United States: The Supreme Court Reins In The SEC Further On Its Time To Pursue Enforcement Remedies

On June 5, the United States Supreme Court unanimously decided in Kokesh v. SEC¹ that when the Securities and Exchange Commission (the SEC or the Commission) seeks the disgorgement of ill-gotten gains that a defendant obtained as the result of wrongful conduct, the remedy is a "penalty" under 28 U.S.C. § 2462 (Section 2462) and subject to Section 2462's five-year statute of limitations. Thus, the SEC must commence any action where it will seek disgorgement within five years of the date a claim accrues.

The decision marks the second time in less than five years that the Supreme Court has interpreted Section 2462 to restrain the SEC. The Supreme Court held in its 2013 decision in Gabelli v. SEC ² that Section 2462's statute of limitations applies when the SEC seeks statutory monetary penalties.³ As detailed below, looking forward the decision will force the SEC to expeditiously initiate and litigate enforcement actions, benefit potential defendants and targets of SEC enforcement actions in defending actions and negotiating with the SEC, and provide any party involved in the securities markets with the peace of mind that there is a fixed date when possible exposure to an SEC enforcement action will end.

Equally important, there is now effectively a five year period for the SEC to investigate possible wrongdoing. Since investigations when they become public cast a cloud over those companies and individuals that are subject to it, Kokesh now limits that cloud to five years.

Background

In late 2009, the SEC commenced an enforcement action against Charles Kokesh for conduct that occurred between 1995 and 2009, and sought remedies including the disgorgement of $34.9 million. A jury ultimately found that Mr. Kokesh's actions violated various securities laws.

The United States District Court for the District of New Mexico then applied Section 2462, which is a five-year statute of limitations that applies to SEC enforcement actions that seek to recover "any civil fine, penalty, or forfeiture."⁴ The court held that disgorgement was not a "penalty" under Section 2462, and therefore no limitations period applied to it. The court then entered a disgorgement judgment of $34.9 million, with $29.9 million of this amount resulting from violations that would have been barred under Section 2462 if it applied. On appeal, the Court of Appeals for the Tenth Circuit affirmed the district court's decision, which furthered a circuit split on the issue with the Court of Appeals for the Eleventh Circuit based on its decision in SEC v. Graham⁵ and ultimately led the Supreme Court to address the issue.

The Decision

The Supreme Court reversed the Tenth Circuit, holding that disgorgement in the securities enforcement context is a "penalty" within the meaning of Section 2462, and thus the statute's five-year limitation period applies when the SEC seeks disgorgement.⁶

The Supreme Court articulated two principles to determine whether a sanction represents a penalty: (1) whether a violation is committed against the United States rather than an aggrieved individual⁷ and (2) whether a sanction is sought for the purpose of punishment and to deter others from "offending in a like manner," as opposed to compensating a victim for his or her loss.⁸ Ultimately, the Supreme Court found that disgorgement in the securities enforcement context is imposed by courts for violations committed against the United States, is punitive because sanctions are imposed to deter infractions against the United States, and is non-compensatory since there is no guarantee that money the SEC recovers will be distributed to victims.

The Supreme Court rejected the SEC's argument that disgorgement is not punitive but "remedial" because it restores the "status quo."⁹ The Supreme Court found that in certain situations, a defendant can sometimes be worse off after a disgorgement judgment. For instance, courts often do not consider a defendant's expenses that reduce the amount of illegal profits the defendant received, or may even award a disgorgement judgment that exceeds a defendant's profits, such as in insider trading cases where a defendant is ordered to disgorge benefits that accrue to third parties that are attributable to the defendant's conduct.

Takeaways

In light of Kokesh, there are certain notable takeaways for potential defendants or targets of SEC enforcement proceedings:

• These parties now have a fixed date as to when their possible exposure to an SEC enforcement action will end. Any party involved in the securities markets will no longer have to fear being subject to an enforcement action based on conduct that occurred years or even, as in Kokesh, decades ago. As the Supreme Court reiterated in both Gabelli and Kokesh, "even wrongdoers are entitled to assume that their sins may be forgotten."¹⁰
• The SEC will have to quickly decide whether it will initiate a potential action, and will also have to litigate its actions expeditiously as well. The Commission will no longer revisit actions based on years-old events.
• These parties will be more likely to settle with the SEC. Old ill-gotten gains that a party may not be able to repay will no longer be at issue. Additionally, the SEC's demand amounts will be less than they would be if Section 2462 did not apply and will be based on recent events, which will allow settlement negotiations to begin in a more practicable place.
• It is less likely that defendants will have to defend an action after "evidence has been lost, memories have faded, and witnesses have disappeared."¹¹
• Defendants may raise whether and to what extent the SEC can pursue disgorgement. The Supreme Court emphasized that its decision should not be interpreted as an opinion on whether courts possess authority to order disgorgement in SEC enforcement proceedings or whether courts have properly applied that authority.¹² As the Supreme Court also highlighted that disgorgement is solely based on courts' equitable powers rather than statutory authority, Kokesh may invite defendants to further challenge the SEC's use of the remedy.

Footnotes

1 Kokesh v. SEC, No. 16-529, slip. op. (June 5, 2017).
2 Gabelli v. SEC, 568 U.S. 442, 454 (2013).
3 See Marc D. Powers and Elizabeth M. Schutte, Restrictions on Remedies and Continued Viability of Tolling Theory in Five Year Old SEC Enforcement Actions Post-Gabelli, WOLTERS KLUWER, Sept. 15, 2016, https://www.bakerlaw.com/webfiles/Litigation/2016/Articles/09-08-2016-Powers-Schutte-Wolters-Kluwer.pdf.
4 28 U.S.C. § 2462.
5 SEC v. Graham, 823 F.3d 1357, 1363 (11th Cir. 2016)
6 Kokesh, slip op. at 1.
7 Id. at 5-6 (quoting Huntington v. Attrill, 146 U.S. 657, 667 (1892)).
8 Id. at 6 (quoting Huntington, 146 U.S. at 668).
9 Id. at 10 (quoting Brief for Respondent at 17).
10 Id. at 5 (citing Gabelli, 568 U.S. at 448-449).
11 Gabelli, 568 U.S. at 449 (quoting Railroad Telegraphers v. Railway Express Agency, Inc., 321 U.S. 342, 348-349, 64 S.Ct. 582, 88 L.Ed. 788 (1944)).
12 Kokesh, slip op. at 5, n.3.

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