Compliance July 7, 2023

Supreme Court Accepts Case Challenging Legitimacy of SEC’s Adjudication System

The court has agreed to hear a case next session which could dramatically reduce the authority of in-house adjudication process for the SEC and other federal agencies.

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The U.S. Supreme Court will hear a challenge to the legitimacy of the Securities and Exchange Commission’s administrative law judges, brought by George Jarkesy, a hedge fund manager. The court will likely hear the case during its next session and rule by June 2024.

The case dates back to 2011, when the SEC began investigating Jarkesy for securities fraud. Jarkesy was managing two hedge funds with more than 100 customers and more than $24 million in assets. Patriot28 LLC was the fund’s adviser and was also charged by the SEC.

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The SEC alleged Jarkesy and Patriot28 defrauded investors by misrepresenting who the prime broker and auditor were; mispresenting the parameters and safeguards of the hedge fund; and overvaluing the funds’ assets in order to justify higher fees.

Jarkesy asked the district and appeals courts in the District of Columbia to review the case, and both responded that they did not have jurisdiction, because Congress empowers the SEC to choose whether to bring a case to federal courts (established via Article III of the U.S. Constitution) or to adjudicate it within the agency.

The SEC adjudicated the case and ultimately fined Jarkesy and Patriot28 $300,000 in civil fines and ordered them to repay $685,000 in ill-gotten gains. Jarkesy was also barred “from various securities industry activities: associating with brokers, dealers, and advisers; offering penny stocks; and serving as an officer or director of an advisory board or as an investment adviser,” according to the appeals court’s decision.

Jarkesy appealed to the 5th U.S. Circuit Court of Appeals, based in New Orleans. The appellate court ruled in his favor and found that the SEC’s in-house adjudication system violated the Seventh Amendment guarantee to a jury trial in federal civil matters in which the amount in dispute exceeds $25. The appeals court also found that Congress improperly delegated legislative authority to the SEC by permitting the commission to bring a case before a court or the agency’s own administrative law judges. Lastly, the appeals court ruled that administrative law judges’ protection to not be removed except “for cause” violates Article II of the U.S. Constitution by improperly shielding them from presidential removal.

The appeals court’s decision stated, “Petitioners had the right for a jury to adjudicate the facts underlying any potential fraud liability that justifies penalties” and “Congress unconstitutionally delegated legislative power to the SEC when it gave the SEC the unfettered authority to choose whether to bring enforcement actions in Article III courts or within the agency.”

The SEC then appealed to the Supreme Court, seeking a reversal of the 5th Circuit’s decision.

The case could have profound consequences for the authority and administration of the SEC and other federal agencies, depending on which legal theories the Supreme Court upholds or reverses. In addition to the SEC, at least 20 other federal agencies employ administrative law judges.

Compliance July 7, 2023

Judge Rejects Proposed Class Certification in Remanded TIAA Retirement Plan Case

Given the appellate court’s ruling, the district court found no ‘single policy’ affecting all putative class participants from Washington University in St. Louis.

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U.S. District Judge J. Paul Oetken denied a class certification claim by plaintiffs seeking to represent about 8,000 participants in Washington University in St. Louis retirement plans managed by recordkeeper TIAA in a June 27 opinion in U.S. District Court for the Southern District of New York.

Oetken’s decision came after the case was remanded from the U.S. 2nd Circuit Court of Appeals in December 2022, when a three-judge panel overturned the district court’s class certification on the grounds that individual issues raised by the defense may differ from that of the full class of participants.

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“The Second Circuit vacated and remanded, instructing the Court to consider whether certain ERISA affirmative defenses raised by TIAA would make class treatment unwarranted because individual issues raised by the defenses predominate over those common to the class,” Oekten wrote. “Following further briefing by the parties and reconsideration of the issues in light of the Second Circuit’s opinion, the Court denies Plaintiff’s motion for class certification.”

Haley et al v. Teachers Insurance and Annuity Association of America was filed in February 2017. The complaint focused on retirement plan loan withdrawals administered by TIAA at the request of plan participants.

The plaintiffs, represented by lead attorneys from Berger Montague PC, alleged that TIAA had earned interest off participants’ collateral as compensation for administrating the loans. They argued those earnings were in violation of Section 406 of the Employee Retirement Income Security Act, which prohibits plan fiduciaries from directly or indirectly engaging in a transaction that presents a conflict of interest.

TIAA countered that the actions were permissible under Section 408(b)(17) of the rule, which allows for a plan to engage in actions that pay no more or less than “adequate consideration” for services.

In March 2018, the district court granted TIAA’s motion to dismiss on four of the five counts in the case, holding that the plaintiffs had not plausibly alleged that TIAA was an ERISA fiduciary, according to the court record. The court allowed one claim to continue with TIAA as a non-fiduciary and permitted leave to amend the complaint. The plaintiff then requested class certification, which was granted by Oetken in November 2020.

On appeal, the 2nd Circuit vacated the class certification ruling and remanded the case, arguing that the district court had not properly considered, under Rule 23(b)(3), that the defense’s claims regarding individual participant issues could not be vetted on a class-wide basis, and therefore a class claim was not warranted.

When the case returned to the district court, TIAA argued that evaluating its defense would require the district court to look into each of the 8,000 participants involved in the complaint, according to the court record. Oetken ultimately agreed, deciding against class action certification.

“Determining the adequacy of consideration for each transaction, concerning a variety of ERISA plans, loans of differing amounts and differing time periods, and localized or regional assessments of prevailing interest rates for similar transactions in space and time … swamp common issues,” Oetken wrote.

ERISA attorneys from Duane Morris, which were not involved with the case, noted in an analysis that ERISA class actions can be difficult to defend against, as the plaintiffs usually argue that plan management affects all the participants in similar ways. The Haley decision, however, will serve as “an exception to the rule.”

“Defendant was able to show that the case was not about a single policy, but about numerous individual actions,” they wrote. “The decision underscores the importance of probing deeply into a putative class members’ allegations to determine whether they meet the rigorous standards of Rule 23.”

Defendants who are accused of violating Section 406, the Duane Morris attorneys wrote, “must carefully consider the defenses provided by Section 408 and raise them in a timely fashion.”

TIAA declined to comment on the ruling. The New York-based firm was represented by Goodwin Proctor LLP.

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