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The SEC is seeking review of a ruling that throws “Cloud” over enforcement

The SEC is seeking review of a ruling that throws “Cloud” over enforcement

The Securities and Exchange Commission asked the entire Fifth Circuit to review a decision that found the agency’s administrative procedures unconstitutional, claiming that the ruling created uncertainty about federal agencies’ use of internal judges to hear cases.

In May, a split panel of the U.S. Court of Appeals for the Fifth Circuit dropped an SEC decision to hedge fund manager George Jarkesy Jr. committed securities fraud. The panel found in part that restrictions on removing SEC administrative court judges violated the division of power only for a reason.

The ruling is in conflict with a ruling from the ninth circuit from 2021, Decker Coal v. Pehringer, which maintained the same removal restrictions for administrative court judges in the Ministry of Labor, the SEC wrote in a petition on Friday. The 2-1 decision calls into question decisions from the SEC and other agencies, the commission said when requesting a banc review.

“The majority’s decision thus makes uncertain how the commission can proceed with custody if it were to use an ALJ” and “throws a cloud of uncertainty over the judgments of all independent agencies using ALJs,” the petition states.

Jarkesy and his consulting firm, Patriot28 LLC, established two hedge funds with around $ 24 million in assets. Following an internal enforcement case, the SEC ruled that Jarkesy violated securities laws by misrepresenting how the funds were managed, audited and valued.

The Fifth Circuit panel also held that the proceeding violated Jarkesy’s seventh amendment to a jury trial. In addition, it said that the SEC’s decision to initiate administrative proceedings, instead of filing a lawsuit in the district court, was an unconstitutional exercise of legislative authority.

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The seventh amendment does not apply because securities laws are “public rights” that can be decided by an administrative court, the SEC said in Friday’s petition.

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

“Although these tax decisions may affect whether a party receives[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, accompanying petition filed 7/1/22.

—With the assistance of Jennifer Bennett.

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