Argument preview: The long arm of the SEC
on Apr 11, 2017 at 1:24 pm
Since 1970, the Securities and Exchange Commission has claimed, and courts have readily conceded, that the commission may sue violators of the federal securities laws for disgorgement of their ill-gotten gains. The amounts recovered – which in 2015 exceeded $3 billion – sometimes are returned to victims. In many cases, however, the recoveries wind up in the U.S. Treasury. This is the case, for instance, when the transgression involves bribery in violation of the Foreign Corrupt Practices Act.
Over time, Congress periodically has expanded the commission’s enforcement authority. In the process, both legislative history and statutory wording have acknowledged the SEC’s use of the disgorgement remedy and disclaimed any intent to constrain it.
Missing from the legislative log, however, is any explicit creation of the disgorgement remedy, much less any attempt to define its parameters. It has fallen to the courts to struggle with niceties like the one presented in this case – whether the commission’s ability to bring an action for disgorgement is subject to 28 U.S.C. § 2462, a statute of limitations requiring that “enforcement of any civil fine, penalty, or forfeiture” be “commenced within five years from the date when the claim first accrued.” According to the U.S. Courts of Appeals for the 1st, 10th and District of Columbia Circuits, the answer is “no.” The U.S. Court of Appeals for the 11th Circuit, however, has begged to differ.
The 1990s are calling and they want their cash back
Charles Kokesh owned and controlled two registered investment advisers that operated four business-development companies investing the funds of “tens of thousands” of small investors in start-up companies. Between 1995 and 2006, Kokesh managed to misappropriate $34.9 million from the business-development companies. Some of the money went directly to support Kokesh and his private stable of 50-plus polo ponies and some was directed to satisfy expenses of his controlled investment advisers. The SEC brought a civil enforcement action in 2009, alleging violations of the Securities Exchange Act, the Investment Advisers Act and the Investment Company Act; the jury found violations of all three.
The United States District Court for the District of New Mexico, at the behest of the SEC, ordered a civil monetary penalty of $2.4 million, based on Kokesh’s conduct beginning in 2004, as well as non-compensatory disgorgement of $34,927,329 (plus prejudgment interest), representing the full amount misappropriated beginning in 1995. All concerned recognized the applicability of Section 2462’s statute of limitations to the civil penalty. Kokesh urged Section 2462’s application to the disgorgement order as well, but the court followed 10th Circuit precedent in concluding that disgorgement is not a penalty subject to Section 2462 because it is not punitive; rather, it is remedial, returning the wrongdoer to the pre-wrongdoing status quo.
On appeal, the 10th Circuit reiterated that disgorgement is not a penalty and addressed Kokesh’s additional claim that disgorgement is a forfeiture governed by Section 2462. It noted that in common parlance “forfeit” and “disgorge” may be used interchangeably, and that there are similarities in modern dictionary definitions of the terms. It politely declined to follow the 11th Circuit, in SEC. v. Graham, in relying on those similarities to conclude that disgorgement is a forfeiture under Section 2462. Instead, it plunged into a thicket of legal history and statutory interpretation, emerging with the conclusion that congressional understanding at the time of enactment of Section 2462’s precursor should control. This understanding was that “forfeiture” means a “proceeding brought by the government against property that either facilitated a crime or was acquired as a result of criminal activity.” By contrast, modern disgorgement is an action for money brought against a wrongdoer and thus is not a “forfeiture.”
The arguments of the parties
Both parties agreed on the importance of granting certiori in this case. Then, of course, agreement ceased, with both sides relying on many of the same authorities for their competing propositions. Kokesh’s 63-page argument (supplemented by eight amicus briefs, including one from Mark Cuban) and the SEC’s 51-page brief are briefly summarized (and slightly reorganized) below.
Before getting to the merits, it’s worth noting that there are so many opinions of the court in play in the briefs it’s hard to keep track. Eyecatching, though, is the fact that the SEC’s last attempt (in Gabelli v. SEC) to catch a break on the interpretation of Section 2462 was spectacularly unsuccessful – Chief Justice John Roberts wrote for a unanimous court in holding that the statute of limitations starts to run when a violation occurs, not when the commission discovers it.
