A federal appeals court ruled on May 18 that the Securities and Exchange Commission’s (SEC) use of in-house courts violated a hedge fund manager’s constitutional right to a jury trial, a decision that could have far-reaching consequences for the regulator’s enforcement powers.
According to Bloomberg News, one of the defendants was hedge fund manager George Jarkesy Jr., who had created a couple of hedge funds that totaled about $24 million in assets. He hired Patriot28 LLC to advise on investments. Jarkesy and Patriot 28 are alleged to have misrepresented parameters and safeguards and exaggerated the value of assets, so they could charge “exorbitant” fees, leading to the SEC’s involvement.
The court ruled two-to-one in the defendants’ favor. According to Judge Jennifer Walker Elrod, the Seventh Amendment guarantees the right of Jarkesy and Patriot28 to a jury trial.
In the majority opinion, Elrod further stated that neither Congress itself nor an agency acting on its behalf could decide the claims without the involvement of a jury.
The defendants made the case that when Congress allowed the SEC to decide whether the case would be pursued in the federal courts or internally, it violated his Constitutional rights. Meanwhile, the SEC argued that its choice was simply prosecutorial discretion. Judge Elrod agreed with Jarkesy and Patriot28.
The SEC had made no response to requests for comment. Those representing the defendants also did not comment, Bloomberg reports.
The SEC’s ability to seek penalties in situations like the Jarkesy case was expanded after the 2008 financial crisis. The Dodd-Frank Act, named after its sponsors, Senators Barney Frank and Christopher Dodd, was passed in 2010. It established the Financial Stability Oversight Council to monitor the stability of major financial firms.
Other agencies established by the legislation included the Consumer Financial Protection Bureau, the Volcker Rule to limit speculative trading, the SEC’s Office of Credit Rating, and an expansion of the whistleblower program.
Reuters reports the SEC argued it was acting in the interest of investors and was attempting to enforce the rights of the public.
Judge Elrod and Judge Andrew Oldham disagreed and were responsible for the majority opinion.
They said that because seeking penalties is akin to debt collection, which is a private right, the defendants were entitled to a jury trial.
Judge Eugene Davis was the sole dissenter. He also disagreed with the majority regarding whether SEC judges are unconstitutionally protected from being fired, according to Reuters.
Just two days before this ruling, the U.S. Supreme Court agreed to review another case against the SEC heard by the Fifth Circuit.
The attorneys representing Jarkesy and Patriot28 are S. Michael McColloch and Karen Cook, both based in Dallas.