Jarkesy v. United States Securities and Exchange Commission

UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF COLUMBIA

GEORGE R. JARKESY, JR., et al.

Plaintiffs, Civil Action No. 14-114 (BAH)

v. Judge Beryl A. Howell

UNITED STATES SECURITIES AND

EXCHANGE COMMISSION,

Defendant.

MEMORANDUM OPINION

This matter arises out of an administrative proceeding initiated by the Enforcement

Division of the defendant, the U.S. Securities and Exchange Commission (“SEC”), against the

plaintiffs, George Jarkesy and his investment fund management group, Patriot28 (formerly

known as John Thomas Capital Management, LLC) (collectively, “the plaintiffs”). The

gravamen of the plaintiffs’ complaint is that they cannot obtain a fair hearing before the SEC in

an ongoing administrative process because the SEC’s settlement with two of the plaintiffs’ co-

respondents included myriad findings “against Plaintiffs and a formal legal finding that they are

liable for securities fraud.” Compl. ¶ 2, ECF No. 1. Pending before the Court are the plaintiffs’

Motions for Preliminary and Permanent Injunctions and Motion to Expedite (“Pls.’ TRO Mot.”),

ECF No. 3, and their Motion for Leave to Amend Complaint by Filing First Amended Complaint

(“Pls.’ Mot. Am.”), ECF No. 16. Since no District Court has subject matter jurisdiction over this

matter due to the extensive statutory scheme in the securities laws that govern this action, the

plaintiffs’ motions are denied and this matter is dismissed.

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I. BACKGROUND

Plaintiff Jarkesy formed Plaintiff Patriot28 in 2007 “to manage investment funds sold

exclusively by a registered placement agent to high-net-worth individuals who knowingly

accepted the funds’ high-risk investment strategy and acknowledged their ability to bear a loss of

their entire investment.” Compl. ¶ 9. During the financial crisis of 2008, the plaintiffs were

“battered” and still have not fully recovered. Id. ¶ 10. After the crisis, the SEC’s Enforcement

Division investigated and ultimately charged the plaintiffs with violating the Securities Act of

1933 (“the Securities Act”), the Securities Exchange Act of 1934 (“the Exchange Act”), and the

Investment Adviser’s Act of 1940 (“the Adviser’s Act”). Id.

The SEC issued an “Order Instituting Administrative and Cease-and-Desist Proceedings,”

or OIP, on March 22, 2013 against the plaintiffs and two other respondents, John Thomas

Financial, Inc. (“JTF”) and Anastasios “Tommy” Belesis (“Belesis”), who are not parties to this

action. See Pls.’ TRO Mot. Ex. A at 1, ECF No. 3-1. The OIP alleges that the four respondents

engaged in fraudulent conduct and “elevated the interests of Respondents JTF and Belesis over

those of the [Investor] Funds by steering millions of dollars in bloated fees to the broker-dealer.”

Id. at 2.

Using its power under 15 U.S.C. § 77h-1 and 15 U.S.C. § 78u-3, the SEC chose to bring

an administrative action against the plaintiffs and their co-respondents instead of an injunctive

action in a District Court, as provided for in 15 U.S.C. § 78u(d)(1). See Pls.’ TRO Mot. Ex. A at

17; Def.’s Opp’n Pls.’ TRO Mot. (“Def.’s TRO Opp’n”) at 3. As the plaintiffs point out, this

statute allows “[t]he SEC . . . discretion to bring certain cases in an [Administrative Proceeding],

which previously could only be brought in federal court.” Compl. ¶ 25; see also 15 U.S.C. §

78u-3(a) (“If the Commission finds, after notice and opportunity for hearing, that any person is

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violating [securities laws] . . . the Commission may publish its findings and enter an order

requiring such person . . . to cease and desist from committing or causing such violation . . . .”).

Such administrative proceedings are governed by the SEC’s “Rules of Practice,” codified at 17

C.F.R. §§ 201.100 et seq., which provide for, inter alia, procedures for summary disposition, id.

