Justices Skeptical Of SEC Disgorgement Without Time Limits
This article by securities & futures enforcement partner Dan McCaughey and associates Annie Hancock, and Janine Paré was published by Law360 on April 20, 2017.
On Tuesday, the U.S. Supreme Court heard oral argument in Kokesh v. U.S. Securities and Exchange Commission to decide whether the five-year statute of limitations established in 28 U.S.C. § 2462 applies to disgorgement claims in SEC enforcement actions. During the argument, a number of the justices expressed skepticism that the SEC could bring disgorgement claims for conduct reaching back in time indefinitely. If the court determines that the statute of limitations does apply to disgorgement claims, it would meaningfully limit the uncertainty, expense and evidentiary disadvantages faced by entities and individuals responding to SEC investigations into conduct dating back more than five years.
The statute in question provides that “an action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise, shall not be entertained unless commenced within five years from the date when the claim first accrued.” 28 U.S.C. § 2462. The court last addressed Section 2462 in 2013, when it held in Gabelli v. SEC that the five-year clock for civil penalties (a separate monetary remedy that the SEC frequently seeks, in addition to disgorgement) begins to run when the alleged fraud occurs, not when the SEC discovers it. 133 S. Ct. 1216, 1221. That decision emphasized the values underlying statutes of limitations, including “the promotion of “justice by preventing surprises through the revival of claims that have been allowed to slumber until evidence has been lost.” Id. at 1220 n.1, 1221. But it did not address whether the statute applies to SEC disgorgement claims through which the SEC seeks to recover ill-gotten gains from defendants accused of violating the securities laws.
That question has since divided the federal courts of appeals. In May 2016, the Eleventh Circuit held that disgorgement claims were subject to § 2462, reasoning that disgorgement was effectively a synonym of the statutory term “forfeiture.” SEC v. Graham, 823 F.3d 1357, 1363-64. In August, the Tenth Circuit disagreed and held that disgorgement was neither a penalty nor a forfeiture. The Tenth Circuit reasoned that disgorgement was remedial — not punitive — and that historical precedents limited “forfeiture” to in rem proceedings against property, not judgments against a person for money. SEC v. Kokesh, 834 F.3d 1158, 1165-66. The Tenth Circuit decision affirmed a judgment against Charles Kokesh, a New Mexico investment adviser, who was found liable for violating the securities laws and ordered to disgorge nearly $35 million, a large portion of which stemmed from conduct dating back more than five years before the SEC brought suit. Id. at 1160-1161. In January 2017, the Supreme Court granted certiorari to resolve the circuit split.
In assessing whether and how the SEC’s disgorgement remedy fell within the scope of the statute of limitations, the justices pressed questions on a number of fronts, including the characteristics that disgorgement shares (or does not share) with other remedies that definitively fall within the scope of Section 2462, and SEC’s statutory authority to seek disgorgement in the first place. The justices also considered whether in place of a categorical application, the statute of limitations might be applied to civil disgorgement claims on a case-by-case basis.
Who Ultimately Receives Amounts Disgorged — Victims or the Government — May Influence Whether Disgorgement Is a “Penalty” or “Forfeiture”
First, the justices focused on whether disgorgement is exclusively remedial — and solely intended to return the defendant to the position he would have been in without violating the law — or whether it is punitive in nature, and more like a fine that is paid to the government as a punishment. This issue is potentially dispositive because under existing Supreme Court precedent, if disgorgement is even partially designed to punish or deter misconduct, it may fairly be considered a “penalty” and thus subject to Section 2462.1
The SEC contends that disgorgement is not designed to punish, but instead serves to prevent a defendant from becoming unjustly enriched by violating the federal securities laws. Both the SEC and some of the justices compared disgorgement to restitution, money that is returned to victims as the result of unlawful conduct. But the SEC conceded that in just the last three years, it has kept 43 percent of the money disgorged from defendants. Indeed, in many instances, such as Foreign Corrupt Practices Act and insider trading cases, there is no identifiable victim at all. In these cases at least, where the U.S. Treasury retains the amounts disgorged, the payment looks punitive in nature.
Regardless, the money’s ultimate destination does not make disgorgement any more or less of a punishment or deterrent from the defendant’s perspective. The remedy has an obvious deterrent purpose because it removes any potential upside from violations of the federal securities laws. And it would seem odd that the statute of limitations — designed to protect the defendant from stale claims and foster “security and stability” in “human affairs” — would turn on who ultimately receives the money disgorged years after litigation has commenced. Gabelli, 133 S. Ct. at 1221. Justice Neil Gorsuch in particular picked up on this point, noting that criminal forfeitures are considered punitive even though the funds sometimes go to the government and sometimes to victims, just like in civil disgorgement.
