A principal enforcement tool of the SEC since the 1970s, disgorgement requires those who violated securities laws to pay back what was obtained through unlawful means. Resolving the circuit split over whether the SEC can obtain disgorgement beyond the 5-year statute of limitations applicable to monetary penalties, the U.S. Supreme Court recently held in Kokesh v. SEC, 580 U.S. __ (June 5, 2017), that disgorgement is, in fact, a “penalty” and therefore subject to the same 5-year limitations period.

Background

In 2009, the SEC brought an enforcement action against investment adviser Charles Kokesh for the misappropriation of funds from 1995 through 2009. The district court ordered Kokesh to pay a $2.3 million civil penalty – an amount that represented his personal gain during the applicable 5-year limitations period for civil monetary penalties pursuant to 28 U.S.C. § 2462. However, because the SEC did not interpret disgorgement to be a “penalty” under § 2462, it was not bound by the 5-year limitations period and the district court also ordered Kokesh to pay $34.9 million, the entire amount of profits dating back to the initiation of the illegal behavior ($29.9 resulted from violations outside the 5-year limitations period). The Tenth Circuit affirmed. The Supreme Court reversed.

The Kokesh Decision

In ruling for Mr. Kokesh, a unanimous Supreme Court found that disgorgement constitutes a “penalty” within the meaning of § 2462 and therefore is subject to the 5-year limitations period. The Court reasoned that disgorgement bears the hallmarks of a penalty because it is imposed as a consequence of violating public law against the United States rather than an aggrieved individual – precisely why a securities enforcement action may proceed even if victims are not parties to the prosecution. Further to the point, the Court noted that disgorgement funds can be dispersed to the U.S. Treasury instead of victims at a district court’s discretion. In reaching these conclusions, the Court rejected the SEC’s position that disgorgement is remedial rather than punitive, noting that disgorgement may be ordered without regard for expenses that reduced the illegal profit and can exceed the profits actually reaped by a defendant from a violation.

Implications

By reining in the SEC’s power to recover ill-gotten gains, the Kokesh decision will have a significant impact on the scope of SEC enforcement proceedings in the following ways:

  • The SEC must change how it calculates disgorgement. Days after the Kokesh decision, the SEC dropped $45 million from its requested disgorgement of $208 million in administrative proceedings against private equity manager Lynn Titlon and her Patriarch Partners. In a June 9, 2017 letter citing Kokesh, the SEC stated it would no longer seek disgorgement that stems from alleged misconduct that occurred more than five years prior to the initiation of that action.
  • The SEC may become more aggressive in seeking tolling agreements in cases that implicate long-running alleged violations. Alternatively, it may seek higher civil penalties to offset more limited disgorgement remedies.
  • The SEC may streamline pre-enforcement action investigations in an attempt to minimize statute of limitations issues.

A Look Ahead

The Kokesh decision explicitly left open the question of whether courts even possess the authority to order disgorgement in SEC civil enforcement actions. Specifically, the Court noted that in the 1990s Congress passed legislation authorizing the SEC to seek civil monetary penalties – but not disgorgement – and that the Commission nonetheless continued to seek disgorgement pursuant to its general equitable powers in civil actions. At oral argument, the Court appeared skeptical of the SEC’s authority to utilize this enforcement tool in civil actions absent statutory authority. As such, the Court may revisit this issue and further limit the SEC’s ability to seek disgorgement in civil actions going forward.