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News June 12, 2017 Issue

Supreme Court: SEC Cannot Impose Disgorgement After Five Years

You could almost hear the champagne bottles uncorking at the law offices of securities defense attorneys from coast to coast. At the same time, one can imagine a mood akin to a funereal grim at the SEC Division of Enforcement. The reason for both was the same: The U.S. Supreme Court on June 5 ruled that the Commission cannot require disgorgement for violations that occurred outside a five-year statute of limitations.

The unanimous Supreme Court ruling, written by justice Sonia Sotomayor, centered on the high court’s finding that disgorgement, as applied by the agency, meets the legal definition of a "penalty," and is therefore subject to the same five-year statute of limitations as civil money penalties.

"Because SEC disgorgement operates as a penalty under [28 U.S.C] §2462, any claim for disgorgement in an SEC enforcement action must be commenced within five years of the date the claim accrued," the Supreme Court opinion states.

The ruling was especially good news for investment adviser Charles Kokesh, who brought the appeal to the Supreme Court following an October 2016 ruling against him by the United States Court of Appeals for the 10th Circuit, which itself was an appeal of a March 2015 ruling against him by the U.S. District Court for the District of New Mexico. A jury trial in that case found Kokesh guilty of misappropriating money collected by two of his advisory firms from 1995 to 2009 (ACA Insight, 5/14/15), and assessed sanctions that included $34.9 million in disgorgement. The SEC’s original complaint was filed with the district court in October 2009.

What to expect

The SEC now faces a different calculation when deciding on enforcement actions to undertake, as well as how long to continue enforcement actions already underway. Wait too long, and the amount of disgorgement available is likely to shrink.

"Kokesh is going to have a significant impact on the way the SEC staff conducts investigations, particularly in the Foreign Corrupt Practices Act and asset management areas, where the cases can be very large and investigations often take years to complete," said Debevoise partner and former SEC Division of Enforcement Asset Management Unit co-chief Julie Riewe.

"In the past, parties that faced significant disgorgement liability for conduct more than five years old may have agreed to settle to avoid a potentially sprawling financial exposure," she said. "Now that there is a five-year limit on disgorgement, however, the SEC staff will not have the same leverage to negotiate these sorts of settled resolutions with firms that are otherwise inclined to litigate."

In addition, Riewe suggested that "the examination staff will face pressure to complete exams and make any resulting referrals to the Division of Enforcement quickly. On the Enforcement Division side, the staff will likely begin pushing firms and individuals to produce documents and appear for testimony early and without lengthy delays so that they can finish investigations faster."

"What this means for everyone is much greater clarity as to the risks of potential SEC actions," said Stern Tannenbaum partner Aegis Frumento. "As a practical matter, when you consider that an investigation generally takes a couple of years, this decision should make the SEC more focused on ongoing and recently-ended activity, and less interested in actions three or more years old. It essentially closes the books on any conduct that is over five years old, like a true statute of limitations should."

"At times, the Commission is going to have to work on a more accelerated time line," said Mayer Brown partner Richard Rosenfeld. "This could implicate the SEC’s willingness to agree to ‘stay’ or take a back seat to the Department of Justice and slow a case down. The Enforcement staff is going to think about how quickly it will need to see a case through to a conclusion."

"In some cases, particularly borderline ones or older ones where the money component is longer ago than the statute, the SEC staff may choose not to continue," he said. "But with serious fraud, the SEC won’t be dissuaded."

One strategy the agency may look into more is the use of tolling agreements, under which the respondent agrees to freeze the statute of limitations in exchange for a certain amount of good will from the agency, in the hope that cooperation will yield kinder agency decisions, such as deciding to drop the case, Rosenfeld said.

The footnote

Looking ahead farther, a footnote in the Supreme Court’s ruling also has captured some attention: "Nothing in this opinion should be interpreted as an opinion on whether courts possess authority to order disgorgement in SEC enforcement proceedings or on whether courts have properly applied disgorgement principles in this context." Is that an invitation by the high court for a future appeal?

"The Supreme Court all but invited another challenge: whether the SEC even has the authority to obtain disgorgement at all, which, if successful, would obviously have a significant impact on SEC actions and remedies," said Riewe.

