Split In The Circuits Widens As Jarkesy Challenges SEC

October 1, 2015

It hasn't been a particularly good year for the Securities and Exchange Commission ("SEC") as its Administrative Proceedings ("APs") have come under attack by respondents citing bias and lack of due process. Although many pundits expected that such appeals would founder upon the historic disinclination of federal courts to substitute their judgment for that of the federal securities regulator, some courts have stayed proceedings and noted concerns about the fairness of the SEC's in-house process. See, for example:
The other day, however, the beleaguered SEC caught a judicial break.


On March 22, 2014, the Securities and Exchange Commission ("SEC") filed an Order Instituting Administrative Proceedings  ("OIP") In the Matter of John Thomas Capital Management Group LLC, D/B/A Patriot28 LLC, George R. Jarkesy Jr., John Thomas Financial, Inc., and Anastasios "Tommy' Belesis, Respondents (Order Instituting Administrative and Cease and-Desist Proceedings and Notice Of Hearing; '33 Act Rel. 9396; '34 Act Rel. 69208; Inv. Adv. Act Rel 3571; Inv. Co. Act Rel 30435; Admin. Proc No. 3-15255 / March 22, 2013). As alleged in the Summary portion of the OIP:

1. This case concerns fraudulent conduct by Jarkesy, the manager of two hedge funds formerly known as the John Thomas Bridge and Opportunity Fund LP I ("Fund I") and John Thomas Bridge and Opportunity Fund LP II ("Fund II," collectively the "Funds"), and the Funds' adviser, formerly known as JTCM. As alleged herein, Jarkesy also elevated the interests of Respondents JTF and Belesis over those of the Funds by steering millions of dollars in bloated fees to the broker-dealer.

2. Jarkesy and JTCM launched Fund I in 2007 and Fund II in 2009. Since September 2011, the Funds have been known as Patriot Bridge and Opportunity Fund LP I and LP II and the adviser has been known as Patriot28 LLC.1

3. The Funds invest in three asset classes: bridge loans to start-up companies; equity investments principally in microcap companies; and life settlement policies. The Funds' assets under management peaked at approximately $30 million at the end of 2011.

4. Among other things, Jarkesy and JTCM:  

a. recorded arbitrary valuations without any reasonable basis for certain of the Funds' largest holdings, thus causing the Funds' performance figures to be false and misleading and their own compensation to be falsely inflated;

b. marketed the Funds on the basis of false representations about, among other things, the identities of their auditor and prime broker; and

c. breached their fiduciary duty of full and fair disclosure to the Funds by failing to disclose their repeated favoring of the pecuniary interests of Belesis, the chief executive officer of JTF, and JTF, which served as the Funds' placement agent.

5. While they shared the same brand name, JTCM (the adviser) purported to be wholly independent of JTF (the placement agent).

6. Notwithstanding representations that he was "responsible for all of the investment decisions" of the Funds, Jarkesy capitulated to Belesis' aggressive demands regarding certain investment decisions. JTCM's purported independence from JTF was a sham designed to enrich Belesis at the expense of the Funds, and to insulate him from future accusations of wrongdoing.

7. In addition to capitulating to Belesis' demands regarding certain Fund activities, Jarkesy and JTCM abandoned their fiduciary duty to the Funds by negotiating arrangements whereby borrowing companies would divert large fees to JTF and Belesis using proceeds received from the Funds. For example, in connection with certain bridge loans made by Fund I, Belesis (acting through JTF) received hundreds of thousands of dollars in "fees" for providing little or no services.

8. Jarkesy and JTCM placed the interests of Belesis and JTF above the interests of the Funds, thereby violating the fiduciary duty that they owed to the Funds. For example, after being berated by Belesis for not delivering enough fees, Jarkesy promised him in an email in late 2009, "We will never retreat we will never surrender and we will always try to get you as much [fees] as possible, Everytime [sic] without exception!"

