In yet another setback for the SEC, the Supreme Court unanimously decided that disgorgement actions, a cornerstone of SEC enforcement, are subject to a five-year statute of limitations. Previously, in Gabelli v. SEC, a unanimous Supreme Court had already decided that civil penalties were subject to a five-year bar. This time, the question before the Court was whether disgorgement in particular was a penalty for purposes of the five-year statute of limitations. Justice Sotomayor, writing for the unanimous court, concluded that disgorgement was a penalty and not, as the SEC contended, simply a measure of restitution.
Two months ago, we discussed the circuit split that had set the stage for yesterday’s decision. In SEC v. Kokesh, which was the decision reviewed by the Supreme Court, the Tenth Circuit reasoned that because disgorgement only deprived the wrongdoer of the illicit gains, it did not inflict punishment and, thus, could not be considered a penalty per se. The Eleventh Circuit, in SEC v. Graham, thought otherwise, explaining that because disgorgement was a subset of forfeiture, it was subject to a five-year statute of limitations.
In a brief opinion, Justice Sotomayor emphasized the punitive nature of disgorgement actions. Deterrence is not merely an incidental effect of disgorgement, Justice Sotomayor wrote. Rather, courts have consistently held that the primary purpose of disgorgement orders is to deter violations of the securities laws. In addressing the SEC’s remedial-versus-punitive arguments, Justice Sotomayor noted that disgorgement did not “return the defendant to the place he would have occupied had he not broken the law.” Indeed, disgorgement sometimes exceeds the profits of the wrongdoing and, in this context, disgorgement is clearly a punitive, rather than a remedial, sanction.
The Court’s decision is a significant limitation on the SEC’s enforcement powers. Now, given the smaller window for disgorgement actions, as we opined weeks ago, the SEC will likely respond by seeking more tolling agreements or proceed more expeditiously in its enforcement actions, which could be difficult in the more sophisticated and complex cases.
In the wake of the Great Recession, we have seen a marked uptick in the SEC’s policing and enforcement efforts. However, yesterday’s decision would suggest that the Supreme Court is not as willing to grant the SEC a blank check when it comes to enforcement powers as one might expect. Indeed, given yesterday’s decision, the decision in Gabelli in 2013, and the recent rumblings over the appointment of the SEC’s administrative law judges, it would appear that SEC enforcement has had a poor track record with the courts recently.
Ultimately, we should expect to see more requests by the SEC for tolling agreements in the future. The question for companies and individuals is whether to summarily agree to toll the statute of limitations or challenge the SEC. The choices are fraught with risk and reward.
Generally, there is very little for an individual “target” to gain from cooperating with the SEC as it relates to tolling agreements. In other words, if you represent the main actor in the case, the SEC generally will not offer you a material benefit for agreeing to signing the tolling agreement. Therefore, as a general matter, it may be the case that individuals continue to decline signing tolling agreements, but that remains to be seen. We are assuming that there is no “cooperation” benefit to exchange with the SEC.
The more complex issue is related to companies. The SEC will no doubt argue that a failure to sign a tolling agreement will be viewed as a lack of cooperation, possibly resulting in greater fines and penalties, although there is no specific available data showing the benefits of signing such an agreement. The anecdotal wisdom is that by not signing the agreement the SEC will punish companies more. Perhaps, it is time to revisit this question going forward in light of the Supreme Court’s ruling.