An Atlanta federal court judge this week slammed the brakes on a SEC case against Larry Gray and his company, which advises some of the largest public pension systems in the metro region.
In the process, Judge Leigh Martin May’s ruling could call into question whether the U.S. Securities and Exchange Commission has created an unfair advantage for itself as it polices the financial industry in the wake of the 2008 economic meltdown.
The SEC announced its intention to use its administrative law process, rather than the federal court system, in cases against both Gray Financial and Atlanta developer Charles Hill Jr., who is accused of using insider information to make a quick $744,000 on a series of investments in 2011.
May ruled Wednesday that the SEC’s method of appointing administrative law judges (ALJs) to preside over those hearings is unconstitutional, and the agency would have to take a different tact.
That ruling conflicts with a decision by a federal judge in the D.C. circuit, who found the SEC’s process to be legal.
With the conflicting rulings, and yet another case pending in New York, the issue ultimately could be decided by the U.S. Supreme Court, said Kent Barnett, an administrative law expert and assistant professor of law at the University of Georgia.
And there’s a lot at stake. An adverse ruling by the high court could affect the SEC and 27 other agencies across the federal government. The SEC only uses a handful of ALJs, while an agency like the Social Security Administration uses about 1,300, Barnett said.
May’s ruling is technical and doesn’t address the merits of the government’s cases, which she was never asked to consider.
The SEC brought the enforcement action against Gray, co-chief executive Robert Hubbard and Gray Financial in May, about two years after The Atlanta Journal-Constitution reported that the company took advantage of a change in state law to create a fund that guaranteed large returns.
The 2013 newspaper investigation found that Gray Financial then advised the public pensions under its care to invest in the so-called alternative investment fund, which in turn invested the money in private equity, real estate and distressed or start-up companies.
MARTA and the three city of Atlanta systems have invested a combined $42 million as of Dec. 31, 2014, according to a recent audit of the fund. Contracts with the pension systems guarantee Gray Financial a 1-percent annual fee.
The SEC accuses Gray, Hubbard and the company of fraud, because they steered the investments to the fund even though it allegedly did not adhere to particular constraints in Georgia law when the pensions invested. Whether the fund met those requirements was also a question raised in the newspaper’s investigation.
May’s 36-page order in the Gray case says the SEC does not appoint administrative law judges in accordance with federal law. The ruling suggests that the agency could remedy the problem by taking the case to federal court, or having an SEC commissioner properly appoint the ALJ for it. May said another alternative would be for an SEC commissioner to preside over the case.
“The court notes that this conclusion may seem unduly technical,” May wrote, before adding that the U.S. Supreme Court has stressed the importance of the appointment process because it “preserves … the Constitutional’s structural integrity by preventing the diffusion of appointment power.”
“The public has an interest in assuring that citizens are not subject to unconstitutional treatment by the government,” May wrote.
The SEC could appeal May’s order. An agency spokeswoman declined to comment.
May issued a similar ruling Wednesday in favor of Hill. The arguments against the ALJ appointment process are nearly identical in the Hill and Gray lawsuits against the SEC.
Gray’s attorney, Terry Weiss, said the SEC’s process in appointing administrative law judges is important because they have so much power — they act as judge and jury, presiding over hearings, ruling on admissibility of evidence, issuing orders, reconsidering their own decisions and more.
Weiss’ complaint says that administrative hearings are more advantageous to the SEC than federal court proceedings, and cites a National Law Journal study from January that found the agency had won its last 219 decisions before administrative law judges. A Wall Street Journal analysis found that the SEC won 90 percent of its cases before ALJs from October 2010 through March.
“If it is so easy for the SEC to fix this, then why has the SEC not done so?” Weiss asked in an interview with the AJC. “Instead, the SEC is spending hundreds of thousands of dollars — if not more — of taxpayer money litigating this issue.”
Barnett said an adverse ruling could call into question all pending SEC cases and those on appeal. He said it is an “open question” whether past cases would be impacted. It is also unclear how ALJs in other agencies are being appointed, and what impact an adverse ruling would have on them, the professor said.
SEC attorneys argued that their method of appointing the ALJs is proper, and that rulings from administrative hearings can be appealed into the federal court system.
But the judge ruled that an appeal after the administrative hearing “would become moot as the Court of Appeals would not be able to (stop) a proceeding which has already occurred.”
Andrew Stoltmann, a Chicago attorney who represents shareholders in lawsuits against public companies, said the administrative route is often the most appropriate place for such cases.
If the SEC’s power to use in-house judges is ultimately curtailed, it could put the regulator at a disadvantage to companies with high-priced defense attorneys.
“The SEC just keeps getting beat by really good defense lawyers in (federal) court,” he said.
Reporter J. Scott Trubey contributed to this report.
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