Five-year limit placed on SEC disgorgement penalties

Game plans are about to change for enforcement actions by the Securities and Exchange Commission and companies either in its crosshairs or that uncover bad conduct rising to the level of self-disclosures.

A unanimous Supreme Court decision on June 5, in the case of Kokesh v. SEC, ruled that disgorgement collected by the SEC is also subject to the five-year statute of limitations on monetary civil penalties.

“There has long been a rule in many circuits that disgorgement actions brought by the SEC were not subject to the standard five-year statute of limitations that governed civil actions for other types of relief,” says Harry Sandick, partner at law firm Patterson Belknap Webb & Tyler, previously an assistant U.S. attorney for the Southern District of New York. “Now, the Supreme Court has made clear that a disgorgement action is no different from other types of civil enforcement actions: They are all subject to the statute of limitations.”

“This is a major win for securities litigants and puts pressure on the SEC to speed up its investigations rather than to depend on the existence of a particular form of relief that does not have a statute of limitations,” he adds.

The case that the Supreme Court ruled on last week dates back to the 2009 conviction of Charles Kokesh, a resident of New Mexico, on charges he misappropriated money from four investment companies he controlled. He was ordered to pay a $2.4 million civil penalty, plus $35 million in disgorgement, a sum determined by combining all misappropriations dating back to 1995.

During an appeal, Kokesh argued the SEC should be able to collect only $5 million in disgorgement, an amount representing conduct within the five-years preceding Commission action.

The case eventually found its way to the Supreme Court. Its unanimous decision, authored by Justice Sonia Sotomayor, held that “because SEC disgorgement operates as a penalty … any claim for disgorgement in an SEC enforcement action must be commenced within five years of the date the claim accrued.”

Among the reasons cited for the decision: “SEC disgorgement is often not compensatory.”

“Regulated entities need to have a fixed date in which government examination ends; there needs to be certainty about a defendant’s potential liabilities for actions taken with regard to the securities markets.”
Ronald Betman, Counsel, Ulmer & Berne

“Disgorged profits are paid to the district courts, which have discretion to determine how the money will be distributed. They may distribute the funds to victims, but no statute commands them to do so,” Sotomayor wrote. “When an individual is made to pay a non-compensatory sanction to the government as a consequence of a legal violation, the payment operates as a penalty. “

In its defense, the government responded that “SEC disgorgement is not punitive but a remedial sanction that operates to restore the status quo,” she added. “It is not clear, however, that disgorgement simply returns the defendant to the place he would have occupied had he not broken the law. It sometimes exceeds the profits gained as a result of the violation.”

Disgorgement does not simply restore the status quo, she argued, “it leaves the defendant worse off and is therefore punitive. Because they go beyond compensation, are intended to punish, and label defendants wrongdoers … disgorgement orders represent a penalty and fall within [the] five-year limitations period.”

Under established law, a five-year statute of limitations applies to any “action, suit, or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise.”

As the dust settles, both the SEC and companies under investigation will need to reassess longstanding assumptions regarding disgorgement. The amounts involved are hardly trivial: The Commission has demanded nearly $3 billion in disgorgement payments in 2016 alone, twice the amount collected through other penalties.

The decision “removes ammunition from the arsenal of the SEC in negotiating potential settlements with public companies, investment advisers, and others since there no longer is any open question as to how far back the SEC can go in seeking disgorgement,” says Ronald Betman, counsel at law firm Ulmer & Berne. “Without a defined limitations period, defendants would be faced with the dire prospect of having to defend against claims of alleged wrongdoing—with faded witness memory and stale or missing evidence—that may have occurred 10 or 15 years ago.”

Betman was a member of the respondent’s trial team in Johnson v. SEC, a 1997 case in which the D.C. Circuit Court of Appeals became the first appellate court to hold that an SEC administrative action seeking a censure and suspension of a regulated securities supervisor is a “penalty” subject to a federal five-year statute of limitations.

“Regulated entities need to have a fixed date in which government examination ends; there needs to be certainty about a defendant’s potential liabilities for actions taken with regard to the securities markets,” he said, adding that a ruling in favor of the government’s position would have meant that “publicly-traded companies, private equity firms, and hedge funds would be faced with SEC disgorgement risk in perpetuity.”

