Opinion analysis: A statute of limitations does apply to SEC actions for disgorgement
on Jun 6, 2017 at 11:06 am
In light of the questioning at the April 18 oral argument in Kokesh v. Securities and Exchange Commission, yesterday’s 9-0 opinion siding with appellant Charles Kokesh and determining that SEC disgorgement actions are subject to a statute of limitations hardly called for stopping the presses. That is not to say it was not a significant holding, and in more than one way.
First and most obviously, the court’s decision, in an opinion written by Justice Sonia Sotomayor, is going to be an expensive one for the government, which urged the Supreme Court to review the case.
Second, the opinion features one of those portentous footnotes, suggesting that the threshold matter of whether courts should be ordering disgorgement in Securities Exchange Commission enforcement actions at all might be up for grabs.
Third, even without that footnote (number 3, by the way), the court’s reasoning suggests – probably even logically demands – that disgorgement be characterized as a civil monetary penalty (something that previously was different from disgorgement) and thus subject to the schedules of penalties the commission generally is required to follow.
Fourth, the analysis should cause a bit of a stir in insider-trading jurisprudence.
Fifth, the court appears to have said more definitively than ever before that, in the context of government enforcement, deterrence is punitive in nature. The resulting sound bite very well may resonate through the federal law of crime and punishment, and elsewhere.
All that in less than 11 pages.
The main event
Since 1970, the SEC has successfully sought the remedy of disgorgement from violators of the federal securities laws. In 2015 alone, the amount recovered exceeded $3 billion. Although there have been glimpses in legislation along the way that Congress is aware of the existence of the remedy, it has never been expressly authorized – if it had been, there might have been explicit attention paid to whether it was subject to a statute of limitations.
As it was, it fell to the courts to determine whether 28 U.S.C. § 2462, a five-year statute of limitations for “enforcement of any civil fine, penalty, or forfeiture,” applies to the commission’s actions for disgorgement. The U.S. Court of Appeals for the 11th Circuit thought it did; three other federal appellate courts thought not, including the U.S. Court of Appeals for the 10th Circuit in confirming the U.S. District Court of New Mexico’s now-reversed resolution of this case.
Charles Kokesh misappropriated $34.9 million of investors’ funds between 1995 and 2006. In its 2009 enforcement action, the SEC conceded that Section 2462 governed its ability to seek the express civil monetary penalties it is permitted by statute to pursue, thus limiting it to the collection of $2.4 million for Kokesh’s conduct commencing in 2004. The commission sought and received the full $34.9 million (plus interest) in the form of disgorgement of Kokesh’s ill-gotten gains since 1995. Kokesh appealed on the grounds that the disgorgement was either a “penalty” or a “forfeiture.” As a result of the court’s opinion yesterday, the amount of the ordered disgorgement must be trimmed dramatically.
Sotomayor’s opinion is quite straightforward. After acknowledging the purpose of the federal securities laws and summarizing the evolution of the commission’s enforcement authority to include the ability (conferred by statute) to pursue injunctive relief, the authority (judicially recognized) to seek disgorgement, and the ability (again by statute) to obtain civil monetary penalties, she reviewed the facts and history of the case.
Five pages into the decision, Sotomayor praised statutes of limitations as “vital to the welfare of society,” quoted Section 2462, and announced the court’s conclusion that SEC disgorgement constitutes a “penalty.” It is at that point that footnote 3 appears in order to explain that the court is not opining on whether the federal courts have, in the first place, the authority to order disgorgement in SEC enforcement proceedings.
In concluding that SEC disgorgement is a penalty, Sotomayor relied exclusively on an analysis of the court’s own precedents. To some, this may be an interesting contrast to lower-court opinions that have struggled mightily with legal history and statutory interpretation. In any event, the opinion’s starting point was the 1892 declaration in Huntington v. Attrill that a “penalty” is a “punishment … imposed and enforced by the State, for a crime or offen[s]e against its laws.” This definition, the court explained in Kokesh, required two findings. First, the wrong sought to be redressed must be one against the public. Second, the putative penalty must be sought “for the purpose of punishment, and to deter others from offending in like manner.”
