Skip to main content
Menu Icon
Close

InfoBytes Blog

Financial Services Law Insights and Observations

Filter

Subscribe to our InfoBytes Blog weekly newsletter and other publications for news affecting the financial services industry.

  • Supreme Court holds that defendants are entitled to jury trial if the SEC seeks civil penalties

    Courts

    On June 27, the U.S. Supreme Court decided SEC v. Jarkesy which held that, pursuant to the Seventh Amendment, when the SEC brings an enforcement action seeking civil penalties, it must do so in federal court, where a jury trial is available, rather than through its own in-house proceedings. When the SEC would adjudicate a matter in-house, however, there were no juries — the Commission (or a delegated member or Administrative Law Judge) presided over the action and acts as the factfinder.

    In the underlying case (covered by InfoBytes here), the SEC initiated an enforcement action and sought, among other remedies, civil penalties. The SEC, as was typical, adjudicated the matter in-house rather than proceed in federal court and imposed a $300,000 civil penalty. The defendant sought review, ultimately raising before the Supreme Court the question of whether the Seventh Amendment entitled a defendant to a jury trial when the SEC seeks civil penalties for securities fraud. The Supreme Court held that it did as the Seventh Amendment guaranteed that “the right of trial by jury shall be preserved” in “suits at common law”; “money damages are the prototypical common law remedy,” and civil penalties — a form of monetary relief — were “a type of remedy at common law that could only be enforced in courts of law.”

    For a deeper look at this important case, please read our recent Orrick Insight here.  

    Courts Federal Issues U.S. Supreme Court SEC ALJ Fifth Circuit Securities Act Securities Exchange Act Securities Exchange Commission Enforcement

  • FINRA issues guidance on broker-dealers using generative AI tools

    Courts

    On June 27, FINRA issued Regulatory Notice 24-09 that discussed the implications to broker-dealers in their use of artificial intelligence (AI), including large language models (LLMs) and other generative AI tools. Although FINRA stated that while AI offered broker-dealers opportunities to improve their services and enhance their operational and compliance efficiencies, it also reminded firms that its rules and federal securities laws continue to apply. In discussing use cases, FINRA noted that AI tools can analyze financial data, summarize documents, and assist in investor education, but also raise concerns about accuracy, privacy, bias, and security.

    When using these tools, FINRA reminds firms that: (1) they must have appropriate supervisory systems and governance in place, whether those tools are developed in-house or provided by third parties; and (2) they should evaluate AI tools before use to ensure compliance with FINRA rules. FINRA also stated that in some instances, it could issue further guidance for specific use cases. FINRA encouraged firms to seek interpretive guidance where ambiguous rule applications may exist and have ongoing discussions with their Risk Monitoring Analyst.

    Courts Securities Supreme Court ALJ Seventh Amendment

  • FTC to hold an informal hearing on its proposed “junk fee” rules

    Federal Issues

    On March 27, the FTC published a notice in the Federal Register informing the public of its decision to hold an informal hearing on its proposed rule prohibiting “junk fees.” As previously covered by InfoBytes, the FTC released a notice of proposed rulemaking (“NPRM”) titled “Rule on Unfair or Deceptive Fees” and extended the comment period last October. In the NPRM, the FTC presented the opportunity for any party to present their positions orally. The FTC announced that 17 commenters requested to partake in the informal hearing by presenting oral statements and an administrative law judge for the FTC will serve as the presiding officer. The informal hearing will be presented virtually on April 24 at 10:00 a.m. Eastern time. The hearing will be presented live to the public on the FTC’s website, and a recording will be placed in the rulemaking record.

    Federal Issues FTC Junk Fees ALJ

  • FTC orders tax filing software company to cease and desist following ALJ decision

    Federal Issues

    On January 22, the FTC issued an opinion and order against the maker of a popular tax filing software.  The FTC found that the company engaged in unfair and deceptive acts or practices by marketing the software as “free” when it was not available as free to more than two-thirds of consumers and ordered the company to “cease and desist making the deceptive claims.”

    The FTC’s opinion and order were issued after its de novo review following the September 2023 ruling from an administrative law judge (“ALJ”), in the FTC’s March 2022 administrative complaint against the company (previously reported by InfoBytes here), in which the ALJ found that the company engaged in deceptive advertising. 