KOKESH v. SEC

The following are selections from a Supreme Court decision in the case of Kokesh v. Securities and Exchange Commission. The unanimous opinion was authored by Justice Sonia Sotamayor.
Because SEC disgorgement operates as a penalty under §2462, any claim for disgorgement in an SEC enforcement action must be commenced within five years of the date the claim accrued.
The definition of “penalty” as a “punishment, whether corporal or pecuniary, imposed and enforced by the State, for a crime or offense against its laws.” Huntington v. Attrill, gives rise to two principles. First, whether a sanction represents a penalty turns in part on “whether the wrong sought to be redressed is a wrong to the public, or a wrong to the individual.” Second, a pecuniary sanction operates as a penalty if it is sought “for the purpose of punishment, and to deter others from offending in like manner” rather than to compensate victims.
The application of these principles here readily demonstrates that SEC disgorgement constitutes a penalty within the meaning of §2462. First, SEC disgorgement is imposed by the courts as a consequence for violating public laws, i.e., a violation committed against the United States rather than an aggrieved individual. Second, SEC disgorgement is imposed for punitive purposes. Sanctions imposed for the purpose of deterring infractions of public laws are inherently punitive because “deterrence [is] not [a] legitimate nonpunitive governmental objective. Bell v. Wolfish.  Finally, SEC disgorgement is often not compensatory. Disgorged profits are paid to the district courts, which have discretion to determine how the money will be distributed. They may distribute the funds to victims, but no statute commands them to do so. When an individual is made to pay a non-compensatory sanction to the government as a consequence of a legal violation, the payment operates as a penalty.
The Government responds that SEC disgorgement is not punitive but a remedial sanction that operates to restore the status quo. It is not clear, however, that disgorgement simply returns the defendant to the place he would have occupied had he not broken the law. It sometimes exceeds the profits gained as a result of the violation.
And, as demonstrated here, SEC disgorgement may be ordered without consideration of a defendant’s expenses that reduced the amount of illegal profit. In such cases, disgorgement does not simply restore the status quo; it leaves the defendant worse off and is there- fore punitive. Although disgorgement may serve compensatory goals in some cases, “sanctions frequently serve more than one purpose.”
Source: Supreme Court

“The justices pushed aside the SEC’s agency interpretation of ‘disgorgement’ and looked at the practical applications—that disgorgement is a penalty no matter how characterized,” says Jack Yoskowitz, a partner at law firm Seward & Kissel. The unanimous decision “brings certainty to investigations and enforcement actions where the SEC had relied on large disgorgement threats to force respondents to the settlement table.”

The Court was careful to state in a footnote, however, that it was not taking a position about whether courts have authority to order disgorgement as a remedy in SEC enforcement proceedings at all, explains Daniel Sullivan, partner with the law firm Holwell Shuster & Goldberg and a former law clerk to Justice Antonin Scalia of the United States Supreme Court.

That footnote reads: “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. The sole question presented in this case is whether disgorgement, as applied in SEC enforcement actions, is subject to [the] limitations period.”

The SEC, reacting to the Supreme Court’s ruling, will need to exercise discretion when deciding which cases they are going to put their resources into. “Anecdotally, we certainly have a number of cases before the agency with older conduct or cases where the agency has taken years to resolve the issue including more than five years.

Among the reasons for protracted investigations by the SEC are that “sometimes it takes a long time to discover that an improper payment was made,” says Saskia Zandieh, an attorney with law firm Miller & Chevalier whose practice focuses on corporate compliance and white-collar defense, primarily involving the Foreign Corrupt Practices Act. “Sometimes the agencies don’t learn about it until the conduct is older. Other times, even if the conduct is discovered initially by the company, it chooses not to make a voluntary disclosure, “so the agencies don’t learn of the misconduct immediately and have to wait until it comes out in the press or there is a whistleblower.”

“The SEC tends to move more slowly because they have always had the luxury of taking their time with disgorgement,” she adds.

In the short term, the decision will force the SEC to abandon any monetary remedies, no matter how characterized, in cases based on conduct occurring outside of the five-year statute of limitations and for which the it has not secured a waiver of the statute of limitations, Zandieh says. The Court's decision will also “force the SEC to resolve cases more quickly, and there will be increased pressure on the Commission to tailor their statute of limitations waivers more narrowly than they have in the past.”

This decision will also give companies much-needed certainty as to the amount of time they can be liable for an FCPA violation. “Though there will be many factors that will continue to encourage companies to make voluntary disclosures in FCPA cases, it is conceivable that this case will tilt the scales against voluntary disclosure for companies discovering older conduct, as those companies may gamble on the possibility that the statute of limitations will pass before the SEC and Justice Department learn of the improper conduct,” she said. “If a company discovers conduct that is four-and-a half years old, it may gamble on the fact that the agencies may not hear about it for the next six months and ride out that time.”

Pravin Rao, a partner with law firm Perkins Coie and a former assistant U.S. attorney and SEC Enforcement branch chief, expects that the ruling won’t have much of an effect on the majority of cases the SEC is dealing with. In fact, it may help the SEC prioritize cases.

“At the Justice Department, we always joked that there were very few ways that you could get disciplined or fired as a prosecutor,” he says. “One of them was blowing past the statute of limitations. When you are a prosecutor it is drilled into you that you have five years, 10 years for bank fraud.”

The SEC’s ongoing enhancements in technology now allow it “to process a huge amount of data faster than it did before,” Rao says.  The better, faster use of data in supervision, examinations, and investigations actions means that the new time limits on disgorgements “may be the new normal, but I don’t see it being a sea change.”