Supreme Court Unanimously Holds That Five-Year Limitations Period Applies to SEC Civil Disgorgement Claims
On June 5, 2017, the United States Supreme Court unanimously held in Kokesh v. Securities and Exchange Commission1 that a five-year limitations period applies to disgorgement claims brought by the United States Securities and Exchange Commission (SEC) in enforcement proceedings. In particular, the Court held that "SEC disgorgement constitutes a penalty" within the meaning of 28 U.S.C. § 2462, which provides that government actions seeking a "civil fine, penalty, or forfeiture" are subject to a five-year limitations period.
While the SEC has acknowledged the applicability of § 2462 to civil penalties, it has long taken the position that disgorgement of ill-gotten gains is not subject to any limitations period because disgorgement is a remedial measure that prevents unjust enrichment by violators of the securities laws. The Supreme Court has now squarely rejected this position, resolving a circuit split on the applicability of the five-year limitations period to SEC disgorgement claims. As discussed below, this decision may have a significant impact on the manner in which the SEC conducts investigations as well as the approach it takes to remedies it seeks for violations of the securities laws.
In civil actions, the SEC often seeks monetary relief in the form of penalties, disgorgement, or both.2 Disgorgement, along with accompanying prejudgment interest, has been a significant tool for the SEC and an important part of its enforcement program for many decades. The applicability of the five-year limitations period of § 2462 to disgorgement claims, however, has recently divided the Circuit Courts. Last year, the Eleventh Circuit, in SEC v. Graham,3 held that disgorgement is a "forfeiture" and, accordingly, is subject to the five-year limitations period. While the Eleventh Circuit did not reach the question of whether disgorgement is a "penalty," the Tenth Circuit, in SEC v. Kokesh,4 subsequently held that disgorgement is neither a "penalty" nor a "forfeiture" and permitted disgorgement for conduct that occurred prior to the five-year period.
The Kokesh case commenced in October 2009, when the SEC brought a civil action alleging that Charles Kokesh, an investment adviser, violated federal securities laws between 1995 and 2006 by misappropriating funds from four SEC-registered business development companies. After a jury returned a verdict in favor of the SEC, the district court imposed a monetary penalty of $2.4 million for funds received during the limitations period and ordered disgorgement of $34.9 million–$29.9 million of which was based on violations arising more than five years prior to the commencement of the action. The court also ordered payment of an additional $18.1 million in prejudgment interest. Kokesh appealed, arguing that the district court's disgorgement order was a "penalty" or a "forfeiture" within the meaning of § 2462 and therefore subject to the five-year limitations period. The Tenth Circuit affirmed, holding that the five-year limitation did not apply to disgorgement, and the Supreme Court subsequently granted certiorari.
The Supreme Court reversed, holding that SEC disgorgement is a "penalty" within the meaning of § 2462. Writing for a unanimous Court, Justice Sotomayor began by recounting the historical definition of "penalty," explaining that whether a remedy is a penalty depends on two principles: (i) whether the wrong redressed is a public one and (ii) whether the remedy is sought to punish and deter. The Court held that SEC disgorgement "readily" satisfies both principles. First, the Court recognized that SEC disgorgement is a consequence of violating public laws, observing (for example) that an SEC action may proceed when the victims are not a party to the action. Second, the Court explained that the SEC imposes disgorgement for punitive purposes (and not just as a compensatory mechanism), citing numerous prior authorities finding that the primary purpose of disgorgement is deterrence. The Court also noted that, even though district courts sometimes distribute disgorged funds to compensate victims, there is no statutory mandate to do so–and, as a result, certain disgorged funds revert to the United States Treasury.
The Court explicitly rejected the SEC's argument that disgorgement is "remedial" because it simply returns defendants to the "place [they] would have occupied had [they] not broken the law." For example, the Court observed that "disgorgement sometimes exceeds the profits gained as a result of the violation," such as in insider trading cases where individuals frequently have been forced to disgorge profits that they did not receive. Accordingly, the Court noted that sometimes disgorgement "does not simply restore the status quo; it leaves the defendant worse off." The Court also noted that, while "disgorgement serves compensatory goals in some cases," it also serves the purpose to penalize.
Notably, the Court also expressly reserved the issues of "whether courts possess authority to order disgorgement in SEC enforcement proceedings" and "whether courts have properly applied disgorgement principles in this context," perhaps reflecting the questions of several Justices at oral argument about the source of authority for the SEC to pursue disgorgement.5
The Supreme Court's decision in Kokesh may have significant implications for parties being investigated by the SEC, as it is now clear the SEC lacks legal authority to seek disgorgement for conduct occurring more than five years prior to the commencement of an enforcement action. This decision, along with the Court's 2013 decision in Gabelli (which held that the five-year limitations period accrues when a fraud is complete, not upon its discovery by the Government)6 likely will lead to the SEC increasing efforts to expedite investigations, expanding the use of tolling agreements earlier and more frequently during investigations, and seeking higher penalty and disgorgement amounts for conduct occurring within the limitations period.
In addition, the Court's reasoning in Kokesh for why the five-year limitations period of § 2462 applies to disgorgement claims provides additional support for the application of the statute to certain non-monetary SEC remedies. For example, Kokesh may encourage additional litigation regarding civil injunctions and officer and director bars when sought with respect to older conduct falling outside the statute. While the SEC likely will continue to assert that such remedies are equitable (and not subject to the statute), the litigation risk may impact the SEC's views of which remedies to pursue in certain cases.
Kokesh v. Securities and Exchange Commission, 581 U.S. ___ (2017).
For additional background on disgorgement, the prior circuit split, and oral argument in Kokesh, see Advisories,Supreme Court to Decide Limitations Period for `Securities and Exchange Commission Enforcement Matters(Apr. 21, 2017).
SEC v. Graham, 823 F.3d 1357 (11th Cir. 2016).
SEC v. Kokesh, 834 F.3d 1158 (10th Cir. 2016).
See Advisories, Supreme Court to Decide Limitations Period for `Securities and Exchange Commission Enforcement Matters (Apr. 21, 2017).
Gabelli v. SEC, 133 S. Ct. 1216 (2013). For additional background on theGabelli case, see Advisories, Supreme Court: Discovery Rule Does Not Apply to SEC Enforcement Actions for Civil Penalties Under Investment Advisers Act (Mar. 2013).