United States: In Unanimous Opinion, SCOTUS Curbs SEC Disgorgement

On June 5, 2017, the U.S. Supreme Court issued a unanimous opinion holding that disgorgement imposed by the SEC is a "penalty" subject to a five-year statute of limitations. In Kokesh v. S.E.C., the Court rejected the SEC's long-standing position that disgorgement is a remedial sanction that permits the agency to claw-back ill-gotten gains unconstrained by any time limit.

Kokesh is the second time since 2013 that the Supreme Court has issued a ruling curtailing the agency's ability to extract monetary sanctions in SEC enforcement actions, following Gabelli v. S.E.C., in which the Court similarly held that monetary fines are subject to the five-year statute in 28 U.S.C. § 2462.

Disgorgement is a Penalty

Section 2462's five-year limitations period applies to any "action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise."

The question presented in Kokesh was whether disgorgement is encompassed within Section 2462's term "civil . . . penalty." Writing for the Court, Justice Sotomayor reasoned that "SEC disgorgement . . . bears all the hallmarks of a penalty: It is imposed as a consequence of violating a public law and it is intended to deter, not to compensate."

The Court observed that, originally, the SEC lacked the statutory authority to obtain disgorgement and was limited only to injunctive relief barring future violations of the securities laws. At the SEC's insistence that courts invoke their "inherent equity power to grant relief ancillary to an injunction," courts later began issuing disgorgement orders in SEC enforcement actions.

In 1990, the SEC obtained statutory authority from Congress to seek civil monetary penalties, but nevertheless continued its practice of seeking disgorgement in enforcement proceedings. Unlike traditional disgorgement, which was a form of "restitution measured by the defendant's wrongful gain," the Court noted in Kokesh that disgorgement in the securities enforcement context may exceed the defendant's illicit profits and, in some cases, may not be paid to the defendant's victims but rather to the U.S. Treasury.

Kokesh resolved a split amongst the circuit courts, in which the Tenth (the court from which the Kokesh appeal was taken), First and D.C. Circuits had previously held – consistent with the SEC's position – that disgorgement was akin to civil forfeiture and therefore not subject to the five-year limitations period of Section 2462. The Supreme Court's decision in Kokesh validates the Eleventh Circuit's view that disgorgement operates as a civil penalty subject to Section 2462.          

As a result of the Court's ruling in Kokesh, the SEC's order of disgorgement against the appellant, a New Mexico investment adviser, will be reduced from $35 million to approximately $5 million.

Key Takeaways from Kokesh

Kokesh is a highly significant decision, which will have effects both on pending and future SEC investigations and enforcement actions. For one, existing SEC investigations where the relevant conduct, or the bulk of it, is outside the five-year statute will have to be reevaluated by the agency. While the SEC may nevertheless continue to seek injunctive relief in the most serious cases, there is no longer an available monetary sanction, which may impact the agency's decision concerning the allocation of its investigative resources.

The effect of the Court's ruling may be most dramatic in cases that typically have a longer latency period to discovery, such as FCPA investigations, for example, in which the misconduct typically takes place overseas and can be long-running.

Going forward, the SEC can be expected to more aggressively seek tolling agreements during investigations in order to maximize the available monetary sanctions in any eventual enforcement action. Companies and individuals confronted with requests to toll limitation periods will have difficult judgments to make in light of Kokesh.

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