Moreover, apart from whether or not it is punitive, the disgorgement remedy is not necessarily outside of the statute of limitations solely because it sometimes provides restitution to victims. While the SEC claims that “forfeiture” under the statute is also punitive — and therefore distinguishable from disgorgement — Kokesh’s counsel appeared to encounter little resistance in explaining the striking similarities between other civil forfeiture remedies and SEC disgorgement. Thus, even if the justices do not uniformly agree that disgorgement is always punitive in nature, they could agree that it is uniformly a “forfeiture” and thus still subject to § 2462, much like the Eleventh Circuit held in Graham. In the words of Justice Sonia Sotomayor, “if it looks like a forfeiture, why don’t we treat it like a forfeiture?” 2
The Lack of Express Congressional Authority for Disgorgement Makes § 2462 the Logical Backstop and Highlights the Potential for Abuse
Second, the justices also expressed concern about the SEC’s ability to abuse the disgorgement remedy by bringing stale claims, especially because that remedy is not expressly authorized or governed by statute.
This matters because the securities laws are creatures of statute. Congress has expressly authorized the SEC to pursue certain remedies under those statutes and has generally provided corresponding statutes of limitations. As Chief Justice John Roberts noted, because Congress has never expressly authorized the SEC to seek disgorgement, there is no corresponding statute of limitations. Instead, the chief justice observed, disgorgement was a remedy the government just “devised on its own.”
It is accordingly logical that disgorgement would be subject to Section 2462, which is a general catch-all statute designed to apply to remedies for which Congress has not otherwise prescribed a statute of limitations. Given that Section 2462 covers a broad range of civil remedies, from fines, to penalties, to forfeitures, whether “pecuniary or otherwise,” it would seem contrary to the purpose and text of the statute that the SEC could “gerrymander” the remedy — as Kokesh’s counsel phrased it — in such a way that disgorgement is immune from the limitations period, even though it bears striking resemblance to both penalties and forfeitures.
The lack of statutory authorization also raises concerns about due process and fairness, which the court emphasized in Gabelli. Justice Elena Kagan asked the SEC’s attorney whether, in the 50 years that the SEC has sought disgorgement, anyone at the agency had “ever set down in writing what the guidelines are for how the SEC is going to use disgorgement and what’s going to happen to the monies collected?” It had not. Justice Kagan found it “unusual that the SEC has not given some guidance to its enforcement department ... that everything is just sort up to the particular person at the SEC who decides to bring such a case.” That discretion is cause for further concern when disgorgement awards are ordered not by Article III courts but rather by the SEC’s own administrative courts, which themselves have come under constitutional attack.
Picking up on the theme, Chief Justice Roberts noted that the government has argued disgorgement is punitive when it has been advantageous to do so (in the area of tax and bankruptcy) but nonpunitive when it is not (securities enforcement). That inconsistency, coupled with complete discretion to bring disgorgement claims at any time without any internal guidelines, governing statute, or regulatory framework, makes disgorgement ripe for abuse, which is only compounded by the absence of any limitations period.
Potential Outcomes and Implications
Although the justices’ questioning appeared to favor Kokesh’s position, it is less clear how exactly the court might fashion its ruling. Both Kokesh and the SEC urged the court to categorically decide whether or not disgorgement is always subject to the statute, based on the parties’ respective views of the inherent nature of the remedy. Such a bright-line rule would be easier to follow for the lower courts, the agency and market participants, as it would provide clarity at the outset as to whether disgorgement claims are in or out of an investigation or a subsequent SEC lawsuit. The uniform application of the statute of limitations would also limit the SEC’s ability to retroactively target market practices that it deems objectionable years after the fact, as it has arguably done in recent enforcement actions against private equity advisers.3
Alternatively, some of the justices, including Justice Anthony Kennedy, intimated that the court could hold that disgorgement is a “penalty” or “forfeiture” only in certain circumstances, such as where none of the money goes to victims, but such a case-by-case approach poses practical problems. It is hard to imagine, for instance, how litigants or a court could evaluate in advance of a trial whether a disgorgement claim in a particular case is compensatory or punitive, or how it would be ultimately distributed. Such a ruling could also eliminate the benefits of certainty regarding the scope of SEC investigations into conduct dating back more than five years, and the corresponding burden and expenses faced by respondents in these matters.
These practical problems highlight the need for a clearly defined limitations period that operate on an easily determined set of facts. We will know by this summer whether the court agrees.
1 See Austin v. United States, 509 U.S. 602, 610 (1993) (“[A] civil sanction that cannot fairly be said solely to serve a remedial purpose, but rather can only be explained as also serving either retributive or deterrent purposes, is punishment, as we have come to understand the term.” (quoting United States v. Halper, 490 U.S. 435, 448 (1989)); see also United States v. Bajakajian, 524 U.S. 321, 331 n.6 (1998) (A sanction is punitive “if it constitutes punishment even in part.”).
2 Kokesh also argued that even if disgorgement were properly framed as restitution, it would still be subject to the statutes of limitations applicable to securities laws claims brought by private parties, in whose shoes the government would effectively be standing. While the line of authority Kokesh cites is old, the Justices could find that even when disgorgement is remedial in nature and goes to victims, it is governed by the statutes of limitations that generally govern private securities claims.
3 For a more detailed discussion of SEC disgorgement claims in the private equity context, please see our previous article: The Need For A Limitations Period On SEC Disgorgement Claims.