§ 201.250; interlocutory review by the SEC’s Commissioners, id. § 201.400; and, of particular

relevance to the instant matter, settlement before an administrative hearing has been conducted,

id. § 201.240. The settlement portion of the Rules of Practice provides that “[a]ny person who is

notified that a proceeding may or will be instituted against him or her, or any party to a

proceeding already instituted, may, at any time, propose in writing an offer of settlement.” Id.

§ 201.240(a).

In October 2013, the plaintiffs’ two co-respondents exercised the option provided by §

201.240(a) by making an offer of settlement that contained “a consent to a finding that they

‘aided, abetted and caused the Manager’s and Adviser’s breaches of their fiduciary duties to the

Funds.’” Def.’s TRO Opp’n at 7; see Pls.’ TRO Mot. Ex. Q (Order Making Findings, Imposing

Remedial Sanctions and a Cease-and-Desist Order) (“the Order”) at 2, ECF No. 3-3. Neither

plaintiff in the instant matter is referred to by name in the settlement offer, but Plaintiff Jarkesy

admits to being the “Manager” and “Adviser” referred to therein. See TRO Hrg. Tr. (“Tr.”)

6:20-22, Jan. 31, 2014. The SEC accepted the offer of settlement in an Order dated December 5,

2013. See Pls.’ TRO Mot. Ex. O (“Petition for Interlocutory Review and Stay of Proceedings”)

at 1, ECF No. 3-3.

The plaintiffs allege that in accepting the settlement offer and issuing the subsequent

Order, the SEC “entered detailed and unqualified findings of fact and conclusions of law against

Plaintiffs, including finding that Plaintiffs engaged in fraudulent conduct and violated a specific

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provision of the Advisers Act.” Compl. ¶ 19 (emphasis in original). The plaintiffs further allege

that the Order “contains elaborate findings so sweeping as to establish violations of all of the

[SEC’s Enforcement] Division’s charges and to support each of the remedies sought.” Id. The

plaintiffs assert that making such findings in the Order was “totally unnecessary to effect the

settlement with [the plaintiffs’ co-respondents] Belesis and JTF and, therefore, serve[d] no other

purpose than to express the opinions and conclusions of the Commission.” Id. ¶ 20.

Following the entry of the Order and before the commencement of the administrative

hearing against the plaintiffs, the plaintiffs filed a Petition for Interlocutory Review and Stay of

Proceeding, seeking to disqualify the SEC’s Commissioners from hearing any proceedings

related to the matter and a dismissal of the administrative proceeding. Pls.’ TRO Mot. Ex. O at

1. In their petition, the plaintiffs allege that the Order “establishes that the Commission has

conclusively prejudged the case against the [plaintiffs], and engaged in impermissible ex parte

communications with the [Enforcement] Division staff in connection with the settlement.” Id. at

1–2. The administrative law judge (“ALJ”) assigned to the matter denied the plaintiffs’ motion

and the SEC Commissioners subsequently denied the plaintiffs’ interlocutory appeal. See Pls.’

TRO Mot. Ex. N (“Order Denying Certification for Interlocutory Review”) at 1–2, ECF No. 3-3.

The plaintiffs filed suit in this Court on January 29, 2014, seeking a temporary restraining

order to stay the administrative hearing scheduled for February 3, 2014, and a declaratory

judgment that, inter alia, the SEC violated the plaintiffs’ right to due process and violated the

Administrative Procedure Act, 5 U.S.C. § 551 et seq. Compl. ¶¶ 66–72. The Court held a

hearing on the plaintiffs’ Motion for a Temporary Restraining Order, filed contemporaneously

with their Complaint, on January 31, 2014. See generally Tr. Following the TRO hearing, the

Court denied the plaintiffs’ motion for a Temporary Restraining Order. See Tr. 73:1-4.