    The company is a publicly traded corporation that offers a variety of software programs. The software in question is a program that assists customers with preparing and filing their taxes. The FTC alleged that since 2016 the company marketed its tax filing software in violation of Section 5 of the FTC Act through television and online ads, stating consumers could file their taxes for free when less than one-third of taxpayers were eligible for the company’s free edition of the software.

    The FTC took issue with the company’s claim that the software was “free” when it restricted its eligibility for the free version to those with “simple tax returns.” While the definition of “simple tax returns” has changed over time, in 2022 it was limited to filed returns that included a Form 1040 with limited attached schedules. However, the FTC alleged most taxpayers do not have “simple tax returns” as defined by the company, including those with mortgage or property income, investment income, or charitable donations over $300.

    According to the FTC, from 2016 to 2022, the company ran “dozens” of unique ads through television, radio, the internet, social media, and other advertising channels, that garnered “billions of impressions.” The company and its ad agency understood that advertising its product as free would be a “powerful” lure to entice new customers, stating “Lead with [f]ree to raise heads and drive traffic and acquisition[.]” Although disclaimers are present in the ads, the FTC alleged the company’s disclaimers are inadequate to “cure the misrepresentations” faced by the consumer.

    The company continued to market its products as free for three years after multiple lawsuits were filed by the Los Angeles City Attorney and the County Counsel for the County of Santa Clara, California, alleging unfair and deceptive marketing of free versions of the software. Various state Attorneys General opened subsequent investigations that led the company to enter into a settlement agreement with all fifty states pursuant to which the company agreed to pay $141 million and submit to restrictions on its advertising and marketing of the software. Among other restrictions, the FTC’s final order prohibits the company from making any misrepresentations of the cost of its products and services, or the requirement that a consumer use its paid products or services in order to accurately file their taxes online or claim a credit or deduction. Additionally, the order imposes record-keeping and reporting requirements that will remain effective for a period of twenty years after the issuance date of the order.

    Federal Issues FTC Cease and Desist ALJ FTC Act

  • Supreme Court hears oral argument in case challenging SEC ALJ use

    Courts

    On November 29, the Supreme Court heard oral argument in the SEC’s request to appeal the 5th Circuit’s decision in Securities and Exchange Commission v. Jarkesy. As previously covered by InfoBytes, the 5th Circuit held that the SEC’s in-house adjudication of a petitioners’ case violated their Seventh Amendment right to a jury trial and relied on unconstitutionally delegated legislative power. At oral argument, Justice Kavanaugh stated in his questioning of Principal Deputy Solicitor General Brian Fletcher (representing the SEC) that given the severity of the potential outcome of cases, the SEC’s decision-making process fully being carried out in-house could be “problematic,” and that it “doesn’t seem like a neutral process.” Meanwhile, Fletcher mentioned that the boundaries and “outer edges” of the public rights doctrine can be “fuzzy.” Justices’ questions also centered around Atlas Roofing v. Occupational Safety and Health Review Commission—a Supreme Court case that held that “Congress does not violate the Seventh Amendment when it authorizes an agency to impose civil penalties in administrative proceedings to enforce a federal statute.”

    Courts Appellate U.S. Supreme Court ALJ Constitution Securities Exchange Act SEC Advisers Act Fifth Circuit Securities Act

  • SEC files brief in its Supreme Court appeal to reverse 5th Circuit ruling against use of adjudication powers and ALJs

    Courts

    On August 28, the SEC filed a brief in its appeal to the U.S. Supreme Court to reverse the decision of the U.S. Court of Appeals for the Fifth Circuit’s 2022 ruling that the commission’s in-house adjudication is unconstitutional. As previously covered by InfoBytes, the 5th Circuit held that the SEC’s in-house adjudication of a petitioners’ case violated their Seventh Amendment right to a jury trial and relied on unconstitutionally delegated legislative power. The brief argues that securities laws are “distinct from common law because they authorize the government to seek civil penalties even if no private person has yet suffered harm from the defendant’s violation (and therefore no person could obtain damages).” Moreover, the SEC argues that the Court has continually upheld the right of an agency to decide whether to enter an enforcement action through the civil or criminal process. The SEC referenced the 1985 Heckler v. Chaney case, which set the precedent that there is no constitutional difference between the power to decide whether to pursue an enforcement action and where to pursue an enforcement action, as they are both executive powers, supporting the claim that there is “a long and unbroken line of decisions that have relied on the public-rights doctrine in upholding such statutory schemes against Article III and Seventh Amendment challenges.” The SEC also reminded the Court that when it enforces securities laws through an administrative enforcement proceeding with a result that is not in favor of the respondent, the respondent may obtain a judicial review through the court of appeals. Finally, the commission contends that the 5th Circuit erred when it held that statutory removal restrictions for ALJs are unconstitutional, and that Congress has “acted permissibly in requiring agencies to establish cause for their removal of ALJs.”