Jarkesy DDC Complaint

Following the filing of the OIP, which remains ongoing, on January 29, 2014, Jarkesy and Patriot28, LLC filed a Complaint in the United States District Court for the District of Columbia ("DDC") seeking emergency injunctive and declaratory relief to prevent the SEC's AP from going forward. George R. Jarkesy, Jr. and Patriot28, LLC, Plaintiffs, v. United States Securities and Exchange Commission, Defendant (Complaint, DDC, 14-CV-00114, January 29, 2014). As set forth in the Preliminary Statement in the Complaint:

2. The SEC charged Plaintiffs with securities law violations and seeks lifetime securities-industry and officer-and-director bars and $100 million in punitive "civil" money penalties, but has denied Plaintiffs their fundamental rights of due process, jury trial, equal protection, and has usurped a legislative prerogative, violating the constitutional separation of powers. Among the most egregious of the SEC's violations is the clear prejudgment of the AP, memorialized in a Commission order - issued and published prior to the hearing on the merits of the case - containing pages of factual findings against Plaintiffs and a formal legal finding that they are liable for securities fraud.

DDC Order and Opinion

On June 10, 2014, the DDC issued  an Order dismissing without prejudice Plaintiffs claims for lack of subject matter jurisdiction; and, citing "futility," the Court denied Plaintffs' Motion for Leave to File a First Amended Complaint and Motions for Preliminary and Permanent Injunctive Relief and Motion to Expedite.  In offering its rationale, DDC explained that:

The statutory and regulatory regime under which the SEC's Enforcement Division brought the instant matter against the plaintiffs precludes this Court from exercising subject matter jurisdiction to hear the plaintiffs' claims. The Exchange Act, which the plaintiffs are accused of violating, provides that "[a] person aggrieved by a final order of the [SEC] . . . may obtain review of the order in the United States Court of Appeals." 15 U.S.C. § 78y(a)(1). This statute presents two insurmountable obstacles for the plaintiffs' case in this Court: first, no final order has yet been entered by the SEC, which raises substantial questions about the ripeness of this action for review; and, second, even were this action ripe, federal court review must take place in one of the courts of appeals.

With respect to the first issue, the plaintiffs' counsel implicitly admitted at oral argument that the SEC has issued no final order binding on the plaintiffs, referring to the Order-against their co-respondents-as separate and distinct from "the next [order] that would be coming up, [which] one will have a completely preclusive effect and will trigger a cascade of lawsuits" against the plaintiffs. See Tr. 50:19-23. In admitting that no final ALJ decision has been entered against them, let alone a finding by the SEC's Commissioners, the plaintiffs appear to concede that they are not yet persons "aggrieved by a final order of the [SEC]." 15 U.S.C. § 78y(a)(1). In any event, since no District Court would have subject matter jurisdiction over this matter even if it were ripe for decision, see 15 U.S.C. § 78y(a)(1), the Court need not address this issue any further.

Pages 6 - 7 of the DDC Memorandum Opinion

DCCir Appeal

Plaintiff's appealed the DDC ruling to the United States Court of Appeals for the District of Columbia Circuit ("DCCir") George R. Jarkesy, Jr. and Patriot28, LKC, Appellants, v. Securities And Exchange Commission, Appellee (Opinion, DCCir14-CV-00114; No. 14-5156 / September 29, 2015). In affirming DDC, the DCCir preliminarily explained that:

The Securities and Exchange Commission brought an administrative proceeding against George Jarkesy, Jr., charging him with securities fraud. That proceeding remains ongoing. In the meantime, Jarkesy filed this action in federal district court seeking the administrative proceeding's termination. He argues that the proceeding's initiation and conduct infringe his constitutional rights in several ways. The district court dismissed his action for lack of subject-matter jurisdiction. The court concluded that Congress, by establishing a detailed statutory scheme providing for an administrative proceeding before the Commission plus the prospect of judicial review in a court of appeals, implicitly precluded concurrent district-court jurisdiction over challenges like Jarkesy's.

We agree with the district court and affirm its judgment. In Thunder Basin Coal Co. v. Reich, 510 U.S. 200 (1994), the Supreme Court set forth a framework for determining when a statutory scheme of administrative and judicial review forecloses parallel district-court jurisdiction. The ultimate question is whether Congress intended exclusivity when it established the statutory scheme. Applying the considerations outlined in Thunder Basin and its progeny, we find the answer here is yes. The result is that Jarkesy, instead of obtaining judicial review of his challenges to the Commission's administrative proceeding now, can secure judicial review in a court of appeals when (and if) the proceeding culminates in a resolution against him.

Page 2 of the DCCir Opinion

Bill Singer's Comment

Seems to me that we likely have not heard the last of Jarkesy and the matter may be headed to the Supreme Court. It will be interesting to see if cert is granted. Frankly, there appears to be a split among some federal circuits and the pipeline of appellants may well be building. We will continue to watch Tilton, Duka, and others.