"It’s a good bet that the SEC will not be able to use disgorgement as a way to feather its treasury, and yes, the Court is definitely inviting an appeal to that effect," said Frumento. "I think it will be a split decision, but I would guess that the use of disgorgement as a penalty is at risk (because the statute does not expressly provide for it) and its use of disgorgement will be limited to cases where some victim is being compensated with the money."

"Penalties are defined in the securities laws and disgorgement is not included as a ‘penalty’ in the statute," he said. "Disgorgement was invented and applied only by courts in their exercise of ‘equitable remedies,’ so the Supreme Court is within its rights to redefine how a court should apply it. Looking at the rest of the opinion, it’s clear that the Supremes would like to see more precision in this area."


"This was a narrow ruling based not on policy, but rather the simple idea that disgorgement is punitive (essentially a forfeiture), and that Congress, for better or worse, put a five-year limit on punitive enforcement," said Georgetown University School of Law professor Donald Langevoort. "This does tie the hands of the SEC with respect to cases where the fraud is buried, but the agency has argued, and will continue to argue, that buried fraud is ‘continuing’ fraud, so that the five years does not start until it is entirely over. Although clearly a loss for the SEC, it is not a devastating one."

"The decision does not impact the substance of any of the SEC’s enforcement powers, but it does place a limit on how long after a violation the SEC can wait to bring suit," said University of North Carolina at Chapel Hill law professor Thomas Lee Hazen. "It is noteworthy that although the circuit courts had been split on the issue, the Supreme Court’s ruling was unanimous. Supreme Court unanimity is rare given the current court."

Hazen, whose treatise on SEC enforcement action was cited by Sotomayor in her ruling, noted that the ruling should not affect the agency’s ability to put injunctions in place. "Presumably, the five-year limitation period would not apply if the SEC seeks only injunctive relief without a monetary penalty," he said. "However, the possibility of injunctive relief alone has much less severe impact on a company."

Defense counsel generally welcomed the decision.

"I think it’s a blow," said Rosenfeld. "The SEC is now locked in by statute now for both penalty and disgorgement."

"The ruling is a very nicely reasoned and lawyerly decision," said Frumento. "The Supreme Court pointed out, quite rightly, that SEC ‘disgorgement’ is a misnomer. The SEC does not take property away from a wrongful possessor to give it back to its rightful owner. In SEC disgorgement, the money ‘disgorged’ usually goes to the public treasury, just like any other fine or penalty would. The SEC can act even when there are no victims complaining, and even when no victims get a dime of the ‘disgorged’ amount."

"Remember that generally, with a few exceptions, there is no private right of action under the securities laws, so private victims would not even be able to recover except under state law remedies," he said. "So, the Supreme Court said, calling it ‘disgorgement’ doesn’t make it so. ‘Disgorgement’ is really a penalty, and therefore it is subject to the five-year statute of limitations just like any other penalty. I think that’s absolutely right."

The SEC declined to comment on the ruling.

The high court’s reasoning

The definition of a sanction as "penalty" under §2462 rests, according to the Supreme Court ruling, on two principles:

  • Whether the wrong that the sanction addresses was a wrong to the public or a wrong to an individual, and
  • Whether the financial sanction was sought for the purposes of punishment and deterrence rather than for the purpose of compensating victims.

If the sanction was to address a wrong to the public and for the purposes of punishment and deterrence rather than victim compensation, then it qualifies as a "penalty," the ruling said.

"The application of these principles here readily demonstrates that SEC disgorgement constitutes a penalty within the meaning of §2462," wrote Sotomayor. "First, SEC disgorgement is imposed by the courts as a consequence for violating public laws. . . . Second, SEC disgorgement is imposed for punitive purposes. Sanctions imposed for the purpose of deterring infractions of public laws are inherently punitive because ‘deterrence [is] not [a] legitimate non-punitive government objective."

"Finally," she wrote, "SEC disgorgement is often not compensatory. Disgorged profits are paid to the district courts, which have discretion to determine how the money will be distributed. They may distribute the funds to victims, but no statute commands them to do so."

In response to the SEC’s argument that disgorgement is not punitive, but simply a remedial sanction that seeks to restore the status quo prior to the violation, the Court ruled that this was "not clear. . . . It sometimes exceeds the profits gained as a result of the violation. And, as demonstrated here, SEC disgorgement may be ordered without consideration of a defendant’s expenses that reduced the amount of illegal profit. In such cases, disgorgement does not simply restore the status quo; it leaves the defendant worse off and is therefore punitive."