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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.”
On February 14, the SEC and state regulators reached a $100 million settlement with a New Jersey-based financial services company in parallel actions to resolve allegations that the company failed to register the offers and sales of its retail credit lending product—marking the SEC’s “first-of-its-kind action” taken with respect to crypto lending platforms. According to the SEC, the company offered a product whereby retail investors lent crypto assets to the company “in exchange for the company’s promise to provide a variable monthly interest payment.” Among other things, the SEC found that because the company’s product are securities under applicable law, the company was required to register its offers and sales of the product or qualify for an exemption—both of which the company failed to do. The company also allegedly violated the Securities Act by making misleading statements on its website concerning its collateral practices and the level of risk in its loan portfolio and lending activity. Additionally, the company allegedly violated the Investment Company Act by engaging in interstate commerce while failing to register as an investment company with the SEC. While the company neither admitted nor denied the findings, it agreed to pay $50 million to the SEC and another $50 million to 32 states to settle similar charges. The company also agreed to cease engaging in unregistered offers and sales of its product, and will stop offering or selling its product in the U.S. Additionally, the company’s parent company stated its intention to register the offer and sale of a new lending product under the Securities Act.
On January 28, the U.S. District Court for the Eastern District of Michigan issued judgments (see here and here) against a real estate company and its CEO in the SEC’s first crowdfunding regulation enforcement action. As previously covered by InfoBytes, the SEC filed a complaint last September alleging that several entities and related individuals participated in a fraudulent scheme to sell nearly $2 million of unregistered securities through two crowdfunding offerings. The complaint alleged that two of the entities issued securities without registering with the SEC, while their principals diverted investor funds for personal use rather than using the funds for the disclosed purposes. Without admitting or denying the SEC’s allegations, the real estate company and the CEO consented to be permanently enjoined from violating certain securities laws. The CEO also agreed to a prohibition on “acting as an officer or director of any issuer that has a class of securities registered pursuant to Section 12 of the Exchange Act [15 U.S.C. § 78l] or that is required to file reports pursuant to Section 15(d) of the Exchange Act [15 U.S.C. § 78o(d)].” The judgments decreed that, upon motion of the SEC, the court will decide whether disgorgement and/or civil money penalties are appropriate.
On January 28, the SEC announced a settlement subject to court approval with a private technology company to resolve allegations that the company, through its former CEO, falsely inflated key financial metrics and doctored internal sales records. The complaint, which alleged violations of the antifraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934, claimed that the CEO significantly inflated the value of numerous customer deals, and then masked the inflation by creating fake invoices and altering real invoices to make it seem as if customers had been billed higher amounts. The company’s board of directors conducted an internal investigation, which led to the removal of the CEO, a revised company valuation, and remedial efforts including repaying investors. The company also hired new senior management, expanded its board, and implemented processes and procedures to ensure transparency and accuracy of deal reporting and associated revenues. While the company neither admitted nor denied the allegations, it agreed to be permanently enjoined from violations of the antifraud provisions. The SEC highlighted that the lack of a penalty in the settlement is significant, and demonstrates the Commission’s position that a company may receive credit if it makes significant remedial efforts in the wake of an internal investigation. “For companies wondering what types of remedial actions and cooperation might be credited by the Commission after a company uncovers fraud, this case offers an excellent example,” stated Gurbir S. Grewal, Director of the SEC’s Division of Enforcement. “[The company’s] remediation and cooperation included not just its internal investigation and revised valuation, but also repaying harmed investors and improving its governance—all of which were factors that counseled against the imposition of a penalty in this case.”
On November 2, the U.S. District Court for the Middle District of Georgia granted the SEC’s motion for default judgement in its suit accusing a Georgia-based investment firm and three of its officers of defrauding investors out of approximately $3 million. In July, the SEC filed a complaint against the defendants for allegedly defrauding investors through a prime bank scheme by falsely promising that their funds would remain in a purported escrow account and earn lucrative returns without any risk of loss, which violated the antifraud provisions of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. In its memorandum of law in support of its motion for default judgment, the SEC alleged that none of the defendants filed answers or responsive pleadings with the district court and had “engaged in egregious misconduct, acted with scienter, failed to admit their wrongdoing, were thoroughly dishonest with authorities, and have not demonstrated their financial means.” The district court granted the motion, approved permanent injunctions barring the defendants from committing future violations of securities laws, and required the defendants to return the investors' money with interest, in addition to the profits obtained through the alleged scheme. According to the order, the defendants are required to pay approximately $2.7 million total in disgorgement, exclusive of prejudgment interest, and pay a civil penalty of approximately $192,000.
On September 23, the SEC filed a complaint against two former principals of a subprime automobile finance company for allegedly misleading investors about certain subprime auto loans. According to the SEC, the defendants made false and misleading statements and engaged in deceptive conduct concerning the company’s servicing practices in connection with a $100 million offering backed by a pool of subprime auto loans. The SEC alleged that the defendants took measures to artificially inflate the value of the collateral underlying the offering, such as by (i) including poorly-performing and delinquent loans that were disguised to appear to be performing better than they really were; (ii) applying “fake borrower payments” to delinquent loans; and (iii) extending terms on delinquent loans without contacting the borrower to disguise how far behind the borrowers were on payments. Because of these improper practices, the SEC claimed that servicing and performance information provided by the company to investors at the time of the offering and later on was false. The complaint charges the defendants with violations of the anti-fraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934, and seeks permanent injunctions, officer and director bars, disgorgement with prejudgment interest, and civil penalties.
