In November 2009, a federal jury in Brooklyn acquitted Ralph Cioffi and Matthew Tannin of securities fraud charges arising from the failure of their hedge fund at Bear Stearns.  The case was noteworthy because it was one of the few attempts to criminally prosecute anyone for activity arising out of the 2008 financial crisis.  Cioffi and Tannin escaped with their freedom, but still faced a civil enforcement action from the SEC for the same conduct. Eventually, the SEC came to settlement terms with Cioffi and Tannin.  But when the parties submitted the settlement to the court, they faced some resistance in Judge Frederic Block.

The problem was, investors lost about $1.6 billion from the hedge fund’s collapse, but Cioffi and Tannin were being asked to pay just over $1 million in disgorgement for their role in it.  When the proposed settlement was submitted, on February 13, Judge Block called the disgorgement figure “chump change.”  At the time, he was perhaps feeling some courage from his colleague in the next borough.  Judge Jed Rakoff in the S.D.N.Y. was then in the middle of ordering around the SEC and Citigroup and demanding extra briefing about a proposed settlement related to Citigroup’s structuring and sale of mortgage-related investments prior to the financial crisis.  In March, though, the Second Circuit indicated in a preliminary ruling that Judge Rakoff probably inappropriately usurped the SEC’s authority to decide how to spend its enforcement resources.

So last week, Judge Block approved the settlement before him.  In doing so, he acknowledged that while the case would not begin to redress the huge losses caused by Cioffi and Tannin, it probably did what the SEC could do.  But what can the SEC do?   In its civil actions against defendants, the SEC can seek:

  •  injunctions against “any acts or practices which constitute or will constitute a violation of” the securities laws;
  • disgorgement of ill-gotten gains; and
  • civil penalties.

Other remedies, including officer-and-director bars, exist, but these first three are the baseline of what the SEC can get and what it tries to get in most cases.  The injunctions and penalties are authorized by statute, and disgorgement is based in judicial doctrine.  Critically, this short list does not include money damages.  To repeat, no statute or other authority gives the SEC power to seek money damages in its enforcement actions.

The financial sting of an SEC case comes largely from disgorgement.  But what does that mean?  The D.C. Circuit told us in SEC v. First City Financial Corp., Ltd., 890 F.2d 1215, 1230 (D.C. Cir. 1989) (internal citations omitted):

Disgorgement is an equitable remedy designed to deprive a wrongdoer or his unjust enrichment and to deter others from violating the securities laws.  Unless otherwise provided by statute, all the inherent equitable powers of the District Court are available for the proper and complete exercise or that jurisdiction.  We see no indication in the language or the legislative history of the 1934 Act that even implies a restriction on the equitable remedies of the district courts.  Disgorgement, then, is available simply because the relevant provisions of the Securities Exchange Act of 1934, sections 21(d) and (e) . . . vest jurisdiction in the federal courts.

But disgorgement is not the same as damages.  If a defendant breaks the law in a way that earns her, say, $1 million, but causes losses that stretch into the billions for other investors, the SEC’s authority is limited to taking the $1 million back from the defendant.  It can do very little about the billions.  It is true that civil penalties are meted out per violation, and at times a draconian reading of the facts can conjure many, many violations on which penalties can be applied.  But such readings are quite rare, and courts are unlikely to push monetary figures very high based on such theories.  Importantly for the current matter, Judge Block recognized the SEC’s statutory limitations and approved the settlement when the parties had few other options.