By John Durrant
On June 5, 2017, the U.S. Supreme Court unanimously ruled that claims by the Securities and Exchange Commission seeking disgorgement must be commenced within five years of accrual. The ruling, which resolved a circuit split, represents a very important curtailment of the SEC’s enforcement authority. The SEC had previously argued that there was effectively no limitations period that applied to disgorgement and accordingly sought to disgorge purportedly ill-gotten gains going back, in some cases, decades. Justice Sotomayor’s lucid opinion categorically rejected the SEC’s position. Potentially more disconcerting for the SEC, language in the decision suggests the Court may look at further limitations on the judicially created disgorgement remedy in the future.
The sole question posed in Kokesh v. SEC, case number 16-529, 581 U.S. ___ (2017), was whether 28 U.S.C. § 2462 applied to claims by the SEC for disgorgement. Section 2462 sets forth a 5-year statute of limitations for “an action, suit or proceeding for the enforcement of any civil fine, penalty or forfeiture” brought by the Government. The SEC argued that its claims for disgorgement did not fit this definition – that a disgorging defendant was merely giving up that to which he or she was not entitled and that disgorgement was an “equitable remedy” not a “penalty.” The Court rejected this argument, holding that disgorgement “bears all the hallmarks of a penalty” (i.e., a Government-imposed “punishment”) in two regards: (i) it seeks to redress a wrong to the public (not an individual); and (ii) it seeks to punish wrongdoers and deter similar wrongdoing by others.
This formulation, which relied on jurisprudence developed over almost 200 years, refused the SEC’s argument that disgorgement was merely “remedial” or something that restores the status quo ante prior to the wrongdoing. Rather, the Court noted that the SEC’s disgorgement remedy sometimes exceeds the personal gain for a wrongdoer (e.g., when an insider trading “tipper” must disgorge unlawful gains that have accrued to third party “tippee” or when a wrongdoer’s expenses are not deducted from his or her “gains”). The Court further noted that, while the proceeds of disgorgement are often remitted to victims of fraud, that is not determinative: the relief is sought in the name of the United States (not any individual person) and intended to punish and deter.
For the SEC, Kokesh will pose significant challenges. For one, the SEC has often taken years to investigate wrongdoing; it will now have to marshal its resources and efforts to bring matters in a timely manner. Moreover, the SEC will be unable to fully recapture ill-gotten gains from many long-running, highly complex, or hard-to-detect schemes, such as Ponzi schemes or FCPA violations. Finally, while the SEC has often sought receiverships or asset freezes based on its maximal theoretical recovery, relying on an unlimited statute of limitations for disgorgement, it will no longer be able to do so, and may leave more defendants in enforcement actions able to fully and vigorously defend themselves with capable counsel and expert assistance.
Apart from the questions of whether Kokesh is legally correct (and the reasoning of the Court’s unanimous decision seems inarguable), questions will be asked about whether the decision is good policy – whether the Court is placing too high a burden on the SEC to carry out its important work. Ultimately, it is important to remember that the SEC has vast resources and immense capabilities and will now simply have to use greater discipline in managing its review and prosecution of matters. The SEC will still have many advantages in enforcement actions, but will need to contend with a somewhat less tilted playing field in regards to disgorgement. Much as private plaintiffs cannot seek recovery for an indefinite time period, the Government also will not be able to do so. The SEC also still has other powerful enforcement remedies at its disposal, including monetary recovery through penalties, though those will also be limited by the 5-year limit of Section 2462. See Gabelli v. SEC, 568 U.S. 442, 454 (2013).
Congress may be able to change the rule outlined in Kokesh, but such legislation is not likely to be forthcoming. So, Kokesh will be the law for the foreseeable future. The Court in Kokesh noted that the “disgorgement” remedy itself is a judicially created doctrine – not a product of legislation. This lack of legislative guidance and the breadth of the disgorgement remedies sought by the SEC had concerned the Court at oral argument. The Court expressly reserved for itself the question of “whether courts possess authority to order disgorgement in SEC enforcement proceedings or . . . whether courts have properly applied disgorgement principles in this area.” So, while Kokesh is a very important limitation on the SEC’s enforcement authority, it may be that further decisions will discipline use of this unduly elastic remedy to a yet greater degree.