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Specifically, the Court found that the plaintiffs failed to sustain their burden in seeking

injunctive relief because (1) the Court was “not convinced that [it has] jurisdiction over this

matter or that this case is ripe for decision[;]” (2) the plaintiffs had failed to show they did not

have adequate remedies at law, as provided for by the various securities laws they are accused of

violating; (3) the plaintiffs failed to show that they would be irreparably harmed by submitting to

an ALJ proceeding; and (4) the balance of equities did not favor the plaintiffs. See Tr. 73:5–

74:18. The parties were ordered to submit a proposed briefing schedule to address the pending

motion for preliminary injunction. See Minute Order, Jan. 31, 2014.

Rather than continue briefing on the preliminary injunction motion, the parties proposed

“that the Court first issue a ruling on subject matter jurisdiction” since, if “the Court finds it does

not have subject matter jurisdiction over Plaintiffs’ claims, no further briefing by either party

would be necessary.” Prop. Br. Sched. at 2, ECF No. 11. The parties were subsequently ordered

to show cause why the plaintiffs’ motion for a preliminary injunction was not moot, since the

administrative proceeding the plaintiffs sought to delay had proceeded as scheduled. See Minute

Order to Show Cause, Feb. 18, 2014. In connection with filing their response, the plaintiffs

sought leave to amend their complaint to “add more facts supporting their claims against

Defendant,” in essence to show that the plaintiffs’ request for a preliminary injunction was not

moot. See Pls.’ Mot. Am. Compl. at 1, ECF No. 16; Prop. First Am. Compl. ¶ 1, ECF No. 16-2

(noting plaintiffs sought to “prevent the SEC from proceeding with . . . all other phases of the

[Administrative Proceeding], that has violated, and will continue to violate, Plaintiffs’

fundamental constitutional rights.”). The Court now addresses the threshold issue of whether it

has subject matter jurisdiction over the plaintiffs’ claims.

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II. LEGAL STANDARD

“‘Federal courts are courts of limited jurisdiction,’ possessing ‘only that power

authorized by Constitution and statute.’” Gunn v. Minton, 133 S. Ct. 1059, 1064 (2013) (quoting

Kokkonen v. Guardian Life Ins. Co. of Am., 511 U.S. 375, 377 (1994)). Indeed, federal courts

are “forbidden . . . from acting beyond our authority,” NetworkIP, LLC v. FCC, 548 F.3d 116,

120 (D.C. Cir. 2008), and, therefore, have “an affirmative obligation ‘to consider whether the

constitutional and statutory authority exist for us to hear each dispute.’” James Madison Ltd. by

Hecht v. Ludwig, 82 F.3d 1085, 1092 (D.C. Cir. 1996) (quoting Herbert v. Nat’l Acad. of Scis.,

974 F.2d 192, 196 (D.C. Cir. 1992)). Absent subject matter jurisdiction over a case, the court

must dismiss it. McManus v. District of Columbia, 530 F. Supp. 2d 46, 62 (D.D.C. 2007).

It is the plaintiffs’ burden to establish a court’s jurisdiction over the subject matter by a

preponderance of the evidence. See Lujan v. Defenders of Wildlife, 504 U.S. 555, 561 (1992).

The Court must accept as true all uncontroverted material factual allegations contained in the

complaint and “construe the complaint liberally, granting plaintiff the benefit of all inferences

that can be derived from the facts alleged and upon such facts determine jurisdictional

questions.” Am. Nat’l Ins. Co. v. FDIC, 642 F.3d 1137, 1139 (D.C. Cir. 2011) (internal citations

and quotation marks omitted). The Court need not accept inferences drawn by the plaintiff,

however, if those inferences are unsupported by facts alleged in the complaint or amount merely

to legal conclusions. See Browning v. Clinton, 292 F.3d 235, 242 (D.C. Cir. 2002). In

evaluating subject matter jurisdiction, the Court, when necessary, may look beyond the

complaint to “undisputed facts evidenced in the record, or the complaint supplemented by

undisputed facts plus the court’s resolution of disputed facts.” Herbert, 974 F.2d at 197; see also

Alliance for Democracy v. FEC, 362 F. Supp. 2d 138, 142 (D.D.C. 2005).

