The Securities and Exchange Commission’s primary remedies against corporate officers and directors are injunctions against future violations, disgorgement, civil penalties and bars against serving as an officer or director of a public company. Although it has always been clear that civil fines, penalties, and forfeitures are covered by a five-year statute of limitations under 28 U.S.C.§ 2462, the Fifth Circuit Court of Appeals this week held that an injunction against future violations and an “officer and director bar” are also penalties subject to the same statute of limitations. SEC v. Bartek, No. 11-10594 (5th Cir., Aug. 7, 2012). This ruling, which recognizes the sometimes drastic effects of entering an injunction, appears to put the Fifth Circuit in conflict with at least three other circuit courts of appeals that recognize no statute of limitations applicable to SEC actions seeking such equitable remedies.1
Injunctive proceedings are generally considered “equitable” in nature and are therefore tried by a judge rather than a jury.2 SEC injunctions rarely impose any specific obligations on the violator beyond a general order to obey the law.3 But these injunctions have substantial potential consequences. First, a defendant who disobeys an injunction may be held in contempt of court, the consequences of which may be harsher than the penalties for the securities fraud itself. Second, individuals subject to an injunction may in appropriate cases be barred by the SEC from being a registered broker or dealer 4 or investment advisor.5 Third, other licensing or procurement agencies may take adverse actions on the basis of an injunction, employers may not hire enjoined individuals, and potential investors and customers may be reluctant to trust individuals who have been enjoined, especially where it is an anti-fraud injunction.6
In the Bartek case, the SEC alleged that the individual defendants had engaged in fraud and aided and abetted records-keeping violations of their employer, Microtune Company. The action stemmed from an alleged 2000-2003 scheme in which they allegedly back-dated options for new hires, existing employees and executives, while failing to properly expense these grants on the company’s books. Microtune immediately settled when the SEC filed suit on June 30, 2008, more than five years after the alleged back-dating occurred. The SEC sought equitable relief of an injunction and an officer-and-director bar, as well as civil penalties. The SEC does not appear to have sought disgorgement.
The district court granted the defendants’ motion for summary judgment pursuant to the five-year limitation of § 2462, holding that the SEC failed to pursue diligently its claims and that there was no evidence of self-concealing conduct. Further, the injunctive and officer-and-director bar remedies were dismissed because: (1) these remedies would have significant collateral consequences to the defendants; (2) they did not address past harm caused by the defendants; and (3) the remedies did not focus on preventing future harm because of the low likelihood that the defendants would engage in similar harmful behavior in the future.
The Fifth Circuit agreed. The Court first held that a “plain reading of 2462 reveals no discovery rule exception.” It noted that this statute lists one exception to its applicability, but not a failure to discover the violation. The Court distinguished the situation from the “special rule” where “fraudulent concealment” may apply because, “as a matter of law,” the SEC had not shown the defendants’ “alleged fraudulent acts were self-concealing.”
The Court then rejected the SEC’s arguments that the injunction and officer-and-director bar should survive because they are equitable remedies not subject the statute of limitations for penalties. The Court explained that, although these are “traditionally remedial” remedies, “even remedial sanctions carry the sting of punishment.” 7 The Fifth Circuit applied a test from the DC Circuit’s decision in Johnson v. SEC, 87 F.3d 484, 487 (DC Cir. 1996), and considered “the degree and extent of the consequences to the subject of the sanction.” The Court opined:
The SEC’s sought-after remedies would have a stigmatizing effect and long-lasting repercussions. Neither remedy addresses past harm allegedly caused by the Defendants. Nor does either remedy address the prevention of future harm in light of the minimal likelihood of similar conduct in the future.
Whether the Fifth Circuit will reach this same result with regard to an SEC request for disgorgement is an open question, as is the question of whether any other circuit court (or the Supreme Court) will adopt this reasoning and reach the same result. The remedy of disgorgement requires a person to surrender any ill-gotten gains or unjust enrichment caused by a securities violation. The SEC may argue that this is the essence of “address[ing] past harm allegedly cause[d] by the Defendants.” Defendants may argue that it does not directly prevent any future violation and really is a penalty for past conduct, especially since it sometimes may be paid into the U.S. Treasury, although that now seldom occurs outside of Foreign Corrupt Practices Act (FCPA) cases.
In any event, the Court in SEC v. Bartek takes a realistic view of the actual consequences of an SEC injunction. The decision will provide defendants with a significant argument in the Fifth Circuit, and one that defendants may build upon in other circuits.