In June 2017, the US Supreme Court unanimously held in Kokesh v. Securities and Exchange Commission that the availability of disgorgement as a remedy in Securities and Exchange Commission (SEC) civil injunctive actions is subject to the five-year statute of limitations on civil penalties.1 The decision’s immediate impact is to profoundly limit the ability of the SEC to seek disgorgement in its civil injunctive actions. Yet the implications of this decision may have rippling effects on other longstanding practices and the perceived authority of the SEC.
The Supreme Court’s Kokesh decision
Federal law applies a five-year statute of limitations to fines, penalties, forfeitures, and other punitive remedies in civil enforcement matters. 28 U.S.C. § 2462. In its 2013 decision, Gabelli v. SEC, the Supreme Court unanimously upheld the five-year time bar for monetary penalties in SEC enforcement actions but reserved the question of whether Section 2462 applies to claims for disgorgement.2 In the aftermath of Gabelli, the SEC argued that the five-year statute of limitations did not apply to disgorgement because disgorgement is an equitable remedy, not a penalty. The US Courts of Appeals for the DC Circuit and the First Circuit agreed, finding that the statute did not apply to disgorgement.3 But the Eleventh Circuit disagreed, holding that disgorgement is effectively the same as forfeiture and thus subject to the five-year statute of limitations.4
In Kokesh, a jury found investment adviser Charles Kokesh liable for misappropriating investor money from four funds for over a 12-year period. The jury ordered Kokesh to disgorge nearly $35 million, the amount of proceeds misappropriated throughout the entirety of his scheme, the bulk of which were received outside the five-year limitations period. On appeal, the Tenth Circuit found Section 2462 inapplicable, reasoning that disgorgement is not a penalty. The Supreme Court granted certiorari to resolve the circuit split.
The Supreme Court held that disgorgement does operate as a penalty and thus is subject to the five-year statute of limitations. In doing so, the Court laid out two principles that determine whether a sanction, including disgorgement, is a penalty: 1) if the wrongful act was perpetrated against the public rather than an individual; and 2) if the sanction is used to punish the offending party and deter others from engaging in similar behavior rather than to compensate victims.
The Court applied these principles in finding that SEC disgorgement constitutes a penalty. First, it stated that courts impose SEC disgorgement as a remedy for violations of public laws against the United States rather than against an aggrieved individual. Second, it held that SEC disgorgement is imposed for punitive rather than compensatory purposes. The Court cited cases that emphasized the use of disgorgement “to deprive the defendants of their profits in order to . . . protect the investing public by providing an effective deterrent to future violations” and to punish offenders.5 This holding prohibits the SEC from bringing an action seeking disgorgement more than five years after the underlying conduct has occurred.
Do the principles in Kokesh implicate the SEC’s ability to seek injunctions for past conduct?
While Kokesh is immediately significant for its limitation on disgorgement, its holding may lay the groundwork for applying Section 2462’s five-year statute of limitations to the Commission’s use of injunctions for past conduct. Courts might apply the same principles from Kokesh in determining whether an injunction is a penalty subject to the five-year statute of limitations. In doing so, courts may consider whether the wrongful act was perpetrated against the public rather than an individual and whether the injunction is imposed primarily for punitive and deterrent purposes rather than to remedy ongoing misconduct or protect against future violations.
Meeting the first principle appears relatively straightforward. Like with disgorgement, courts impose SEC injunctions to remedy violations against the United States and the public at large rather than aggrieved individuals.