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III. DISCUSSION

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.

Two Supreme Court cases, Thunder Basin Coal Co. v. Reich (Thunder Basin), 510 U.S.

200 (1994), and Free Enterprise Fund v. Public Co. Accounting Oversight Board. (Free

Enterprise), 130 S. Ct. 3138 (2010), are dispositive as to why no District Court may hear the

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plaintiffs’ suit. In Thunder Basin, the Supreme Court examined a statutory review mechanism

similar to the one at issue in the instant case. See 510 U.S. at 205. Specifically, the Court

reviewed the Federal Mine Safety and Health Amendments Act of 1977, which provides that

“[c]hallenges to enforcement are reviewed by the Federal Mine Safety and Health Review

Commission . . . and by the appropriate United States Court of Appeals.” Id. at 204. In Thunder

Basin, “[t]he Act establishe[d] a detailed structure for reviewing violations,” consisting of a

proceeding initiated by the agency before an ALJ, who adjudicates any challenges to such action,

an appeal to the agency, and then review before the Court of Appeals. See id. at 207–08. In the

instant matter, a virtually identical four-step process is mandated, where (1) charges are brought

by the SEC’s Enforcement Division before an ALJ; (2) the plaintiffs have the opportunity to be

heard and present evidence challenging the charges; (3) the plaintiffs may appeal an adverse ALJ

decision to the SEC Commissioners; and (4) if the plaintiffs are aggrieved by the resulting final

order, the plaintiffs may appeal to a federal Court of Appeals. See 15 U.S.C. §§ 78u-3,

78y(a)(1).

Where Congress has established such a comprehensive scheme for review of agency

enforcement proceedings, the Supreme Court in Thunder Basin held that litigants may

nevertheless bring claims to the District Court if the “claims considered [are] wholly collateral to

a statute’s review provisions and outside the agency’s expertise, particularly where a finding of

preclusion could foreclose all meaningful judicial review.” 510 U.S. at 212–13 (internal

quotation marks and citations omitted). The Thunder Basin Court went on to find that the

exception did not apply to the plaintiff in that matter, despite the plaintiff raising a constitutional

due process claim—as the plaintiffs are raising here. See id. at 215–16. The Thunder Basin

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Court concluded that any “statutory and constitutional claims . . . can be meaningfully addressed

in the Court of Appeals” following agency review. Id. at 215.

Similarly to the plaintiff in Thunder Basin, the plaintiffs in the instant matter have failed

to establish that the exception outlined by the Supreme Court in that case applies. Although the

plaintiffs raise various allegations of violations of their constitutional rights to due process and

equal protection, see generally Compl., those claims are inextricably intertwined with the

conduct of the very enforcement proceeding the statute grants the SEC the power to institute and

resolve as an initial matter. See 15 U.S.C. § 78y(a)(1). While the constitutional questions may

be outside the purview of the agency’s expertise, there is no dispute that the plaintiffs will have

the opportunity to raise all of their constitutional claims before a Court of Appeals should the

ALJ and the Commission issue orders adverse to them. See id.

The Supreme Court’s decision in Free Enterprise does not counsel a different result and,

indeed, illustrates why the plaintiffs’ claims are not heard appropriately by any District Court. In

Free Enterprise, the Supreme Court found that the petitioners were not challenging the

application of a particular rule to them, but rather they were challenging makeup of the federal

agency in question and whether the agency’s very existence was constitutional, making their

challenge wholly collateral to the statutory scheme that would otherwise strip the District Court

of jurisdiction. See 130 S. Ct. at 3150. Moreover, the Supreme Court noted that, in Free

Enterprise, the petitioners were faced with the prospect of having knowingly to violate the rules

they were challenging, which would entail the risk of a substantial fine, in order to initiate a

proceeding that could eventually lead to judicial review. See id. at 3151 (“We normally do not

require plaintiffs to ‘bet the farm . . . by taking the violative action’ before ‘testing the validity of

the law’” (quoting MedImmune, Inc. v. Genentech, Inc., 549 U.S. 118, 129 (2007))). Thus, an

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animating concern in Free Enterprise was the fact that the petitioners would have to commit a

violation they otherwise would not have committed merely to trigger the opportunity to review

the constitutionality of the challenged agency’s existence. See id.