Disgorgement either is or isn’t a penalty under Section 2462
Before the court, Kokesh renews his argument that disgorgement is a penalty, which traditionally has equated with a punishment. He notes various authorities’ observations that disgorgement plays an important role in deterring wrongdoing, and reasons that because deterrence is a goal of punishment, disgorgement must be punishment. He also (more convincingly) argues that since amounts disgorged frequently go to the government and are paid over only by reason of wrongdoing, they are sanctions and thus penalties. He also invokes cases holding that compensatory actions are not punitive and therefore not subject to Section 2462, and concludes that the line between when a compelled payment is a penalty and when it is not is whether its goal is compensatory.
Kokesh also argues that disgorgement remedies sometimes are classified as penalties under other statutory schemes, that the court has characterized similar remedies as penalties, and that, when it has suited the government, it has claimed that disgorgement is a penalty (e.g., for purposes of a statute making penalties non-deductible for tax purposes).
The SEC contends that preventing wrong-doers from profiting from their violations does not punish them. (An analogy might be to say that refusing to give a student credit for a plagiarized paper is not a punishment, although suspension or expulsion would be.) Moreover, disgorgement frequently does result in victim compensation, which is clearly non-punitive. More importantly, just because earlier authorities have held that compensatory actions are non-punitive does not necessarily mean that non-compensatory actions are punitive.
Disgorgement either is or isn’t a forfeiture under Section 2462
There is simply no way to do justice in a short space to the parties’ vigorous battle over what Congress meant, in 1839, when it used the word “forfeiture.” Kokesh turns to the first edition of Webster to argue that “forfeiture” is the “losing of some right … or effects, by an offense….” He presents a variety of early American legal usages of “forfeit,” such as a 1789 statute requiring a customs violator to “forfeit and pay a sum double the value of the goods … concealed or purchased.” He observes that the multiplication of value involved in such statutes clearly implicates a penalty subject to Section 2462, and he charges the commission with “slicing and dicing” when it contends that paying over the value of the item itself is merely disgorgement rather than forfeiture.
The SEC avails itself of authority stating that Section 2462 is intended to apply to punishments, and argues that only forfeitures that punish are subject to its limitations. It also contends that there were only three possible understandings of forfeiture at the time of enactment, all of which involved punishment and none of which included disgorgement (which did not exist until 1970).
Policy and presumption
The briefs also feature a hearty back and forth on the need to prevent government over-reaching (Kokesh) and just why that would be unlikely to occur in the context of disgorgement (the commission). Also featured is a sword-swinging exchange about the Supreme Court’s statement (in E.I. Dupont De Nemours & Co. v. Davis) that “an action on behalf of the United States in its governmental capacity … is subject to no time limitation, in the absence of congressional enactment clearly imposing it.” Is this a presumption against expansive interpretation of statutes of limitation in all litigation brought by the government (the commission), or just when the government seeks to recover for an injury to itself (Kokesh)? Presumably, the answers to both of these questions could make a difference if the court otherwise views this as a close case.
Although Kokesh might have tried to coat-tail on SEC v. Graham’s modern plain-language approach, he probably was well advised to roll up his sleeves and crack the old books. Whatever the outcome, this case clearly is a win for lovers of legal history.
That said, the arguments are intricate and some things get lost in the shuffle. For instance, not a lot of care is given in the briefs to analyzing what some of the older authorities actually require a wrongdoer to give up and whether it is akin to the disgorgement in this case. Also somewhat submerged – although the SEC’s brief does point it out – is that if Section 2462 does not apply, equity would still take the passage of time into account.
Finally, lurking in the shadows is exactly what should happen in the case of SEC enforcement actions that (unlike this one) do seek disgorgement for victims. It would certainly complicate matters if they were exempt from Section 2462 and non-compensatory disgorgement actions were not. After all, as noted in the commission’s brief, it often is the court, rather than the SEC, which decides what is to be done with disgorged proceeds. It might well be the case that a great deal of litigation gamesmanship and, perhaps, waste might ensue if the treatment of compensatory and non-compensatory disgorgements were severed.