Unanimous Supreme Court Limits Key SEC Bargaining Chip
On Monday, the Supreme Court resolved an ongoing circuit split in its unanimous Kokesh v. Securities and Exchange Commission decision, putting to rest the question of whether or not disgorgement is subject to a 5-year limitations period. Disgorgement is a form of restitution that is measured by the defendant’s ill-gotten gain. The remedy seeks to deprive the defendant of any profits and remove any rewards associated with the unlawful conduct. A main purpose of disgorgement is to deter the defendant from repeating the same or similar violation in the future. In some cases, the Securities and Exchange Commission (“SEC”) uses this remedy as leverage in settlement negotiations.
The circuits have been split as to whether disgorgement constitutes a penalty, forfeiture, or neither, for purposes of imposing the 5-year limitations period required by 28 U.S.C.A. § 2462. Imposing the limitation would prevent the SEC from seeking disgorgement on ill-gotten gains obtained more than five years prior to the action. Some circuits were imposing the 5-year limitations period after finding disgorgement to be a penalty or forfeiture, while others, such as the 10th Circuit, found that § 2462 did not apply to disgorgement at all. Justice Sotomayor, writing for the Court in Kokesh, finally answers the question – disgorgement is a penalty and is subject to the 5-year statutory limitations period.
In Kokesh, the SEC brought an enforcement action after Kokesh allegedly misappropriated $34.9 million from four businesses from 1995-2009. After a jury found Kokesh’s actions in violation of the Investment Company Act of 1940, the District Court imposed an injunction, civil monetary penalty, and disgorgement. The District Court held that disgorgement is neither a penalty nor a forfeiture for the purposes of § 2462. Thus, disgorgement was awarded based on Kokesh’s ill-gotten gains over the entire fourteen years. The total remedies amounted to $2,354,593 for the civil monetary penalty and $34.9 million for the disgorgement judgment. The 10th Circuit affirmed this decision.
The Supreme Court unanimously disagreed. Several aspects of disgorgement convinced the Court that the remedy is punitive in nature. First, disgorgement is a court-imposed consequence for violating a public law effecting the Government, as opposed to an action against a private victim. Second, disgorgement acts as a deterrent for future violations by taking away the ill-gotten gains from the violator. While the Government tried to argue that disgorgement is compensatory rather than punitive, the Court was not persuaded. Ill-gotten gains are not always returned to the victims, and in some instances, may be sent to the Treasury instead.
The practical effect of Monday’s decision is that Kokesh’s disgorgement judgment will go from $34.9 million to no more than $5 million. This sizeable decrease illustrates the important issues that may arise from the Kokesh decision, like will the implementation of a limitations period for disgorgement weaken the deterrent effect sought after in the first place? Only time will tell.