    Courts Securities SEC U.S. Supreme Court Fifth Circuit ALJ Constitution Securities Act Securities Exchange Act Enforcement

  • Online lender asks Supreme Court to review ALJ ruling

    Courts

    A Delaware-based online payday lender and its founder and CEO (collectively, “petitioners”) recently submitted a petition for a writ of certiorari challenging the U.S. Court of Appeals for the Tenth Circuit’s affirmation of a CFPB administrative ruling related to alleged violations of the Consumer Financial Protection Act (CFPA), TILA, and EFTA. The petitioners asked the Court to first review whether the high court’s ruling in Lucia v. SEC, which “instructed that an agency must hold a ‘new hearing’ before a new and properly appointed official in order to cure an Appointments Clause violation” (covered by InfoBytes here), meant that a CFPB administrative law judge (ALJ) could “conduct a cold review of the paper record of the first, tainted hearing, without any additional discovery or new testimony.” Or, the petitioners asked, did the Court intend for the agency to actually conduct a new hearing. The petitioners also asked the Court to consider whether an agency funding structure that circumvents the Constitution’s Appropriations Clause violates the separation of powers so as to invalidate prior agency actions promulgated at a time when the Bureau was receiving such funding.

    The case involves a challenge to a 2015 administrative action that alleged the petitioners engaged in unfair or deceptive acts or practices when making short-term loans (covered by InfoBytes here). The Bureau’s order required the petitioners to pay $38.4 million as both legal and equitable restitution, along with $8.1 million in penalties for the company and $5.4 million in penalties for the CEO. As previously covered by InfoBytes, between 2018 and 2021, the Court issued four decisions, including Lucia, which “bore on the Bureau’s enforcement activity in this case” by “deciding fundamental issues related to the Bureau’s constitutional authority to act” and appoint ALJs. During this time, two different ALJs decided the present case years apart, with their recommendations separately appealed to the Bureau’s director. The director upheld the decision by the second ALJ and ordered the lender and its owner to pay the restitution. A district court issued a final order upholding the award, which the petitioners appealed, arguing, among other things, that the enforcement action violated their due-process rights by denying the CEO additional discovery concerning the statute of limitations. The petitioners claimed that they were entitled to a “new hearing” under Lucia, and that the second administrative hearing did not rise to the level of due process prescribed in that case. 

    However, the 10th Circuit affirmed the district court’s $38.4 million restitution award, rejecting the petitioners’ various challenges and affirming the director’s order. The 10th Circuit determined that there was “no support for a bright-line rule against de novo review of a previous administrative hearing,” nor did it see a reason for a more extensive hearing. Moreover, the petitioners “had a full opportunity to present their case in the first proceeding,” the 10th Circuit wrote.

    The petitioners maintained that “[d]espite the Court’s clear instruction to hold a ‘new hearing,’ ALJs and courts have reached divergent conclusions as to what Lucia requires, expressing confusion and frustration regarding the lack of guidance.” What it means to hold a “new hearing” runs “the gamut,” the petitioners wrote, pointing out that while some ALJs perform a full redo of the proceedings, others merely accept a prior decision based on a cold review of the paper record. The petitioners argued that they should have been provided a true de novo hearing with an opportunity for new testimony, evidence, discovery, and legal arguments. The rehearing from the new ALJ was little more than a perfunctory “paper review,” the petitioners wrote.

