United States: Supreme Court Unanimously Rules SEC Power To Seek Disgorgement Subject To Five-Year Statute Of Limitations

A unanimous Supreme Court ruled yesterday that the Securities and Exchange Commission's power to recover ill-gotten profits from misconduct, also known as "disgorgement," is subject to a five-year statute of limitations.

The case, Kokesh v. Securities and Exchange Commission, No. 16-529, was one the Commission commenced in federal district court in 2009, alleging that between 1995 and 2009, Kokesh, through his investment-advisor firms, misappropriated $34.9 million from development companies to whom it had provided investment advice. The Commission also alleged that Kokesh had caused the filing of false and misleading SEC reports and proxy statements. The Commission sought civil monetary penalties, disgorgement and an injunction barring Kokesh from future violations of securities laws.

A federal jury found Kokesh's actions violated the relevant securities and investment advisor laws and the district court limited the penalties for misappropriation to $2.3 million (for activity after 2004), citing 28 U.S.C. § 2462, a statute that establishes a five-year limitations period for "an action, suit, or proceeding for the enforcement of any civil fine, penalty, or forfeiture." However, the district court agreed with the Commission's request for a $34.9 million disgorgement judgment – $29.9 million of which resulted from violations outside the same limitations period – ruling that a "disgorgement" was not a "penalty" within the meaning of § 2462, and thus no limitations period applied.

The Court of Appeals for the Tenth Circuit affirmed the $34.9 million judgment and added that a disgorgement is not a "forfeiture" within the meaning of § 2462.

Justice Sotomayor, writing for the unanimous Supreme Court, overruled the Tenth Circuit (and resolved a disagreement among Circuits), ruling that disgorgement claims in SEC proceedings are subject to the five-year limitations period. The Supreme Court held that a disgorgement is a "punishment," or a "penalty," in both the literal sense and, according to Supreme Court precedent, in which a statutory "penalty" is one that seeks to redress a wrong to the public at-large and operates as a deterrent to future unlawful conduct. The Court reasoned that the disgorgement process "bears all the hallmarks of penalty: It is imposed as a consequence of violating a public law and is intended to deter, not to compensate." An SEC disgorgement is imposed for punitive purposes and is typically payable to the public fisc (the district court or the Treasury); it is not, as the Commission urged, a remedial measure intended to restore the "status quo" before the violation or to pay back wronged investors.¹

As commentators have already noted, the ruling is a setback for the SEC and is a limitation on the panoply of enforcement tools at its disposal. Although many mainstream enforcement cases are brought well within the limitations period, a narrow class of cases – like Kokesh – concern more complex, longer-running frauds, including Ponzi schemes, that take time to develop and uncover. Even in cases successfully brought within the five- year limitations period, Kokesh will prevent the SEC from pursuing payments for fraud spanning decades. The decision will likely force the Commission to place added emphasis on securing tolling agreements as an investigation proceeds.

Footnote

1. In an interesting footnote, the Court disclaimed that the decision does not squarely address "whether the courts possess authority to order disgorgement in SEC proceedings, or whether courts have properly applied disgorgement principles in this context." The footnote appears to follow from a line of inquiry during oral argument in which the Justices – specifically, Justices Alito, Sotomayor and Kennedy – all questioned the source of authority for the Commission to pursue disgorgement remedies in the first place. Newly-seated Justice Gorsuch remarked "there's no statute governing it. We're just making it up." This concern and skepticism that the remedy is untethered from any statutory provision may have guided the decision to limit the recoverable period to five years.

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