Yesterday, the Supreme Court unanimously held in Kokesh v. SEC that disgorgement orders in enforcement actions by the Securities and Exchange Commission are subject to the same five-year statute of limitations as monetary civil penalties. This holding answered the question left unresolved in Gabelli v. SEC, 133 S. Ct. 1216 (2013), where the Court clarified that the five-year statute of limitations applicable to monetary civil penalties in SEC enforcement actions starts to accrue when the alleged violation occurs, not when the SEC discovers the violation.

Background and SEC position

When Congress established the SEC in 1934, the only statutory remedy available in an enforcement action was injunctive relief barring future securities-law violations. The SEC thus urged courts to order disgorgement in the absence of statutory authorization of monetary damages. Beginning in the 1970’s, as the Court noted in Kokesh, courts routinely ordered disgorgement “to deprive . . . defendants of their profits in order to remove any monetary reward for violating securities laws and to protect the investing public by providing an effective deterrent to future violations.”

Congress authorized the SEC to seek monetary civil penalties in 1990 as part of its Securities Enforcement Remedies and Penny Stock Reform Act. Nevertheless, the SEC has continued seeking disgorgement in enforcement actions. Further, although a five-year statute of limitations applies to monetary civil penalties under 28 U.S.C. § 2462, the SEC has argued, and some lower courts have agreed, that the statute of limitations on monetary penalties did not apply to disgorgement orders because disgorgement is not a penalty.

Supreme Court decision in Kokesh

The Supreme Court resolved a circuit split yesterday when it held in Kokesh that disgorgement is a penalty under § 2462. The SEC alleged that Kokesh misappropriated $34.9 million from several development companies between 1995 and 2009, and it sought monetary civil penalties, disgorgement and an injunction barring Kokesh from violating securities laws in the future. After a jury found that Kokesh had violated securities laws, the district court ordered Kokesh to pay a civil penalty of approximately $2.35 million for violations that occurred within five years of the date on which the SEC filed its complaint. In addition, the district court ordered Kokesh to pay $34.9 million in a disgorgement judgment, $29.9 million of which resulted from violations outside the five-year limitations period. The U.S. Court of Appeals for the Tenth Circuit affirmed the award, agreeing with the district court that disgorgement is not a penalty and thus that the statute of limitations in § 2642 did not apply.

The Supreme Court reversed the decision of the Tenth Circuit, unanimously holding that SEC disgorgement constitutes a penalty subject to § 2642’s limitations period. The Court based its ruling on the following considerations:

  • SEC disgorgement is imposed as a consequence for violating public laws—that is, violations “committed against the United States rather than an aggrieved individual.”
  • SEC disgorgement is imposed for punitive purposes. This is because disgorgement does not “return[] the defendant to the place he would have occupied had he not broken the law.” For example, a defendant’s expenses sometimes do not reduce the disgorgement amount.
  • SEC disgorgement is not compensatory, because disgorged profits are paid to the district court, which retains discretion to determine how and to whom the money will be distributed.

The Court therefore concluded that “SEC disgorgement thus bears all the hallmarks of a penalty.” Accordingly, the Court concluded that the five-year statute of limitations in § 2642 applies when the SEC seeks disgorgement, and that the SEC must commence any disgorgement claims within five years of the date on which the claim accrued.

Potential impact

Although it is too early to know the full impact of the Supreme Court's decision, it is clear that there will be an impact because disgorgement makes up a major portion of the monetary assessments collected by the SEC. FCPA investigations, for example, should be affected, as the SEC likely will ask companies to sign tolling agreements even earlier in an investigation, to ensure that the agency can collect disgorgement for the maximum range of conduct. Gabelli and Kokesh generally should provide an incentive for the SEC to accelerate the pace of its investigations in order to maximize available penalties and disgorgement amounts.