SEC could patch enforcement mechanism, regardless of Supreme Court ruling, analysis shows

LAWRENCE — The Supreme Court recently heard a case about how the U.S. Securities and Exchange Commission prosecutes those accused of financial wrongdoing. The case has some fearing it will end the agency's ability to pursue bad financial actors, while others say it will finally end the agency’s overreach. 

Alex Platt, KU Law Professor
Alex Platt

A new study from a University of Kansas legal expert analyzes the arguments and prosecutions the agency has made in recent years, arguing it is likely neither — and in fact there is a simple patch to apply for the future.

In November 2023, the court heard SEC v. Jarkesy, a case in which the former prosecuted the latter in one its administrative courts for alleged wrongdoing in the way Jarkesy managed hedge funds. The SEC has regularly prosecuted people in its own courts, in which cases are heard by a judge appointed by the agency, without a jury. Jarkesy argued that was illegal, and the 5th U.S. Circuit Court of Appeals ruled in his favor, stating such prosecutions should happen in federal courts.

The Supreme Court decision is pending, but Alexander Platt, associate professor of law at KU, analyzed two years’ worth of similar actions by the SEC for his article, forthcoming in the Notre Dame Law Review Reflection and available on SSRN.

“That opinion evinced a lot of shock waves in the world of securities enforcement,” Platt said of the 5th circuit ruling. “It didn’t surprise anyone the Supreme Court took the case. It wasn’t about whether Jarkesy was guilty or innocent. The 5th Circuit said the Constitution doesn’t allow the SEC to bring this enforcement in its own courts.”

The key, Platt writes, is that Jarkesy was unregistered with the SEC. Securities traders who register with the agency get a license to trade, manage funds and perform other functions, but the financial area Jarkesy worked in was not required to be registered. Recent Supreme Court rulings hold that those who register with the SEC in essence agree to have actions taken against them heard in SEC administrative courts, Platt writes.

“It matters, I think, because there is a legal and constitutional argument that folks who register with the SEC might be consenting to appearing in the SEC’s courts,” Platt said. “You’re giving something up in order to do business.”

Further, Platt examined 1,481 actions the SEC brought in its courts from fiscal years 2021 and 2023. He found that only about 5% of the actions were taken against unregistered parties for fraud-related activities seeking monetary penalties. Therefore, should the high court rule against the SEC, little would have to change, he writes. The agency could simply amend its registration forms to include language that those who register agree to have cases against them heard in the SEC’s courts, while unregistered parties could proceed in federal court.

The paper cites media reports and arguments from legal experts speculating about the ramifications the decision would have, regardless of how the high court rules. Some express concern a ruling against the agency will gut its ability to pursue fraudsters and financial wrongdoers.

“The SEC saw the ruling from the 5th Circuit and said, ‘Oh no, that’s not good for us, because we pursue these actions in our courts all the time,’” Platt said.

Other parties have viewed the case a chance to rid the agency of powers of overreach and a further strike against the administrative state.

The true effect will likely be somewhere in the middle, Platt said, as the numbers show the SEC has pursued action against few unregistered parties. Limiting actions in its administrative courts to registered financial actors could effectively patch any hole the Supreme Court may be about to rip in the agency’s enforcement mechanism.

Mon, 04/15/2024


Mike Krings

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