted a facial, “separation of powers,” challenge to Dodd-Frank, the district court was correct to dismiss his complaint. It reasoned that federal district court jurisdiction is not automatically implicated every time a party makes a claim that is based entirely or in part on a separation of powers argument. It found that because Jarkesy ultimately would have the right to petition the Court of Appeals for review of any final decision by the Commission, his constitutional claims, including his non-delegation challenge to Dodd-Frank, can eventually reach “an Article III Court fully competent to adjudicate” them.
At the heart of the Court’s decision to affirm the district court’s dismissal of Jarkesy’s claims was its analysis of the claims against the principles set forth by the U.S. Supreme Court in Thunder Basin Coal Co. v. Reich, 510 U.S. 200 (1994). Under that framework, the ultimate question is whether Congress intended exclusivity when it established the statutory scheme. The Court found that Congress did intend such exclusivity, and that instead of obtaining judicial review of his challenges to the Commission’s administrative proceeding now, he can secure judicial review in a Court of Appeals when (and if) the proceeding culminates in a resolution against him.
Claims Found not “Wholly Collateral”
According to the Court’s opinion, none of Jarkesy’s claims in the district court complaint were wholly collateral, and all of the issues raised would logically be addressed in the administrative proceeding and would be subject to judicial review after that proceeding ended. For example, the Court was not persuaded by Jarkesy’s allegations regarding the limitations on obtaining discovery and evidence, citing to SEC procedural rules that permit any party in the proceedings to request the issuance of a subpoena for documentary evidence or witnesses. It further noted that, in fact, Jarkesy had filed discovery motions with the Commission, and that any final decisions made regarding those motions would be subject to review should Jarkesy choose to file a petition for review at the conclusion of the proceedings.
The Court similarly found that Jarkesy’s other attacks, including (1) the Commission’s decision to place him in administrative proceedings in the first place (as opposed to a federal court action), (2) its alleged pre-judgment by accepting the settlement of the co-respondents, (3) the Commission’s alleged ex parte communications, and (4) the alleged Brady violations, were all inextricably intertwined with the conduct of the very enforcement proceedings for which the statute grants the SEC the power to institute and resolve as an initial matter. Accordingly, it could not find that the constitutional claims originally made in the district court were wholly collateral for purposes of jurisdiction.
The Court acknowledged that some district courts faced with similar claims have concluded that there is jurisdiction in a case where an individual claims that they should not have to endure a constitutionally deficient proceeding before seeking redress, citing, among others, Gupta v. SEC, 796 F. Supp. 2d, 503, (S.D.N.Y. 2011). Again, however, the Court found that the fact that certain of Jarkesy’s claims, particularly the non-delegation and equal protection claims, attack the process rather than the result does not mean such claims should receive preemptive resolution in a district court.
Somewhat curiously, the court also drew parallels to Younger abstention in the context of criminal cases, elaborating with the example of Deaver v. Seymour, 822 F.2d 66, 70 (D.C. Cir. 1987), which involved former Reagan aide Michael Deaver’s collateral attack on the constitutionality of the qualification of the Independent Counsel to direct a prosecution. In that case, a panel of the DC Circuit found that even if Deaver’s contention regarding the unconstitutionality of the Independent Counsel was right, his rights could be vindicated by a reversal of his conviction.
Court Not Persuaded by Reasoning in Hill v. SEC
The Court’s decision in Jarkesy stands in some contrast to a decision in June of this year by U.S. District Court Judge Leigh Martin May of the Northern District of Georgia, in the case of Hill v. SEC, No. 1:15-cv-1801-LMM (N.D. Ga., June 8, 2015). In Hill, a case that also involved a claim for injunctive relief by an unregistered individual, Judge May issued an injunction against the SEC from conducting the administrative proceeding. The one claim for which Judge May found a substantial likelihood of success was the alleged violation of Article II of the U.S. Constitution relating to the manner of appointment of the administrative law judges. Specifically, ALJs are not appointed by the President, the courts or the SEC commissioners – rather they are hired as employees by the SEC’s Office of Administrative Law Judges. The SEC has simply promulgated regulations making ALJs responsible for the “fair and orderly conduct” of proceedings,” and granting them related authority to carry that out. The SEC has taken steps to appeal the Hill decision.
The Court acknowledged the Hill decision -- specifically noting with disapproval Judge May’s finding that “there can be no fairly discernible Congressional intent to limit jurisdiction away from district courts when the text of the statute provides the district court as a viable forum for SEC enforcement actions.” Instead, the Court in Jarkesy reasoned that Congress, by giving the SEC the option to pursue violations in district court, did not thereby necessarily enable respondents in administrative proceedings to collaterally attack those proceedings in court. It explained further that Congress granted the choice of forum to the Commission, and that authority would be for naught if respondents like Jarkesy could countermand the Commission’s choice by filing a court action.