In checking the first box, Sotomayor took as conceded by the government that the commission acts in the public interest in seeking disgorgement. Checking the second box to conclude that the intent of disgorgement is to punish seemed only slightly more difficult. Sotomayor first looked to district and appellate court cases noting that deterrence is the primary purpose of disgorgement. Establishing that deterrence is punitive was then a quick matter (seven lines) of quoting two of the court’s own cases. One, Bell v. Wolfish (whose facts Sotomayor did not mention), asked whether such practices as pre-trial double-bunking and intrusive body searches were punitive; the Supreme Court concluded that they were not. In a footnote re-characterizing another case’s reasoning, the Bell court noted that “deterrence [is] not [a] legitimate nonpunitive governmental objective[e].” And in U.S. v. Bajakajian, which answered in the affirmative the question whether forfeiture of transported, undeclared currency was a “fine” under the Eighth Amendment’s prohibition of excessive fines, the court stated that “[d]eterrence … has traditionally been viewed as a goal of punishment.”
Sotomayor next established that although disgorgement sometimes results in the compensation of injured investors, that is not always the case. The opinion went on to conclude that disgorgement is penal (evidently even when compensation results). And finally, Sotomayor responded to the SEC’s argument that disgorgement represents a return of the defendant to the status quo, rather than a penalty, by declaring that the amount of the award sometimes exceeds a defendant’s actual profit from wrongdoing. In her view, the court’s own jurisprudence establishes that sanctions that are even partially non-compensatory are punitive.
Things to think about
Yesterday’s opinion does draw a fairly clean line with respect to SEC disgorgement and Section 2462. The section applies, no questions asked – about that. Other questions do arise, though, as I suggested above – including the very important question of whether courts have the authority to order disgorgement.
Moreover, “conflation” is always a fun word, and it seems to describe aptly what this opinion accomplished with respect to SEC disgorgement and civil monetary penalties (sometimes known as “CMPs”). Given that (1) SEC matters are civil, (2) what SEC disgorgement seeks is money, and (3) the conclusion that disgorgement is a penalty, doesn’t that mean that disgorgement should be subject to statutory limitations on CMPs? The result of that line of reasoning would be to prevent the commission from recovering disgorgement on top of other CMPs, at least in some cases.
Questions also remain regarding Sotomayor’s remarks on the forced disgorgement of amounts exceeding a defendant’s profits. She used as a platform for her analysis the recovery from a tipper of a tippee’s gains on inside trading. She quoted without criticism or question various lower courts’ statements more or less to the effect that the ability to obtain disgorgement from a tipper of a tippee’s profits is “well settled.” It is true that lower courts have so held, but the Supreme Court has not. There are interesting issues outstanding that involve the relationship of tippers and tippees and what effect that relationship may have on whether tipping is a violation of the federal securities laws, and Sotomayor’s comments may affect their resolution.
Is a fence a form of punishment?
Finally, the (here it is again) conflation of deterrence and punishment may be a little bold. Can it possibly be true that all deterrence is punitive? It seems as though yesterday’s decision is pushing us toward a dichotomous view of enforcement actions. If the sole purpose of such actions is to seek compensation for investors, they are compensatory. Otherwise, they are punitive. Although there may be ways to avoid this conclusion in contexts other than SEC disgorgement actions, the court’s approach yesterday does not suggest what they might be. This is particularly true given that the reasoning with respect to exactly why deterrence is punitive consisted of the quotation of a very few words from cases that are fairly far afield from the one at hand. The approach the court has taken in this case also could have an unintended spillover effect in areas such as fiduciary liability for self-dealing transactions, in which the rules are quite expressly intended to deter future misconduct.