On September 21, the SEC filed a complaint against a Puerto-Rico based company and its two managing members (collectively, “defendants”) in the U.S. District Court for the District of Puerto Rico alleging that they offered and sold to retail investors the opportunity to share the profits of a purported Colombian gold mining operation. According to the SEC, the offering, which was unregistered with the Commission, was part of a fraudulent scheme that raised approximately $2.7 million. The complaint also alleges that one of the members and the company authorized advertisements that promised “exorbitant returns on the investment, and provided investors with false and misleading [decks] that misrepresented the status of the mining operations,” while the other member allegedly signed contracts with investors when he had knowledge that the company’s statements to investors were misleading. The SEC’s complaint alleges violations of the registration and anti-fraud provisions of the federal securities laws, specifically, the Securities Act of 1933 and the Securities Exchange Act of 1934. The complaint seeks a permanent injunction against the defendants, a permanent ban prohibiting the defendants’ participation in the issuance, purchase, offer, or sale of securities in an unregistered offering, disgorgement of ill-gotten gains, and civil penalties.
On September 20, the SEC brought its first regulation crowdfunding enforcement action against several entities and related individuals allegedly involved in a fraudulent scheme to sell nearly $2 million of unregistered securities through two crowdfunding offerings. According to the SEC’s complaint, two of the entities issued securities without registering with the SEC, while their principals diverted investor funds for personal use rather than using the funds for the disclosed purposes. These actions, the SEC claimed, violated the antifraud and registration provisions of the Securities Act of 1933 and Securities Exchange Act of 1934. Among other things, the SEC claimed that one of the individuals—“a driving force behind both offerings”—also allegedly concealed his participation in the offerings from the public to hide a past criminal conviction arising from a mortgage fraud scheme out of concern that it could deter prospective investors. The SEC also charged the crowdfunding platform that hosted the offering, and its founder and CEO, with violations of the Securities Act and Regulation Crowdfunding for ignoring red flags about the other defendants. The complaint seeks disgorgement plus pre-judgment interest, penalties, permanent injunctions, and officer and director bars. Director of the SEC’s Division of Enforcement, Gurbir S. Grewal, stressed the importance of full and honest disclosures in these types of offerings: “As companies continue to raise funds through crowdfunding offerings, we will hold issuers, gatekeepers and individuals accountable and enforce the protections in place for all investors.”
On September 13, the SEC announced charges against three media companies (respondents) for allegedly violating the Securities Act of 1933 (Securities Act) by conducting an illegal unregistered offering of stock and coin security. In addition, two of the companies were also charged for allegedly conducting an illegal unregistered offering of a digital asset security. According to the SEC’s order, between April and June 2020, the respondents generally solicited thousands of individuals to invest in a common stock offering. During the same time period, two of the companies solicited individuals to invest in their offering of a digital asset coin security. As a result of these two unregistered securities offerings, whose proceeds were commingled, the respondents collectively raised approximately $487 million from over 5,000 investors.
The order finds that, through both the stock and coin offering, the respondents violated Sections 5(a) and 5(c) of the Securities Act by offering and selling securities without having properly registered. The order, to which the companies consented without admitting or denying the findings, notes that the respondents are banned from participating in any offering of a digital asset security, and are required to cease and desist from future violations of the Securities Act and assist the SEC staff in the administration of a distribution plan, among other things. Two of the companies agreed to pay, jointly and severally, disgorgement of approximately $434 million plus prejudgment interest of approximately $16 million, in addition to a civil penalty of $15 million each. The other company agreed to pay disgorgement of approximately $52 million plus prejudgment interest of almost $2 million, as well as a civil penalty of $5 million. The order also establishes a Fair Fund to return monies to injured investors.
On August 16, the SEC announced charges against a London-based educational publishing company for its role in allegedly misleading investors regarding a cyber breach that involved millions of student records and had inadequate disclosure controls and procedures in place. According to the SEC’s order, the company made material misstatements and omissions about a 2018 cyber intrusion that affected millions of rows of data across 13,000 school, district, and university customer accounts in the U.S. According to a 2019 report furnished to the Commission, the company’s risk factor disclosure implied that the company faced the hypothetical risk that a “data privacy incident” “could result in a major data privacy or confidentiality breach” but did not disclose that a data breach involving the company had previously taken place. In response to an inquiry by a media outlet, the company sent a breach notification to its affected customers and issued a previously prepared statement that included misstatements regarding the breach and data involved. The order found that the company failed “to maintain disclosure controls and procedures designed to analyze or assess such incidents for potential disclosure in the company’s filings.” The SEC charged the company with violating, among other things, Rule 13a-15(a) of the Securities Act, which requires every issuer to maintain disclosure controls and procedures, and Section 13(a) of the Exchange Act which requires “every foreign issuer of a security registered pursuant to Section 12 of the Exchange Act to furnish the Commission with periodic reports containing information that is accurate and not misleading.” The order, which the company consented to without admitting or denying the findings, imposes a civil money penalty of $1 million and provides that the company must cease and desist from committing or causing any future violations of the Securities Act and the Exchange Act.
- Daniel R. Alonso discussed “The importance of the FCPA in the world and its current impact” at a ‘Competitive Breakfast’ event sponsored by the international compliance firm Intedya
- Jedd R. Bellman discussed “The CFPB’s crackdown on collection junk fees and the growing anti-CFPB rhetoric” at an Accounts Recovery webinar
- Buckley Webcast: State supervision, enforcement, and multistate coordination
- Benjamin W. Hutten to discuss “Latest on AML regulations and impact of economic sanctions” at a Mortgage Bankers Association webinar
- Hank Asbill to discuss “Ethical issues at sentencing” at the 31st Annual National Seminar on Federal Sentencing
- Benjamin W. Hutten to discuss “Fundamentals of financial crime compliance” at the Practicing Law Institute
- Benjamin W. Hutten to discuss “Ongoing CDD: Operational considerations” at NAFCU’s Regulatory Compliance & BSA Seminar