Here, the plaintiffs do not raise a “wholly collateral” challenge, nor are they being forced

to “bet the farm” on an action they would not otherwise take. See id. at 3150–51. The plaintiffs

are challenging the SEC’s interpretation of its own regulations—pertaining to ex parte

communications and settlement authority—and the SEC’s interpretation of various securities

laws as they pertain to the plaintiffs. See generally Compl. Far from challenging something

wholly collateral to their own situation, the plaintiffs’ claims here are entirely related to their

own actions, just as were the petitioner’s claims in Thunder Basin. See 510 U.S. at 214.

Additionally, unlike the petitioners in Free Enterprise, who had seen the investigation into their

accounting practices conclude without a recommendation for a sanction, yielding no opportunity

for judicial review, see Free Enterprise, 130 S. Ct. at 3150 (“an uncomplimentary inspection

report is not subject to judicial review”), the plaintiffs in the instant matter will either have the

opportunity to seek judicial review if they are aggrieved by the SEC’s final order or, if they are

not aggrieved, their fact-specific challenges will be moot. In either situation, the plaintiffs in the

instant matter have a “‘meaningful’ avenue of relief,” id. at 3151, similarly to the petitioners in

Thunder Basin and unlike the petitioners in Free Enterprise. 1

The D.C. Circuit and other decisions from this Court have applied Thunder Basin to find

subject matter jurisdiction lacking before the District Court. In Sturm, Ruger & Co. v. Chao, 300

1

The Supreme Court has reaffirmed the reasoning in Thunder Basin at least twice since that case was decided. For

example, in Elgin v. U.S. Department of the Treasury, 132 S. Ct. 2126, 2132 (2012), the Court noted that when “the

plaintiff’s claims could be ‘meaningfully addressed in the Court of Appeals,’” and “Congress’ intent to preclude

district court jurisdiction was “‘fairly discernible in the statutory scheme[,]’” the Constitution allowed an agency to

be the first to hear an as-applied challenge to an agency decision. Likewise, in Shalala v. Illinois Council on Long

Term Care, 529 U.S. 1, 19 (2000), the Court explained that the “strong presumption against preclusion of review is

not implicated by [a] provision postponing review,” again finding that Congress has the power to “channel” the first

review of agency decisions away from District Courts.

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F.3d 867, 874–75 (D.C. Cir. 2002), for example, the D.C. Circuit found that a plaintiff’s claim

was not “wholly collateral” to a statutory agency review provision when evaluating the merits of

the plaintiff’s claims “requires interpretation of the parties’ rights and duties” under the operable

statute. At issue in that case was a provision in the Occupational Safety and Health Act

providing to the Department of Labor powers similar to those provided to the SEC under the

Securities Act. Id. at 868. The D.C. Circuit concluded that “barring district court review . . .

[would] not deprive employers of the opportunity to obtain judicial review” because any

employer aggrieved by the Labor Department’s actions could “contest the citation through the

statutory review procedure that ultimately ends in a court of appeals.” Id. at 874.

Alternatively, when a plaintiff is making a facial challenge to a statute, a situation that is

not present in this case, the general Thunder Basin rule does not apply. See Gen. Elec. v. EPA,

360 F.3d 188, 191 (D.C. Cir. 2004). The General Electric court noted that when a statute barred

District Court review of particular agency actions, such a provision did not divest the District

Court of subject matter jurisdiction over the “statute itself.” Id. While the plaintiff in General

Electric was challenging the constitutionality of a statute, the plaintiffs here have made no such

claim about any statute apart from how the statute is being applied to them in the instant

enforcement action. See id. Thus, the plaintiffs’ claims fall squarely within the controlling

authority of Thunder Basin instead of General Electric and, consequently, this Court is without

jurisdiction to hear their claims.

