In a unanimous decision with significant implications for Securities and Exchange Commission (“SEC”) enforcement, the U.S. Supreme Court in Kokesh v. Securities and Exchange Commission1 held June 5, 2017 that disgorgement in the securities context is a “penalty” under 28 U.S.C. § 2462 and therefore subject to a five-year statute of limitations.
As a result of the Court’s decision, the SEC must commence disgorgement actions within five years of the date a claim accrues. The Kokesh decision will shape the Commission’s investigations going forward and has financial implications for current and prospective defendants.
Background
Under 28 U.S.C. § 2462, a five-year statute of limitations applies to any “action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise.”
In Gabelli v. SEC, 133 S. Ct. 1216 (2013), the Supreme Court held that, in the context of civil penalties, § 2462’s five-year limitations period begins to run when a violation occurs, not when it is discovered.2 But the Court did not address whether the five-year limit would bar disgorgement, an SEC sanction designed to deprive a defendant of his or her ill-gotten gains. Since Gabelli, the SEC has consistently taken the position that § 2462 does not apply to disgorgement.3 The SEC has based its interpretation of § 2462 on pre-Gabelli precedent, which reasoned that disgorgement is an equitable remedy and therefore not subject to the statute.4
The Supreme Court has now resolved the question of whether disgorgement is a “penalty” within the meaning of § 2462 subject to a five-year statute of limitations.
Factual and Procedural History
In 2009, the SEC brought an enforcement action against Charles Kokesh, the owner of two investment-adviser firms, for allegedly misappropriating US$34.9 million from four clients in violation of various federal securities laws.5 The SEC sought monetary civil penalties, disgorgement, and an injunction barring Kokesh from future violations. After a jury found Kokesh liable, the District Court held that § 2462’s five-year limitations period applied to the SEC’s request for civil monetary penalties and precluded any penalties for misappropriation occurring at least five years prior to the date the SEC filed its complaint.6 The District Court also held that because disgorgement did not constitute a “penalty” under § 2462, no limitations period applied to the SEC’s request for a US$34.9 million disgorgement judgment. Of the US$34.9 million, US$29.9 million resulted from violations falling outside the five-year period. The Tenth Circuit affirmed on appeal, yielding a circuit split that the Supreme Court resolved on Monday.
The Decision
The Supreme Court held 9-0 that disgorgement constitutes a “penalty” under § 2462 for three principal reasons.
First, disgorgement is imposed as a sanction for violating “public laws” or offenses against the United States, rather than any particular individual. The Court agreed that “[w]hen the SEC seeks disgorgement, it acts in the public interest, to remedy harm to the public at large, rather than standing in the shoes of particular injured parties.”7
Second, the Court found that “SEC disgorgement is imposed for punitive purposes. . . . [I]t has become clear that deterrence is not simply an incidental effect of disgorgement. Rather, courts have consistently held that the primary purpose of disgorgement orders is to deter violations of the securities laws by depriving violators of their ill-gotten gains. . . . Sanctions imposed for the purpose of deterring infractions of public laws are inherently punitive because deterrence [is] not [a] legitimate nonpunitive governmental objectiv[e].”8
Third, the Court observed that “in many cases, SEC disgorgement is not compensatory.”9 The Court noted that disgorged profits are paid to the district court, and it is a matter of discretion how those profits are distributed; some funds are paid to victims, and others to the U.S. Treasury. The Court also rejected the SEC’s argument that disgorgement is remedial and not punitive, that it effects a return to the status quo ante, before a violation took place.10 The Court rejected that position as factually dubious, noting that “SEC disgorgement sometimes exceeds the profits gained as a result of the violation”—namely, in cases in which benefits accrue to third parties and are disgorged by the defendant—and that “SEC disgorgement sometimes is ordered without consideration of a defendant's expenses that reduced the amount of illegal profit.”11
Key Takeaways
The Court’s decision in Kokesh may have a number of implications for the Commission and defendants in SEC enforcement actions.
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The SEC may no longer pursue ill-gotten gains obtained more than five years before it commences a disgorgement action.
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The decision could have significant financial implications for current and prospective defendants in SEC actions. For example, as a result of the Court’s decision Kokesh will have to disgorge only US$5 million of the US$34.9 million originally sought by the SEC, because the remaining US$29.9 million could not be traced to the five-year limitations period. Similarly situated defendants could see similar financial outcomes.
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The decision may catalyze SEC enforcement activity in the short term, as the Commission recognizes that it has a shorter timeline to complete its investigations and pursue disgorgement claims.
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The SEC staff will likely request tolling agreements earlier in its investigations, and companies, individuals and their counsel will need to consider carefully whether to grant those requests. The decision may also lead the SEC staff to compress the Wells process and the time available to respond to a Wells notice.12
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Whistleblowers seeking to obtain rewards under the SEC’s incentive programs may accelerate their disclosures to the government to facilitate enforcement actions within the five-year limitations period.
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The SEC may instead seek an increase in monetary penalties attributable to conduct occurring within the five-year limitations period, including in the settlement context where the penalty amount is negotiated.
The Court’s decision to explicitly characterize disgorgement as “punitive” and a “deterrent” may have other formal and informal ramifications beyond just the application of a statute of limitations. For example, are there other statutory protections that defendants may now be able to invoke, now that disgorgement has been deemed a “penalty” in the securities context? Now that disgorgement is punitive, can a defendant in a parallel DOJ/SEC investigation be forced to pay both a criminal fine and disgorgement?13 Will the SEC choose to view disgorgement through a more punitive lens, making less of an effort to equate disgorgement requests to the actual amount of a defendant’s ill-gotten gains?
