U.S. Supreme Court Considers SEC’s “Disgorgement” Powers

• Posted on: May 3 2017

One remedy the Securities and Exchange Commission (“SEC” or “Commission”) has long relied upon in cases involving broker misconduct is disgorgement. In a nutshell, disgorgement is a remedy that requires a party who profits from illegal conduct to pay back any ill-gotten gains obtained from that conduct.

On April 18, the U.S. Supreme Court heard oral argument in Kokesh v. Securities and Exchange Commission, a case involving a New Mexico-based investment adviser who was sued in federal district court by the SEC in 2009 for misappropriating investors’ money. The adviser was ordered to pay $2.4 million in penalties, plus $34.9 million in disgorgement of ill-gotten profits. The disgorged amounts, however, did not go to the victims, instead, it went to the U.S. Treasury. The U.S. Court of Appeals for the 10th Circuit upheld the disgorgement award as not time-barred by 28 U.S.C. §2462, the statute of limitations requiring that “enforcement of any civil fine, penalty, or forfeiture” be “commenced within five years from the date when the claim first accrued.” Although the 10th Circuit’s opinion comported with that of other courts of appeals (including the First Circuit and the District of Columbia Circuit), it conflicted with the 11th Circuit, which broke from its sister circuits in Securities and Exchange Commission v. Graham.

As noted, under 28 U.S.C. §2462, the SEC has five years to seek penalties, forfeitures, and other punitive remedies, in civil enforcement matters. The Commission, therefore, is incentivized to commence enforcement proceedings seeking such relief within this time frame, especially given the Supreme Court’s 2013 decision in Gabelli v. Securities and Exchange Commission, in which the Court held that the limitations period set forth in Section 2462 begins to run when the fraud occurs, not when it is discovered — a point raised by the SEC during the argument.

The issue in Kokesh is whether disgorgement is a penalty governed by the five-year limitation period. The Commission argued that the statute of limitations did not apply to disgorgement, claiming that disgorgement is equitable relief, which is not a form of punishment but restores the defendant to the position s/he was in prior to the misconduct occurring, while Kokesh argued that disgorgement is either a “forfeiture” or a “penalty” and thus subject to the five-year limitation period.

During the argument, the justices questioned how the SEC applies disgorgement and whether it has the legal authority to force the disgorgement of profits for conduct occurring more than five years from the date of the enforcement action. For example, Justices Alito, Sotomayor and Kennedy questioned the source of authority for the Commission to pursue disgorgement remedies, while newly-seated Associate Justice Neil Gorsuch raised concerns that there is no statute in place governing the remedy and whether the government keeps the money or if it is paid to the victims. “We kind of have a special obligation to be concerned about how far back the government can go when it’s something that Congress did not address because it did not specify the remedy,” Chief Justice John Roberts said.

Justice Kennedy suggested that perhaps there was a “non-categorical” approach, characterizing disgorgement as non-penal and not subject to any statutory definition (e.g., a civil fine, penalty, or forfeiture) when the only objective of the remedy is victim compensation: “The case is presented to us as if disgorgement is this category we must adopt. … It’s always a penalty or it’s always not a penalty. It seems to me that maybe we can give guidance on when it is a penalty.”

A ruling is expected in June.

Takeaway

At this juncture, some observers of the Court believe it will likely rule against the SEC. If the SEC loses, it could impact cases in the pipeline, as well as those in which the defendants were ordered to disgorge profits for conduct dating beyond the five-year statute of limitations.

In light of Justice Kennedy’s “non-categorical” suggestion, it is possible that the Court could create an alternative to the positions advanced by the SEC and Kokesh that is based on that suggestion. In that event, Kokesh could declare victory, while the possibility that the statute of limitations would not apply to enforcement actions that only seek victim compensation would remain open.

Regardless of how the Court rules, many believe it will take an act of Congress to determine whether the five-year statute of limitations applies to disgorgement.

Tagged with: Securities Arbitration