Courts interpreting Free Enterprise have similarly found that where a statute provides an

agency the first opportunity to review a claim before appeal to a Court of Appeals, the statute

deprives the District Court of jurisdiction. See Amerijet Int’l v. U.S. Dep’t of Homeland Sec.,

No.13-1405, 2014 U.S. Dist. LEXIS 70270, at *40–41 (D.D.C. May 22, 2014) (finding, under

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Free Enterprise standard, that review in Court of Appeals after review of action within agency

deprived District Court of subject matter jurisdiction); see also Morgan Drexen, Inc. v.

Consumer Fin. Prot. Bureau, No. 13-1112, 2013 U.S. Dist. LEXIS 149387, at *33–35 (D.D.C.

Oct. 17, 2013) (denying request for injunctive relief and dismissing matter where District Court

had no subject matter jurisdiction over enforcement proceeding involving constitutional issues

where plaintiff had right to appeal in Court of Appeals). 2

In sum, the statutory regime embodied in the Securities Act sets forth an exclusive

mechanism for the plaintiffs to pursue their claims: first, before an ALJ, then before the SEC’s

Commissioners, and finally, if necessary, before a Court of Appeals. To the extent that the

plaintiffs believe their cause has been prejudged by the SEC’s Commissioners, they may seek

review, if necessary, before the Court of Appeals, but the statute leaves no room for this Court to

provide them the relief they seek.

2

At the TRO Hearing, and in their memoranda in support of their request for that injunctive relief, the plaintiffs

relied heavily on a Southern District of New York case, Gupta v. SEC, 796 F. Supp. 2d. 503, 514 (S.D.N.Y. 2011),

in which the district court allowed an equal protection claim against the SEC to proceed in the context of a challenge

to an administrative proceeding, despite dismissing the plaintiff’s remaining claims. See Tr. 34:6–38:24 (discussing

Gupta and equal protection claim); Pls.’ Mem. Supp. TRO Mot. at 14, 16, 18, 34–35, ECF No. 3-1 (same). Notably,

the plaintiff’s do not mention this case in its memoranda submitted after the TRO Hearing. See generally, Proposed

Briefing Schedule, ECF No. 11; Pls.’ Resp. Ct.’s Show Cause Order, ECF No. 12; Pls.’ Reply Def.’s Resp. Order

Show Cause, ECF. No. 15. As the Court indicated at the TRO hearing, the plaintiffs’ reliance on Gupta is

questionable in the wake of Altman v. SEC, 687 F.3d 44, 45 (2d Cir. 2012), which applied Thunder Basin in

affirming a District Court’s decision that it did not have subject matter jurisdiction over a constitutional challenge to

an ongoing SEC administrative proceeding. In any event, the Court finds the controlling precedent in this Circuit to

support only one outcome in this case: namely, dismissal.

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IV. CONCLUSION

The plaintiffs’ Complaint must be dismissed because this Court lacks subject matter

jurisdiction over their claims. See FED. R. CIV. P. 12(h)(3). Moreover, because the proposed

amended complaint does not add any facts to correct the fatal jurisdictional problems with the

plaintiffs’ claims, the plaintiffs’ Motion to Amend is denied as futile.

An appropriate Order accompanies this Memorandum Opinion.

Date: June 10, 2014

Digitally signed by Beryl A. Howell

DN: cn=Beryl A. Howell, o=District

Court for the District of Columbia,

ou=District Court Judge,

email=howell_chambers@dcd.usco

urts.gov, c=US

__________________________

Date: 2014.06.10 16:53:33 -04'00'

BERYL A. HOWELL

United States District Judge

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