Weinberg & Company

Best Practice Newsletter – July 2023

Administrative Law-

Supreme Court Will Hear SEC Appeal-

The U.S. Supreme Court will hear a case (SEC v. Jarkesy) in its 2023-2024 term where the SEC seeks to overturn a Fifth Circuit Court of Appeals decision which ruled that the SEC’s practice of adjudicating cases through administrative law judges (ALJs) violated three provisions of the Constitution.

In May 2022 the Fifth Circuit Court decided:

·    That the SEC violated the Seventh Amendment of the Constitution which protects the right to a jury trial in most civil lawsuits;

·    That Congress gave the SEC too much leeway in deciding which cases are adjudicated before its ALJs or which are sent to federal courts;

·    That Congress violated the separation of powers by giving too much job protection to the ALJs because in-house judges were too insulated from presidential control.

The SEC case against George Jarkesy began in 2013, when the SEC charged the hedge fund manager with mismanagement of two hedge funds totaling $24 million. Jarkesy responded by suing the SEC, arguing that its enforcement powers and structure violated the Constitution.

Under federal law, however, those charged by the SEC are required to wait until the SEC makes its final ruling before bringing suit in federal courts. In 2020, nearly seven years after the initial enforcement action, an SEC ALJ found that Jarkesy had committed securities fraud and imposed fines of approximately $1 million. When Jarkesy’s constitutional challenges against the SEC finally made its way to the Fifth Circuit Court of Appeals, the court ruled in his favor in 2022– nearly 10 years after the SEC’s initial charges.

In the upcoming Supreme Court case, the SEC asks the court to reverse the Fifth Circuit’s decision. Representing the SEC will be U.S. Solicitor General Elizabeth Prelogar, considered to be the Biden administration’s top Supreme Court attorney.

SEC v. Jarkesy is the latest in a series of cases where the SEC’s authority to adjudicate cases through administrative law judges have been at issue.

The most recent is an April 2023 decision, Axon Enterprise, Inc. v. FTC, in which the Supreme Court, in a unanimous ruling made it easier for individuals and companies to challenge complaints filed against them by the SEC and the Federal Trade Commission by going directly to federal court.

In Axon, the ruling revolved around two separate cases: a Texas accountant who challenged the constitutionality of an SEC administrative law judge to hold enforcement proceedings against her, and another case involving the use of an ALJ by the Federal Trade Commission against an Arizona technology company.

Both the Texas accountant and the Arizona technology company sidestepped the internal agency review proceedings and brought their claims directly to district court, seeking to enjoin the administrative proceedings. Both argued they shouldn’t have to endure an expensive process that could take years if required to first go through the in-house ALJ proceeding.

In the Axon decision, written by Justice Elena Kagan, the Supreme Court reaffirmed that individuals and companies facing agency investigations can go straight to federal court, and it challenged whether in-house agency judges can always impartially adjudicate cases.

Justice Kagan wrote that respondents would lose their rights if they couldn’t assert them until after the proceedings were over. Kagan relied on a 1994 decision that said federal trial courts can hear immediate challenges in some circumstances. This ruling said federal judges have jurisdiction when a disputed legal issue might not otherwise get “meaningful judicial review,” lies outside the agency’s expertise and is “wholly collateral” to the in-house review system.

As background, prior to the Dodd-Frank Wall Street Reform and Consumer Protection Act, only registered entities like broker-dealers or licensed investment advisers were subject to the Investment Advisers Act’s administrative enforcement provisions. In response to the 2008 market crash, Congress expanded the SEC’s power to impose harsh civil penalties through its own administrative adjudications. Dodd-Frank effectively provided the SEC “coextensive” authority with federal courts to impose civil penalties.

PCAOB Inspects More Chinese Companies

Inspectors from the Public Company Accounting Oversight Board (PCAOB) have arrived in Hong Kong to start a new round of inspections of the audit papers of Chinese companies listed on U.S. stock exchanges.

Reuters is reporting that the inspections will focus on the audit papers of about a dozen high-profile companies, including Tencent Music Entertainment Group, Didi Global Inc. and NetEase Inc.

These inspections are the result of a 2022 agreement between China and the U.S. which finally allowed PCAOB inspectors full access to the audit papers of Chinese companies listed on U.S. exchanges.

For two decades Beijing had refused to allow audit reviews of the nearly 200 companies that traded on U.S. exchanges, citing national security concerns. Under U.S. pressure and threat of delistings, a deal was brokered to finally allow PCAOB inspections.

The first round of inspections began in September 2022 and focused on the audit papers of eight U.S. exchange-listed Chinese companies. The companies had been audited by Chinese-based affiliates of several Big 4 accounting firms.

The PCAOB issued its report on those inspections in May 2023 finding “unacceptable rates of Part I.A deficiencies, which are deficiencies of such significance that PCAOB staff believe the audit firms failed to obtain sufficient appropriate audit evidence to support its work on the public company’s financial statements or internal control over financial reporting.”

Unwilling to give the PCAOB full access to the audit papers of its largest, state-owned enterprises, the Chinese government announced that it would be delisting all of its largest state-owned enterprises from U.S. stock exchanges.

Smaller Chinese companies, however, are still seeking access to the U.S. markets, with Accounting Today reporting that 16 Chinese companies debuted on U.S. exchanges so far this year, raising a combined $460 million.

Bankruptcies Rise

Overall U.S. commercial bankruptcies rose 18%, to 12,107, in the first half of 2023 compared to the same period last year. Companies filing for Chapter 11 bankruptcies saw an increase of 68% over the same period, with 2,973 companies seeking to restructure their businesses, according to just released data from Eqip Bankruptcy, which tracks bankruptcies in the U.S.

Small business bankruptcies that filed under Subchapter V rules saw an increase of 55% in the first six months of 2023 compared to the same period last year. Subchapter V bankruptcies, which is an election under Chapter 11, provide for a streamlined bankruptcy process for small businesses.

Eqip said the substantial year-over-year increase in Subchapter V elections was the result of Congressional legislation passed in June 2022 which made it easier for smaller companies to qualify for bankruptcy relief.

For more info see: Eqip Report

15-Year-Old Passes CPA Exam

Jimmy Chilimigras has become the youngest person ever to pass the CPA exam. The Mississippi teenager graduated from high school at the age of 12, enrolled with the online Western Governors University earning his bachelor’s degree in accounting, followed by a Master’s Degree by the time he was 14. Then he passed the CPA exam at 15 years old.

The accounting profession must be proud. Healthcare researchers, however, must be anxious to observe how much faster he will age as a practicing Accountant.


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