While the second principle requires deeper analysis, precedent suggests that SEC injunctions punish or deter rather than remediate ongoing misconduct. Courts often look to the extent of the collateral consequences to determine whether an injunction is punitive. Beginning in 1996 in Johnson v. SEC, the DC Circuit found that the “collateral consequences of the censure and suspension” suggest that an injunction is a penalty.6 The court stated that if a permanent injunction is imposed as “a form of punishment” that “goes beyond remedying” the damage allegedly caused by the defendant, it would be a punitive measure, and thus subject to the Section 2462 time bar. Another court further found that enjoining the defendants from any future violations of securities laws “can be regarded as nothing short of a penalty ‘intended to punish,’ especially where [there was] no evidence (or allegations) of any continuing harm or wrongdoing [within the limitations period].”7 More recently in Gabelli, the Supreme Court stated that it “‘would be utterly repugnant to the genius of our laws’” if actions for penalties could “‘be brought at any distance of time.’”8
Whether an injunction is “a form of punishment” that “goes beyond remedying” the harm caused by a defendant would likely be a fact-specific inquiry. Recently, the Eighth Circuit analyzed whether Kokesh bars the SEC from bringing injunctions more than five years after the misconduct occurred.9 In that case, the court found it unnecessary to determine whether an injunction is a penalty under Section 2462, because (1) the defendant continued operating his business after the action was brought and thus there was a reasonable likelihood of future violations; (2) the injunction was meant to protect the public prospectively from the defendant’s wrongful conduct rather than punish him; and (3) the injunction only required the defendant to obey the law. The outcome may differ in a case where a company voluntarily ceased the violative conduct, remediated any harm caused by the misconduct, took actions to prevent future misconduct, and self-reported. Thus, depending on the circumstances, if the at-issue conduct occurred beyond five years, a court may be inclined to find injunctive relief barred by the limitations period. Moreover, in future cases where a court may focus solely on whether to issue an injunction that merely requires obedience to the law, the court may consider that the purpose of such an injunction is to impose a “stigma” that would constitute a penalty.
Will the SEC be ordered to disgorge its disgorgement remedy?
In Kokesh, the Court expressly disclaimed opining on the availability of disgorgement generally: “Nothing 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.”10 This comment may signify a potential challenge to the long-held assumption that courts have the power to order disgorgement in SEC enforcement cases. The loss of disgorgement would prove significant: in fiscal year 2016, the SEC obtained judgments and orders totaling nearly $3 billion in disgorgement.11
While the SEC is statutorily authorized to pursue a wide range of remedies against securities law violators in district court proceedings, including injunctions, Congress has never expressly included disgorgement among them. But disgorgement has been an element of the SEC’s enforcement arsenal since 1970, when it first sought and obtained disgorgement in SEC v. Texas Gulf Sulphur Co. There, the court held that “the SEC may seek other than injunctive relief in order to effectuate the purposes of [the Exchange Act], so long as such relief is remedial relief and is not a penalty assessment.”12 The SEC has obtained disgorgement countless times since.
Despite this initial limitation, courts have often rejected defendants’ assertions that disgorgement is a penalty, even when it goes beyond the sole purpose of depriving wrongdoers of their ill-gotten gains.13 The SEC’s argument that disgorgement is “remedial” in that it “lessen[s] the effects of a violation” by “‘restor[ing] the status quo’” has typically prevailed.14 But in Kokesh, the Supreme Court rejected the SEC’s argument. It held that disgorgement is punitive because it “cannot fairly be said solely to serve a remedial purpose, but rather can only be explained as also serving either retributive or deterrent purposes.”15 Because of this language, the time may have come to reevaluate courts’ authority to order disgorgement in SEC cases.
When courts first ordered disgorgement, there was no statutory authorization for monetary remedies. Simply put, the SEC had no way to impose financial sanctions on wrongdoers. As a result, the SEC argued that courts had the inherent ancillary authority to order equitable relief in the form of disgorgement to strip wrongdoers of their ill-gotten gains. The SEC’s entire enforcement regime changed dramatically in 1990 when for the first time Congress authorized the Commission to seek civil monetary penalties for violations of federal securities laws.16 Over time, Congress authorized the SEC to seek additional sanctions but repeatedly chose not to expressly provide for disgorgement in district court proceedings.17
The enforcement tools at the SEC’s disposal to combat violations of federal securities laws have expanded significantly since it sought and obtained its first order for disgorgement. There has also been an increasing emphasis on the punitive and deterrent aspects of its remedies. Kokesh and Gabelli place limits on the SEC’s remedial regime insofar as the remedies imposed are principally viewed as punitive.
The immediate repercussion of the Supreme Court’s Kokesh decision was profound even if straightforward: SEC disgorgement is subject to the five-year statute of limitations for civil penalties. Yet the Court’s rationale could disturb decadeslong practices at the Commission regarding the use of injunctions and its access to disgorgement generally. Recently, for example, following the SEC’s decision to drop claims for disgorgement based on Kokesh, a defendant moved for complete dismissal as time-barred, asserting that the injunctive relief sought was punitive not equitable.18 Over the coming months and years, defendants in SEC enforcement actions will likely continue to challenge these remedies and other previously well-accepted remedies, in particular for conduct outside the five-year statute of limitations. Thus, there is likely to be increasing uncertainty regarding the range and applicability of certain previously well-accepted SEC remedies.