Finally, it remains to be seen whether the decision in Kokesh reflects broader judicial trends that could fundamentally reshape securities law enforcement. It is notable that the Supreme Court in Kokesh unanimously rejected the SEC’s interpretation of § 2462. The Court’s unanimous rejection of the agency’s proposed interpretation of an enforcement statute may signal, and be consistent with, increased judicial skepticism toward broad agency interpretative authority. Several federal judges (including now-Supreme Court Associate Justice Neil Gorsuch) have expressed skepticism as to the continued viability of Chevron deference14 in the modern administrative and regulatory state.15 Furthermore, other federal courts are considering additional challenges to SEC enforcement on separation of powers grounds.16
1) Kokesh, 2017 WL 2407471 (June 5, 2017).
2) See US Supreme Court Rules That the Government Does Not Have an Unlimited Amount of Time in Which to Bring Civil Penalty Actions, Dechert On Point (Feb. 28, 2013); see also Dechert Achieves Victory in Gabelli et al. v. Securities and Exchange Commission, Dechert News Release (Feb. 27, 2013).
3) In the Matter of John Thomas Capital Mgmt. Grp., Initial Decision Rel. No. 693, 2014 WL 5304908, at *5–7 (ALJ Oct. 17, 2014)(holding that “[c]ease-and-desist orders and disgorgement are not subject to the five year statute of limitations provided in 28 U.S.C. § 2462”); accord In the Matter of David G. Derrick, Sr., Admin. Proceedings Rulings Release No. 2132, 2014 SEC LEXIS 4820, at *1–2 (ALJ Dec. 15, 2014) (order denying motion)(“Right now, [the district court’s decision in] SEC v. Graham is an outlier, and I am not persuaded by its reasoning that the longstanding precedents on the pertinent limitations period were swept aside, in effect, by . . . Gabelli . . . which specifically noted that its holding did not extend to injunctive relief and disgorgement claims.”).
4) SEC v. Rind, 991 F.2d 1486, 1490–93 (9th Cir. 1993)(holding that the statute of limitations did not apply because disgorgement is an equitable remedy); Riordan v. SEC, 627 F.3d 1230, 1234–35 (D.C. Cir. 2010) (holding that Section 2462 did not prevent the SEC from pursuing disgorgement beyond the five-year limitation period).
5) Id. at *4.
6) Id.
7) Id. at *7
8) Id. (internal citations omitted).
9) Id. at *8.
10) Id.
11) Id.
12) A Wells notice notifies an entity or individual of the charges the Commission intends to pursue, and gives the recipient an opportunity to respond.
13) See e.g. United States v. Halper, 490 U.S. 435 (1989) (holding that False Claims Act statutory penalty violated double jeopardy) and Hudson v. United States, 522 U.S. 93 (1997) (holding that double jeopardy clause does not apply to non-criminal penalties).
14) “Chevron deference” refers to the judicial rule from Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984), in which the U.S. Supreme Court held that, where an agency regulation is ambiguous, a court construing such regulation should defer to the agency interpretation.
15) See, e.g., Gutierrez-Brizuela v. Lynch, 834 F.3d 1142, 1149 (10th Cir. 2016) (Gorsuch, J., concurring) (“There's an elephant in the room with us today. We have studiously attempted to work our way around it and even left it unremarked. But the fact is Chevron and Brand X permit executive bureaucracies to swallow huge amounts of core judicial and legislative power and concentrate federal power in a way that seems more than a little difficult to square with the Constitution of the framers' design. Maybe the time has come to face the behemoth.”). See, e.g., Egan v. Delaware River Port Authority, 851 F.3d 263, 278 (3d Cir. 2017) (Jordan, J., concurring) (“The doctrine of deference deserves another look. Chevron and Auer and their like are, with all respect, contrary to the roles assigned to the separate branches of government; they embed perverse incentives in the operations of government; they spread the spores of the ever-expanding administrative state; they require us at times to lay aside fairness and our own best judgment and instead bow to the nation's most powerful litigant, the government, for no reason other than that it is the government.”); see also Somers v. Digital Realty Trust Inc., 2017 WL 908245 at *1 (9th Cir. 2017) (declining to apply Chevron deference when considering an SEC-promulgated regulation).
16) For example, there are several ongoing federal courts challenges to the SEC’s authority to pursue certain types of enforcement proceedings before administrative law judges rather than federal courts. In Bandimere v. Securities and Exchange Commission, the Tenth Circuit found that the SEC administrative law judge who heard an enforcement action was an “inferior officer” and, because he was not constitutionally appointed, he held his office in violation of the Appointments Clause.” Bandimere v. SEC, 844 F. 3d 1168, 1170 (10th Cir. 2016). The Court on that basis “set aside” the SEC’s finding. The District of Columbia Circuit recently reached the opposite conclusion about the status of SEC administrative law judges; that decision has been vacated and is due for a rehearing en banc. Raymond J. Lucia Cos. v. SEC, 832 F.3d 277 (D.C. Cir. 2016), petition for reh’g en banc granted, judgment vacated No. 15-1345 (D.C. Cir. Feb. 16, 2017).
