New Era of SEC Fair Funds Enforcement Brings Hope for Claimants
Over the past several years, SEC Fair Funds have posed significant participation challenges for institutional investor claimants. This is primarily because SEC Fair Funds have different goals and administrative requirements than typical U.S. securities class action settlements, which are relatively streamlined and predictable.
The U.S. Supreme Court’s recent ruling in SEC v. Jarkesy shakes up future SEC enforcement efforts and potentially gives claimants a new forum to challenge the agency’s eligibility decisions in the resulting Fair Funds. Here we’ll examine the decision and its most likely downstream effects on Fair Funds.
The Current State of Play
While class action settlements result from lawsuits brought in federal court, most Fair Funds are a product of the agency’s own enforcement proceedings, with in-house administrative judges handling adjudication. As a result, the SEC controls these matters from end to end – effectively acting as judge, jury, and executioner with minimal oversight.
In Jarkesy, the court found that when civil penalties are involved, SEC enforcement proceedings violate a defendant’s right to a jury trial under the U.S. Constitution. As Chief Justice John Roberts wrote for the majority, “the SEC’s antifraud provisions replicate common law fraud” and accordingly invoke the Seventh Amendment.
While the SEC had already begun bringing litigated proceedings in federal court, Jarkesy now mandates it. Future agency enforcement proceedings will now have to be filed in federal court, with a jury making findings of fact as opposed to administrative judges in agency proceedings.
Investors will not feel the impacts of the Jarkesy decision immediately. Over time, however, we expect two key changes to emerge for Fair Funds.
> Access FRT’s latest Market Insider session for more Fair Fund insights and analysis.
Key Trend #1: A Chance for Fair Fund Challenges by Investors
Currently, before launching a Fair Fund, the SEC publishes a proposed distribution plan on its website and invites public comment. To date, the agency has ignored investor feedback on plan terms that create the greatest challenges for investors. So there is no true forum for investors to challenge eligibility requirements or plan terms.
The Jarkesy decision means that Fair Fund distribution plans must be approved by a federal judge, establishing independent oversight for SEC plans. Investors objecting to Fund terms or their enforcement should have at least some recourse – although there are some caveats.
- The SEC is no longer required to publish proposed Fund plans and solicit public comment, which makes commenting on them more difficult pre-filing.
- Protections afforded to investor classes under Civil Procedural Rule 23 still do not apply, including the requirement for notice of compensation opportunities to investors with opportunities for comment.
- Federal courts may still defer to the agency on Plan terms, particularly since these are voluntary resolutions and do not abridge investor rights.
Ultimately, the decision should give investors greater opportunity to comment on Plan terms and/or to later appeal to the court regarding rejected claim submissions, which is a clear improvement over the status quo.
Key Trend #2: Fewer Small Fair Funds?
By forcing more enforcement proceedings into federal court for jury trials, the SEC’s cost of prosecution will likely increase, and its success rate may decrease. Will this cause the agency to raise its threshold for antifraud enforcement and result in fewer Fair Funds?
Most SEC Fair Fund penalties fall are small – between $1 million and $10 million. Through the first seven months of 2024, FRT has tracked nine new Fair Funds. Six of them had a fund value of less than $20 million, while the other three all exceeded $60 million.
If the Jarkesy decision focuses SEC enforcement efforts on “bigger fish,” we may see fewer of these small Fair Funds. Frankly, this should be a positive development for investors, given that the burden of submitting claims for smaller Fair Funds often exceeds any eventual payout.
A Deeper Discussion on SEC Fair Funds
Recently, I shared Fair Fund trendline data during a live session for clients and prospects. Access the recording below for a comprehensive mid-year update on the 2024 shareholder recovery landscape, including my views on how best to navigate the SEC’s current submission requirements.
> Access the full session recording here
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