When Michael and David Sztrom settled with the SEC in 2022 over alleged fraud, they thought they were free to resume their advisory practice, according to a federal lawsuit.
But they were wrong, and now they're faced with what they deem in a new lawsuit as a "career death penalty."
The Sztroms, a father-son duo operating under the name Sztrom Wealth Management in San Diego, California, agreed in October 2022 to pay $50,000 and accept other sanctions to settle allegations that they had committed fraud several years before. Roughly seven months later, the SEC initiated what's known as a follow-on proceeding seeking to ban the two from the securities industry.
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Follow-on proceedings are used by the SEC following a judgment or settlement to pile on additional penalties — most often an industry bar. Regulators contend follow-on bans are a means of protecting investors from future possible harm.
"The public interest requires a severe sanction when a respondent's past misconduct involves fraud, because opportunities for dishonesty recur constantly in the securities business," Lynn Dean, senior trial counsel for the SEC's division of enforcement, wrote
But the SEC has come under attack in recent years for its reliance on using internal administrative processes like follow-on proceedings to resolve disputes. Critics of industry regulators struck a decisive
That case had questioned the SEC's since-abandoned practice of bypassing courts and instead bringing fraud allegations before in-house adjudicators known as administrative law judges, or ALJs. Opponents of that system argued it placed too much power in SEC hands — giving the industry watchdog the power of "judge, jury and prosecutor."
With the Supreme Court deciding 6-3 against the SEC in the Jarkesy case, regulators are now required to bring fraud charges in court. But that doesn't mean they can't later go back in-house to impose an industry banishment. What's more, according to the complaint, regulators have the ability to give someone the boot without even going to the trouble of holding a formal hearing.
"It's something you almost have to try to explain to your nonlawyer friends," said Michael Rinaldi of the Duane Morris law firm, who's representing the Sztroms. "The same agency that has been prosecuting them for years is now going to be the decisionmaker. People who work down the hall from other people at the SEC are going to make the decision to grant the relief those other people are seeking."
Rinaldi and his fellow counsel on the case, Mary Hansen, said the SEC's follow-on proceedings against the Sztroms are particularly egregious given that regulators never accused the father-son pair of harming investors. The time delays in the case — the alleged misdeed occurred between 2015 and 2018 — also mean the Sztroms have had to endure years of regulatory limbo.
"Then you think you are done when you fight this out in federal court, and seven months later you find out you're not done at all," Hansen said.
Rather than of causing investor harm, the Sztroms were accused of misleading clients about Michael Sztrom's affiliation with a registered investment advisor named Advanced Practice Advisors. Michael Sztrom tried to join Advanced Practice Advisors in 2015 shortly after leaving UBS, which he exited under a cloud following three customer complaints about alleged trading improprieties — claims he denied.
The SEC alleged in its initial filing that Michael Sztrom quickly learned that an ongoing Financial Industry Regulatory Authority Investigation into his conduct at UBS would prevent him from registering with Advanced Practice Advisors.
So he devised a scheme, according to the SEC, to essentially use his son as a front for his continued work in the securities business.
After learning he couldn't become a registered representative of Advanced Practice Advisors, Michael Sztrom managed to have David brought on instead. Sztrom Wealth Management, an unregistered firm, became an "investment advisor representative" to Advanced Practice Advisors.
The parties struck up an agreement that would have Advanced Practice Advisors providing "compliance, fee-billing, software, and other services as necessary in the normal course of business" while Sztrom Wealth Management worked directly with clients, according to the SEC. Michael, according to the SEC, was supposed to have kept a strict distance from the advisory business.
But the lines quickly became blurred, regulators say.
The SEC alleged Michael continued meeting with clients and providing various investment advice functions. Between November 2015 and May 2016, Michael Sztrom impersonated David on 38 calls with Charles Schwab, which was then acting as Advanced Practice Advisors' clearing broker, according to regulators.
The SEC accused the Sztroms of committing various types of fraud banned by the Investment Advisers Act of 1940. In the consent judgment the pair reached with the SEC in federal district court in southern California in 2022, the Sztroms agreed not only to pay $50,000 in total but also to never engage in fraudulent activities again.
Their current suit against the SEC notes that there hasn't been a public complaint filed against them since. "Moreover, the SEC waited seven months after the settlement to file the follow-on administrative proceeding, which has been pending for approximately eighteen months. The SEC's conduct undermines its own claims that the Sztroms present an imminent threat to the public," according to the suit.
An SEC spokesperson declined to comment on the case.
The Sztroms' lawsuit seeks either to have an injunction placed on the SEC's follow-on proceedings or for the scheduling of a formal hearing in which they can present their case. Among other things, the suit accuses the SEC of seeking to deny due process law as guaranteed by the Fifth Amendment, usurp judicial power in violation of Article III of the Constitution and deprive the Sztroms' right to a jury trial under the Seventh Amendment.
It's that last charge that's directly aligned with the U.S. Supreme Court's decision in SEC v. Jarkesy, said Russel Ryan of the New Civil Liberties Alliance, which seeks to set stricter limits on regulatory authority. Ryan himself is
Ryan said the Jarkesy case made it clear that the SEC must turn to the court system when seeking monetary remedies in fraud cases. "But whether Jarkesy applies to in-house proceedings not seeking a monetary penalty but only seeking a bar or a suspension, that's an open issue," he said.
Rinaldi said he thinks the Sztroms' case could strike another blow at the SEC's ability to bypass the court system.
"The Sztroms were put through months and months, now going on years, of this, all culminating in a proceeding where the SEC is going to decide their fate, and we don't even necessarily get a hearing," he said. "We are looking for someone to take a hard look at this and say: Is this fair and legitimate, or this is an example of an agency run amok? We think it's the latter."
