In a unanimous decision handed down on June 5, 2017, the U.S. Supreme Court has imposed what in many cases may be a substantial limitation on the amount of disgorgement the Securities and Exchange Commission (SEC) may seek as part of a securities civil enforcement action.

Justice Sonia Sotomayor’s succinct opinion applies a general statute establishing a five-year statute of limitations on any “action, suit or proceeding” that seeks to impose a “civil fine, penalty, or forfeiture, pecuniary or otherwise,” 28 U.S.C. § 2462, to SEC actions seeking disgorgement. The effect of the holding is to limit the SEC’s disgorgement claims to wrongful gains arising during the five years immediately preceding the filing of the civil enforcement action.

Disgorgement is often sought by the SEC as part of civil enforcement proceedings against individuals and entities that the Commission asserts have profited from violations of the securities laws. Disgorgement seeks to deprive an alleged wrongdoer of the profits earned, often not only by the target of the action her- or himself, but also those “downstream” of the target; an action seeking disgorgement of profits arising from insider trading, for example, may seek from the “tipper” profits earned by the “tippee” as well as the tipper. As a result, disgorgement remedies often require the wrongdoer to give up substantially more than she or he took in through the challenged conduct.

There is no explicit statutory authority for the SEC to pursue disgorgement as part of the remedy in a civil enforcement action; the Commission persuaded courts, beginning in the 1970s, to impose disgorgement remedies as an exercise of its inherent equitable powers. In 1990, Congress granted the SEC explicit authority to seek civil monetary penalties (CMPs) as part of the Securities Enforcement Remedies and Penny Stock Reform Act, 15 U.S.C. § 77t(d). Armed with this authority, the Commission added CMPs to its toolbox of remedies regularly sought in civil enforcement actions – but did not stop seeking disgorgement, as a separate and distinct remedy in addition to any CMP.

In defending the practice of seeking disgorgement stretching back in time substantially more than five years, the SEC maintained that disgorgement is remedial, rather than punitive, in nature, and thus not subject to the five-year statute prescribed for any action seeking a “penalty” or forfeiture.”

The Court, however, decisively rejected this position, holding that disgorgement bears the hallmarks of a penalty: it is a remedy sought to redress a “wrong to the public,” rather than a “wrong to [an] individual,” and it is sought for the purpose of punishing wrongful conduct and deterring similar future conduct, rather than compensating losses incurred by an individual. Disgorgement, explained the Court, is sought to combat violations of public law and in furtherance of the public interest, not to compensate an aggrieved individual; is clearly punitive in nature, seeking primarily to deter violations of securities laws by clawing back ill-gotten gains; and, because paid into the court with no requirement for restitution (and often no practical means of effecting restitution), and often imposed at levels that exceed gains ill-gotten by the defendant, is not compensatory. Invoking its recent decision (Gabelli v. SEC, 568 U.S. 442 (2013)) applying the five-year statute of limitations to CMPs, the Court held that disgorgement orders, like CMPs, “ʽgo beyond compensation, are intended to punish, and label defendants wrongdoers’ as a result of violating public laws,” and thus constitute penalties subject to the five-year statute.

The facts of the case before the Court illustrate the potentially far-reaching practical impact of the decision in many securities enforcement actions. The defendant, Charles Kokesh, was determined by a jury to have violated various securities laws by misappropriating a total of $34.9 million in funds from four business development companies that were clients of Kokesh’s investment advisory firms over the 15-year period preceding the filing of the SEC’s civil enforcement action. The Court imposed a civil monetary penalty of slightly less than $2.4 million, representing Kokesh’s personal gains during the five years preceding the SEC’s filing of suit. But the Court, reasoning that disgorgement was not a “penalty,” granted the SEC’s request to impose a disgorgement obligation of the full $34.9 million diverted over 15 years – almost $30 million of which arose more than five years prior to the filing of suit. The Supreme Court’s decision invalidates that nearly $30 million component of the disgorgement order, trimming the total to be disgorged by 85 percent.

The decision will with certainty affect pending actions for disgorgement, limiting the amount recoverable in those actions. It is likely that the decision also will give rise to efforts to reduce recent disgorgement awards to the extent that they are based upon more than five years of wrongful conduct.

The opinion is Kokesh v. SEC, No. 16-529, slip. op. June 5, 2017.