Representing financial professionals, financial institutions and investors in investment loss, employment and disclosure matters, and in regulatory investigations nationwide.

Supreme Court ruling seen as leading to more SEC settlement offers

On Behalf of | Jul 10, 2024 | Securities and Compliance

Industry experts are weighing the impact of a U.S. Supreme Court ruling curbing the use of one of the Securities and Exchange Commission’s enforcement tools, WealthManagement reports.

In a 6-3 decision, the nation’s highest court said that people accused of fraud by the SEC have the right to a jury trial in federal court.  The court said the in-house proceedings the SEC has used in some civil fraud complaints violate the Constitution.

Securities attorneys told WealthManagement the ruling may lead to more settlement offers by the SEC in these cases. MarketCounsel CEO Brian Hamburger said that the commission had a substantial rate of success in matters that went before in-house administrative law judges, but added that with cases being tried in federal courts the SEC may determine that a settlement is a more appropriate tactic.

“There’s going to be a new weighing of the cost-benefit of settling these matters, and the weight has tipped in favor of registrants and advisors,” Hamburger said. “There has to be a consideration made that having this matter heard in front of a judge that’s not an ALJ is going to change the calculus for their likelihood to succeed.”

The Supreme Court ruling came in the case of a Houston hedge fund manager, George Jarkesy, who was fined $300,000 and ordered to pay $680,000 in allegedly ill-gotten gains after being accused by the SEC of misleading investors about who served as his funds’ prime broker and auditor and about their investment strategies and holdings.

The 5th U.S. Circuit Court of Appeals dismissed the penalties against Jarkesy and his Patriot28 investment adviser, saying the case should have been heard in a federal court instead of before one of the SEC’s administrative law judges.

That ruling was upheld by the Supreme Court, with Chief Justice John Roberts writing, “A defendant facing a fraud suit has the right to be tried by a jury of his peers before a neutral adjudicator.  Rather than recognize that right, the dissent would permit Congress to concentrate the roles of prosecutor, judge, and jury in the hands of the Executive Branch. That is the very opposite of the separation of powers that the Constitution demands.”

The ruling was a victory for conservative activists and business groups who have urged the courts to restrict the enforcement power of federal regulators.

“If you look at the timeline of Jarkesy, the appointment of new judges to the Court, and the conservative reaching of the federal judiciary by and large, you’ll see the staff was keeping tabs on this and decided ‘we have to stop bringing cases to the ALJs,’” said Max Schatzow, an attorney and partner with RIA lawyers.

Attorneys believe that the court’s ruling could also result in state regulators taking on cases that would have fallen under the purview of the SEC.  “It’s possible the SEC might come across some cases where it might make more sense to coordinate with state securities regulators,” said Andrew Jennings, an associate professor at Emory University’s School of Law. “I’d expect that would develop organically between regional SEC divisions and their state counterparts.”

The case could also impact disciplinary proceedings conducted by FINRA, including the use of hearing officers leading arbitration panels in disputed cases, which may now be deemed unconstitutional.

“Their skepticism about agency enforcement through ALJs may also carry over to self-regulatory organization enforcement through their own in-house processes,” said Ben Edwards, a professor at the William S. Boyd School of Law at the University of Nevada, Las Vegas.

Edwards added there may be occasions when the SEC and defendants agree to have a case go before an administrative law judge because it could be a quicker adjudication process than a federal jury trial that may last for years.

The attorneys at Lewitas Hyman include former senior attorneys at the SEC whose legal experience and industry knowledge make them uniquely qualified to provide counsel on securities regulatory, compliance and enforcement matters. Our attorneys fully understand the regulatory scrutiny financial professionals and their firms face from the various regulators that oversee the financial services industry. If your firm is facing an investigation from a regulatory agency, please contact Lewitas Hyman at (888) 655-6002 or through our online contact form.