Supreme Court Ruling Limits SEC Disgorgement Recoveries
Investment Management Update
Date: June 30, 2017
On June 5, 2017, the U.S. Supreme Court unanimously limited the U.S. Securities and Exchange Commission’s (SEC) ability to bring lawsuits seeking disgorgement of a defendant’s ill-gotten gains from misconduct to five years following such activity.
The SEC in 2009 brought an enforcement action against Charles Kokesh, alleging that he had repeatedly misappropriated client funds from 1995 to 2009. In the action, the SEC sought civil penalties, disgorgement and an injunction barring Kokesh from future securities law violations. The district court found Kokesh had violated several securities laws and that the disgorgement judgment was not barred by the federal law that establishes a five-year limit on an action for the enforcement of a civil fine, penalty or forfeiture. The Tenth Circuit court affirmed the district court’s finding that disgorgement is not a fine or penalty under federal law and therefore claims seeking disgorgement are not subject to the five-year limitation.
The Supreme Court, however, found that SEC disgorgement is a “penalty” under federal law and that actions for disgorgement are subject to the five-year limitation period. The SEC could only disgorge Kokesh’s gains from violations that occurred from 2004 onward, in the five years immediately preceding the complaint, and could not recover disgorgement for any of his pre-2004 activity. In reaching its decision, the court disagreed with the SEC’s assertion that disgorgement is simply remedial, stating that disgorgement is a consequence for violating the law, used for punitive purposes and, in many cases, not used for compensatory purposes.
This decision follows the Supreme Court’s 2013 ruling that the SEC’s ability to initiate lawsuits seeking monetary civil penalties is subject to the five-year limitation.
As a result of the recent Supreme Court decision, the SEC must be vigilant in detecting misconduct, and must either act quickly to bring enforcement actions or seek tolling agreements when it intends to seek disgorgement from a defendant. Although the ruling is favorable to defendants because it eliminates the possibility of seeking disgorgement for actions that took place over five years ago, it also encourages the SEC to initiate lawsuits against defendants more swiftly, which brings reputational damage and litigation costs. A tolling agreement could provide both parties an opportunity to explore settlement before the SEC files its complaint. Otherwise, defendants are also incentivized to resolve disputes quickly to avoid negative publicity.
Finally, defendants may not be able to seek insurance reimbursement for disgorgement payments, because both insurance policies and SEC settlement agreements have precluded reimbursement for penalties.
FOR MORE INFORMATION
For more information, please contact:
Andrew J. Davalla
Donald S. Mendelsohn
Philip B. Sineneng
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