    Petitioners asked the Court to grant the petition for three reasons: (i) “the scope of Lucia’s ‘new hearing’ remedy is an important and apparently unsettled question of federal law”; (ii) “the notion Lucia does not require a genuinely ‘new’ de novo proceeding is necessarily wrong because a sham ‘remedy’ provides parties no incentive to litigate Appointments Clause challenges”; and (iii) the case “is an ideal vehicle to provide guidance on Lucia’s ‘new hearing’ remedy.” The petitioners further argued that “Lucia’s remedy should provide parties an incentive to raise separation of powers arguments by providing them actual and meaningful relief.”

    The petitioners’ second question involves whether Appropriations Clause violations that render an agency’s funding structure unconstitutional, if upheld, invalidate agency actions taken under such a structure. The petitioners called this “an important, unsettled question of federal law meriting the Court’s review,” citing splits between the Circuits over the constitutionality of the Bureau’s funding structure which has resulted in uncertainty for both regulators and regulated parties. Recently, the Court granted the Bureau’s request to review the 5th Circuit’s decision in CFSAA v. CFPB, which held that Congress violated the Appropriations Clause when it created what the 5th Circuit described as a “perpetual self-directed, double-insulated funding structure” for the agency (covered by InfoBytes here).

    Courts CFPB U.S. Supreme Court Online Lending Payday Lending Appellate Tenth Circuit Fifth Circuit TILA EFTA CFPA UDAAP Enforcement Constitution Funding Structure ALJ

  • 5th Circuit rules against SEC’s use of ALJs

    Courts

    On May 18, the U.S. Court of Appeals for the Fifth Circuit held that the SEC’s in-house adjudication of a petitioners’ case violated their Seventh Amendment right to a jury trial and relied on unconstitutionally delegated legislative power. The appellate court further determined that SEC administrative law judges (ALJs) are unconstitutionally shielded from removal. In a 2-1 decision, the 5th Circuit vacated the SEC’s judgment against a hedge fund manager and his investment company arising from a case, which accused petitioners of fraud under the Securities Act, the Securities Exchange Act, and the Advisers Act in connection with two hedge funds that held roughly $24 million in assets. According to the SEC, the petitioners had, among other things, inflated the funds’ assets to increase the fees they collected from investors. Petitioners sued in federal court, arguing that the SEC’s proceedings “infringed on various constitutional rights,” but the federal courts refused to issue an injunction claiming they lacked jurisdiction and that petitioners had to continue with the agency’s proceedings. While petitioners’ sought review by the SEC, the U.S. Supreme Court issued a decision in Lucia v. SEC, which held that SEC ALJs are “inferior officers” subject to the Appointments Clause of the Constitution (covered by InfoBytes here). Following the decision, the SEC assigned petitioners’ proceeding to an ALJ who was properly appointed, “but petitioners chose to waive their right to a new hearing and continued under their original petition to the Commission.” The SEC eventually affirmed findings of liability against the petitioners, and ordered the petitioners to cease and desist from committing further violations and to pay a $300,000 civil penalty. The investment company was also ordered to pay nearly $685,000 in ill-gotten gains, while the hedge fund manager was barred from various securities industry activities.

    In vacating the SEC’s judgment, the appellate court determined that the SEC had deprived petitioners of their right to a jury trial by bringing its action in an “administrative forum” instead of filing suit in federal court. While the SEC challenged “that the legal interests at issue in this case vindicate distinctly public rights” and therefore are “appropriately allowed” to be brought in agency proceedings without a jury, the appellate court countered that the SEC’s enforcement action was “akin to traditional actions at law to which the jury-trial right attaches.” Moreover, the 5th Circuit noted that while “the SEC agrees that Congress has given it exclusive authority and absolute discretion to decide whether to bring securities fraud enforcement actions within the agency instead of in an Article III court[,] Congress has said nothing at all indicating how the SEC should make that call in any given case.” As such, the 5th Circuit opined that this “total absence of guidance is impermissible under the Constitution.”

    Additionally, the 5th Circuit raised concerns about the statutory removal restrictions for SEC ALJs who can only be removed for “good cause” by SEC commissioners (who are removable only for good cause by the president). “Simply put, if the President wanted an SEC ALJ to be removed, at least two layers of for-cause protection stand in the President’s way,” the appellate court concluded. “Thus, SEC ALJs are sufficiently insulated from removal that the President cannot take care that the laws are faithfully executed. The statutory removal restrictions are unconstitutional.”

