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U.S. Supreme Court Imposes Limits on SEC’s Favorite Enforcement Tool

June 7, 2017Alerts Securities Industry Alert

In a ruling that severely hampers one of the SEC’s most powerful enforcement tools, the U.S. Supreme Court held on June 5 that the disgorgement authority of the U.S. Securities and Exchange Commission is subject to a five-year statute of limitations.

The unanimous decision in Kokesh v. SEC resolves a growing disagreement among the federal appellate courts on the question of whether disgorgement constitutes a penalty – which is subject to a five-year statute of limitations – or an “equitable remedy” that could reach back indefinitely. By finding that disgorgement is a penalty, the Kokesh decision will profoundly change the SEC’s enforcement efforts, especially in long-running cases.

As noted in Kokesh, the SEC’s enforcement powers were historically limited to seeking injunctive relief. However, beginning in the 1970s, the SEC began successfully obtaining disgorgement of any profits gained from an unlawful scheme. The SEC’s position was that disgorgement was an equitable remedy (like injunctions) that merely returned the status quo. Defendants countered that the SEC often went far beyond the status quo to reach unrealized profits.

Beginning in 1984 – after the SEC had successfully disgorged profits for years from defendants – Congress passed a number of measures allowing the SEC to seek civil penalties. The most notable came when Congress enacted the Securities Enforcement Remedies and Penny Stock Reform Act of 1990, authorizing the SEC to seek monetary penalties against any individual who violated securities’ laws.

Meanwhile, the imposition of federal penalties implicates 28 U.S.C. Section 2462, a broad-based statute that provides a general five-year statute of limitations for any federal civil action – securities or otherwise – that seeks a “fine, penalty, or forfeiture.” In 2013, the Supreme Court ruled in Gabelli v. SEC that the SEC’s power to collect civil penalties was subject to Section 2462.

Against this backdrop, the Supreme Court granted certiorari in Kokesh to determine if disgorgement was an equitable remedy or a penalty subject to Section 2462. In reversing the Tenth Circuit Court of Appeals, the Supreme Court held that disgorgement is a penalty.

The justices relied on a number of factors, including that:

  • disgorgement is imposed as a punitive measure resulting from violations against the United States, rather than violations against a particular victim
  • the amounts disgorged often leave a defendant worse off because they exceed the actual amount of illegal profits
  • disgorgement is non-compensatory because it can be paid to the United States Treasury as opposed to the victims

The effect of the Kokesh decision cannot be understated. Since its inception, disgorgement has been one of the SEC’s most potent enforcement weapons. Disgorged proceeds are the SEC’s most lucrative annual collection, often exceeding the dollar amount of civil penalties by hundreds of millions.

Kokesh’s effects will be especially strong in areas of law dominated by long-running schemes that unwind over a number of years, such as those involving foreign bribery and Ponzi schemes. In the new post-Kokesh era, the SEC now has limited time to investigate what are often extremely complex matters. Even then, violators may only have to return a fraction of the ultimate amount gained.

At the same time, Kokesh provides increased certainty and predictability to the securities’ markets. Coupled with the Supreme Court’s 2013 Gabelli decision, market participants now only need to address a finite period in determining potential liability. This increased certainty will, in turn, lead to reduced transaction costs.