On Monday, the Supreme Court of the United States issued a unanimous opinion in Kokesh v. SEC, resolving the question of whether disgorgements sought in Securities and Exchange Commission (“SEC”) proceedings qualify as a “penalty,” as defined by 28 U.S.C. § 2462, which would trigger a five-year statute of limitations (“SOL”), or simply as a remedy for unjust enrichment. Holding that such disgorgements are, in fact, penalties, in that they are imposed by the courts as a consequence for violating public laws and are punitive, any disgorgement claims in an SEC enforcement action must be sought within five years of the accrual date of that claim.

By way of background, the Supreme Court previously held that a five-year SOL for “enforcement of any civil fine, penalty, or forfeiture,” applies to monetary civil penalties sought by the SEC. See Gabelli v. SEC, 568 U.S. 442, 454 (2013). Nevertheless, since Gabelli, the SEC has continued to characterize disgorgement as an equitable remedy and not as a fine, penalty, or forfeiture within the meaning of the statute.

When the SEC brought an enforcement action against New Mexico-based investment adviser Charles Kokesh in 2009, the Commission sought, among other things, $34.9 million in disgorgement for profits Kokesh misappropriated from four business development companies, including amounts for conduct dating back as early as 1995. Based on Gabelli, however, the SEC conceded to a limitation on the monetary penalties it sought from Kokesh, to $2.4 million for conduct which occurred within the five-year SOL.

After a five-day trial, the U.S. District Court of New Mexico ordered Kokesh to pay $2.4 million in penalties plus $34.9 million in disgorgement of illegal profits ($29.9 million of which resulted outside of the SOL period) and $18.1 million in prejudgment interest.

The Court of Appeals for the Tenth Circuit affirmed, becoming one of three courts of appeal to agree that disgorgement is not a penalty, and further found that disgorgement is not a forfeiture under the statute. The Supreme Court granted certiorari to resolve the Circuit split, and on Monday reversed the Tenth Circuit Court of Appeals, concluding that SEC disgorgement is a penalty under Section 2462.

In writing for the 9-0 Court, Justice Sonia Sotomayor said that the SEC disgorgement process “bears all the hallmarks of penalty: It is imposed as a consequence of violating a public law and is intended to deter, not to compensate.” The Court continued to reject the government’s proposition that disgorgement is not a penalty because its purpose is to compensate the victim, since while “[s]ome disgorged funds are paid to victims; other funds are dispersed to the United States Treasury.” Though acknowledging that disgorgement sometimes serves compensatory goals, the Court held that it should be treated as a penalty because disgorgement is, at least in part, used to punish criminal activity. Sotomayor also refuted the SEC’s argument that disgorgement represents a return of the defendant to the status quo, rather than a penalty, by declaring that the amount of the award sometimes exceeds a defendant’s actual profit from wrongdoing. With a five-year limit, Kokesh’s disgorgement would be reduced from $34.9 million to about $5 million.

The Supreme Court thus handed a victory for defendants in disgorgement proceedings and delivered a blow to the SEC, which will now need to react more rapidly on matters that are often extremely complex. The Court’s decision is also going to be an expensive one for the government. Since 1970, the SEC has successfully sought the remedy of disgorgement from violators of federal securities laws and in 2015 alone, the amount recovered through disgorgements exceeded $3 billion. The ruling in Kokesh is likely to reduce that amount in coming years since it protects defendants from the government overreaching to penalize them when the SOL has expired.

In addition, the Court also appears to have left open the door to further truncating the SEC’s disgorgement power. In a footnote, the Court commented that “[n]othing in this opinion should be interpreted as an opinion on whether courts possess authority to order disgorgement in SEC enforcement proceedings or on whether courts have properly applied disgorgement principles in this context.” The note suggests that at least some members of the Court question the remedy, which may lead to future challenges to funds sought through disgorgement.