    The dissenting judge disagreed with all three of the majority’s constitutional conclusions, contending that the majority, among other things, misread the Supreme Court’s decisions as to what are and are not “public rights,” and that “Congress’s decision to give prosecutorial authority to the SEC to choose between an Article III court and an administrative proceeding for its enforcement actions does not violate the nondelegation doctrine.” The judge further stated that while the Supreme Court determined in Lucia that ALJs are “inferior officers” within the meaning of the Appointments Clause in Article II, it “expressly declined to decide whether multiple layers of statutory removal restrictions on SEC ALJs violate Article II.” Consequently, the judge concluded that he found “no constitutional violations or any other errors with the administrative proceedings below.”

    Courts Appellate Fifth Circuit SEC ALJ Constitution Securities Act Securities Exchange Act Advisers Act Enforcement

  • FDIC codifies appointment of ALJs

    Agency Rule-Making & Guidance

    On January 12, the FDIC published a final rule amending 12 CFR Part 308 to codify the agency’s “practice of having certain adjudicative functions performed by an inferior officer of the United States appointed by the FDIC’s Board of Directors.” The clarification follows a 2018 U.S. Supreme Court decision in Lucia v. SEC, which held that SEC administrative law judges (ALJs) are “inferior officers” subject to the Appointments Clause (Clause) of the Constitution (covered by InfoBytes here). The FDIC notes that while the Lucia decision did not directly affect the agency or FDIC ALJs, the Board has chosen to “formally appoint the ALJs that preside over FDIC enforcement proceedings.” The final rule, which also makes other technical edits to the agency’s rules of practice and procedure to update outdated references to certain position titles, becomes effective immediately.

    Agency Rule-Making & Guidance FDIC ALJ U.S. Supreme Court Bank Regulatory

  • Lender and owner to pay $12.5 million in civil money penalties in CFPB administrative action

    Courts

    On August 4, an Administrative Law Judge (ALJ) recommended that a Delaware-based online payday lender and its CEO be held liable for violations of TILA, CFPA, and the EFTA and pay restitution of $38 million and $12.5 million in civil penalties in a CFPB administrative action. As previously covered by InfoBytes, in November 2015, the Bureau filed an administrative suit against the lender and its CEO alleging violations of TILA and the EFTA, and for engaging in unfair or deceptive acts or practices. Specifically, the CFPB argued that, from May 2008 through December 2012, the online lender (i) continued to debit borrowers’ accounts using remotely created checks after consumers revoked the lender’s authorization to do so; (ii) required consumers to repay loans via pre-authorized electronic fund transfers; and (iii) deceived consumers about the cost of short-term loans by providing them with contracts that contained disclosures based on repaying the loan in one payment, while the default terms called for multiple rollovers and additional finance charges. In 2016, an ALJ agreed with the Bureau’s contentions, and the defendants appealed the decision. In May 2019, CFPB Director Kraninger remanded the case to a new ALJ.

    After a new hearing, the ALJ concluded that the lender violated (i) TILA (and the CFPA by virtue of its TILA violation) by failing to clearly and conspicuously disclose consumers’ legal obligations; and (ii) the EFTA (and the CFPA by virtue of its EFTA violation) by “conditioning extensions of credit on repayment by preauthorized electronic fund transfers.” Moreover, the ALJ concluded that the lender and the lender’s owner engaged in deceptive acts or practices by misleading consumers into “believing that their APR, Finance Charges, and Total of Payments were much lower than they actually were.” Lastly, the ALJ concluded the lender and its owner engaged in unfair acts or practices by (i) failing to clearly disclose automatic rollover costs; (ii) misleading consumers about their repayment obligations; and (iii) obtaining authorization for remote checks in a “confusing manner” and using the remote checks to “withdraw money from consumers’ bank accounts after consumers attempted to block electronic access to their bank accounts.” The ALJ recommends that both the lender and its owner pay over $38 million in restitution, and orders the lender to pay $7.5 million in civil money penalties and the owner to pay $5 million in civil money penalties.

     

    Courts ALJ Civil Money Penalties Payday Lending EFTA CFPB TILA UDAAP

Pages

Upcoming Events