SEC’s Negotiating Power Curbed

Background

In 2009 the SEC commenced an enforcement action against Charles Kokesh, the owner of two investment-adviser firms, alleging that between 1995 and 2005, Mr. Kokesh misappropriated millions of dollars from four business development companies. After a 5-day trial, a jury found that by concealing the misappropriation, Mr. Kokesh had violated various federal securities laws. Addressing whether to impose civil monetary penalties sought by the SEC, the District Court held that 28 U.S.C. §2462, which establishes a five-year limitations period for SEC actions seeking a fine or penalty, precluded any penalties for misappropriation occurring prior to October 27, 2004—that is, five years prior to the date the SEC filed the complaint. The Court, however, granted the SEC’s request for a $34.9 million disgorgement judgment, $29.9 million of which resulted from violations outside the limitations period, holding that because disgorgement is not a “penalty” within the meaning of §2462, no limitations period applied.

The Circuit Split

Mr. Kokesh appealed the District Court’s disgorgement order to the Court of Appeals for the Tenth Circuit, arguing that disgorgement, like monetary civil penalties, was barred by the five-year statute of limitations because the SEC had brought its enforcement action more than five years after most of the claims subject to disgorgement had accrued. The Court of Appeals, however, rejected Mr. Kokesh’s claim and affirmed the lower court’s disgorgement order, thus establishing a circuit split among the Courts of Appeals. SEC v. Kokesh, 834 F.3d 1158 (10th Cir. 2016). To the contrary, last year, the Court of Appeals for the Eleventh Circuit held in SEC v. Graham, 823 F.3d 1357 (11th Cir. 2016), that disgorgement is effectively the same as forfeiture and thus any claim for disgorgement, like any other monetary penalty, is subject to a five-year statute of limitations.^[1]

SEC Disgorgement as a Penalty

In reversing the Tenth Circuit Court of Appeals, the Supreme Court held that SEC disgorgement is a penalty for §2462 purposes because (i) it is imposed by the courts as a consequence of committing a violation against the United States and (ii) importantly, it is imposed for the purpose of punishment and to deter others, as opposed to compensating a victim for a loss. Indeed, the Supreme Court found that over the years, courts have consistently held that the primary purpose of disgorgement is to deter violations of the securities laws by depriving wrongdoers of their ill-gotten gains. Moreover, whenever the courts and the SEC have employed this remedy, disgorged profits have routinely been paid to district courts, which generally have discretion to determine how and to whom the disgorged funds are to be disbursed. Therefore, the Supreme Court opined that when a defendant is made to pay a non-compensatory sanction to the government as a consequence of a legal violation, as in the case of an SEC disgorgement, the payment effectively operates as a penalty which is subject to §2462’s five-year limitations period. (The Supreme Court distinguished “restitution paid to an aggrieved party from penalties paid to the government,” thus leaving a restitution remedy not subject to the statute of limitations.)

Limiting Recovery in Foreign Corrupt Practice Act Enforcement Actions

Among other substantive areas of enforcement, the recent Supreme Court’s decision is significant in the context of SEC enforcement actions alleging violations of the Foreign Corrupt Practices Act (FCPA). Indeed, in FCPA cases, the SEC has generally been able to extract large disgorgement amounts from companies and individuals that have settled FCPA allegations. For instance, in 2016 alone, at least four major companies each paid over $130 million in SEC disgorgement. Moreover, in numerous FCPA enforcement actions, the SEC has taken an expansive view of what constitutes the “ill-gotten gains” it seeks to disgorge, including, for example, severance payments to individuals alleged to have engaged in FCPA violations. Thus, in limiting the SEC’s ability to seek disgorgement to the limitations period, the Supreme Court has dealt a significant setback to the SEC in FCPA cases, where the SEC routinely resorts to the threat of disgorgement to persuade defendants into settling allegations of FCPA and other securities law violations.

^[1] The authors of this client alert represented one of the defendants in SEC v. Straub, No. 11 CIV. 9645, 2011 WL 6841351 (S.D.N.Y. Dec. 29, 2011), which, like Graham and Kokesh, involved a statute of limitations dispute. In Straub, the defendants had argued that all of the SEC’s claims including disgorgement, which operated as a penalty and a deterrent, were time-barred under §2462 because the SEC failed to bring its enforcement action until more than five years after the alleged misconduct had occurred. In its opinion granting in part and denying in part the parties’ motions for summary judgment, however, the Court stated that although “the Graham court’s reasoning is logical, the Second Circuit has construed disgorgement as an expansive equitable remedy . . . and . . . the weight of the authority in this jurisdiction holds that disgorgement, being a traditional equitable remedy, is not covered by Section 2462.” Straub, No. 11 CIV. 9645, 2016 WL 5793398, at *15 (S.D.N.Y. Sept. 30, 2016).