Alert June 06, 2017

United States Supreme Court Limits SEC Disgorgement

Summary

On June 5, 2017, the United States Supreme Court ruled unanimously in Kokesh v. Securities and Exchange Commission that disgorgement in an SEC case is subject to the five-year statute of limitations for civil monetary penalties set forth in 28 U.S.C. § 2462. Before Kokesh, the SEC had argued for decades, largely successfully, that the five-year limitations period applies only to its claims for civil penalties and certain other remedies – but that its claims for disgorgement of ill-gotten gains are not subject to any statute of limitations. In Kokesh, the Supreme Court held that disgorgement is punitive and therefore subject to the same five-year limitations period as monetary penalties, slashing the disgorgement and interest award in the case and limiting the scope of the disgorgement remedy going forward.

In 2009, the SEC charged investment adviser Charles Kokesh with violating federal securities laws by misappropriating money from four companies over a 15-year period and making false and misleading SEC filings to conceal the misappropriations. After a jury found Kokesh liable, the district court awarded the SEC a civil penalty in the amount of $2.4 million based solely on Kokesh’s conduct within the five-year period before the charges were brought. But the SEC also sought and obtained a disgorgement award in the amount of $34.9 million, for money Kokesh had misappropriated from the beginning of the scheme in 1995 – $30 million of which related to pre-2004 conduct. The trial court found that disgorgement, as equitable relief, was not subject to any limitations period. On appeal, the Tenth Circuit Court of Appeals affirmed the lower court’s ruling, holding that the five-year statute of limitations did not govern disgorgement.

The Supreme Court reversed, holding that “[d]isgorgement in the securities-enforcement context is a ‘penalty’ within the meaning of § 2462” and thus must be sought within five years of the violation.  Kokesh v. SEC, No. 16-529, Slip Op. at 1 (U.S. June 5, 2017). Its ruling rests on three premises. First, courts impose disgorgement as a consequence for committing a violation against the United States, rather than against an individual. Second, courts impose disgorgement primarily to deter future violations, which is a punitive purpose. Third, SEC disgorgement is not designed specifically to compensate victims, since the disgorged funds are paid to the court, and in many instances some or all of the disgorged funds ultimately flow to the United States Treasury:  “When an individual is made to pay a noncompensatory sanction to the Government as a consequence of a legal violation, the payment operates as a penalty.” Id. at 7-9. The Court further rejected the SEC’s argument that disgorgement is remedial rather than punitive because it seeks to restore the defendant to his position before his misconduct – observing that in some cases, including some insider trading cases, defendants had been required to “disgorge” benefits that had flowed to third parties rather than to themselves. These points together confirmed that SEC disgorgement is punitive, not purely compensatory, and therefore subject to the same five-year statute of limitations as any other federal civil penalty. Id. at 10-11.

While the Kokesh opinion is unanimous, it reverses the position advanced by the SEC for decades in seeking disgorgement. The influential District of Columbia Circuit and numerous other federal courts had previously sided with the SEC in rulings holding that the SEC could seek disgorgement without regard to a limitations period. Those courts had ruled that “[t]he primary purpose of disgorgement is not to refund others for losses suffered but rather to ‘deprive the wrongdoer of his ill-gotten gain’” and that preventing unjust enrichment is not a punitive measure.  Zacharias v. SEC, 569 F.3d 458, 471 (D.C. Cir. 2009); see also SEC v. Kokesh, 834 F.3d 1158, 1164 (10th Cir. 2016). The lower courts also relied upon Supreme Court precedent holding that statutes of limitations should be interpreted narrowly in the government’s favor and that public policy generally disfavors imposing laches or statutes of limitations on the government. E.g., Kokesh, 834 F.3d at 1162 (citing Guar. Trust Co. of New York v. United States, 304 U.S. 126, 135 (1938)); United States v. Telluride Co., 146 F.3d 1241, 1246 (10th Cir. 1998) (citing E. I. Du Pont De Nemours & Co. v. Davis, 264 U.S. 456, 462 (1924)). The Supreme Court did not discard these general principles, but evidently concluded that the statute simply could not be read the government’s way.

The direct result of the Supreme Court’s Kokesh decision is that companies and individuals facing enforcement actions may only be liable for disgorgement to the extent the claim is brought within five years of the claimed violation. In some cases, like Kokesh, a defendant’s financial exposure will be sharply decreased. In others, where all of the conduct occurred more than five years before the date of suit, the SEC will be unlikely to bring an enforcement claim at all given the inability to recover either disgorgement or civil penalties. The decision may also limit the disgorgement remedy in cases brought by other government agencies. For example, even before Kokesh, the Consumer Financial Protection Bureau acknowledged during an en banc oral argument in May 2017 in PHH Corp. v. CFPB, No. 15-1177 (D.C. Cir. argued May 24, 2017), that its own authority to seek disgorgement would likely be subject to the same limitations argument, even in administrative proceedings where the Bureau had previously argued that no time bar applies at all.

More broadly, the unanimous ruling appears to signal the current Supreme Court’s strong  skepticism of the discretion exercised by the SEC and other federal agencies. For example, at oral argument in Kokesh, five of the Justices questioned the government on whether the SEC has authority to pursue disgorgement remedies at all – calling into question decades of settled SEC practice and law. In its opinion, the Court expressly chose not to address that question. And Kokesh follows on the heels of the Court’s recent decision in Gabelli v. SEC, 133 S. Ct. 1216 (2013), in which the Court held that § 2462’s five-year statute of limitations for SEC civil monetary penalties begins to run when the alleged violation occurs, not on a later date when the SEC may “discover”  the violation. The Court’s recent rulings suggest that, in coming years, it can be expected to show little deference to executive agency practice and discretion on these and other subjects.