On April 18, 2017 the Supreme Court heard oral argument in Kokesh v. SEC in order to resolve whether the federal five-year statute of limitations for civil actions, which applies to “any civil . . . penalty, or forfeiture,” governs the SEC’s claims for disgorgement. This case follows the Court’s recent decision in Gabelli v. SEC, where the Court held that claims for penalties in securities enforcement actions accrue (i.e., the five-year statute of limitations begins to run against a defendant) when “a defendant’s allegedly fraudulent conduct occurs,” rather than when the SEC discovers the conduct occurred. 133 S. Ct. 1216, 1220-21 (2013). Before Gabelli, the SEC had brought claims against defendants for conduct that reached back in time without any limit as long as the SEC had “discovered” the conduct within the past five years, allowing the SEC to seek enormous monetary penalties. The Court halted this practice in Gabelli, and ever since, the SEC has instead sought increasing amounts in disgorgement with no statute of limitations to compensate for the cap on civil penalties. As a result, Kokesh asks whether this statute of limitations also applies to the boundless disgorgement amounts now being sought by the SEC.
Having submitted an amicus curiae brief (i.e., a friend-of-the-court brief) in Kokesh on behalf of businessman Mark Cuban, Brown Rudnick sent associate members of the brief-drafting team to attend the oral argument and hear the reactions of the Court—including those of Justice Gorsuch in his second day on the bench. Not only did Brown Rudnick’s amicus curiae brief raise the question central to the morning’s oral arguments (and repeatedly referenced by the Justices) regarding whether the SEC has authority to order disgorgement, but it has also provided the Court with a way to answer that question, chiefly relying on the Court’s own precedent in Great-West Life & Annuity Insurance Co. v. Knudson and Grupo Mexicano de Desarrollo S.A. v. Alliance Bond Fund, Inc.
In Kokesh v. SEC, a jury found petitioner (Charles R. Kokesh) liable for violating the securities laws by misappropriating funds from four companies through conduct that stretched back more than five years before the SEC filed a complaint against him. The SEC sought and obtained a disgorgement order of $34.9 million and civil penalties of only $2.4 million. Most of the disgorgement amount was outside of the statute of limitations.
Federal law does not provide the SEC with express authority to order disgorgement. Thus, without any statutory authority regarding disgorgement or a statute of limitations for disgorgement, the general federal five-year statute of limitations will only apply if disgorgement functions as a fine, penalty, or forfeiture. At oral argument, counsel for the petitioner argued that disgorgement is, at a minimum, forfeiture, and so the statute of limitations applies. The SEC argued that disgorgement is not a fine, penalty, or forfeiture, and so the statute of limitations does not apply. To solve the dispute, the Justices asked questions that focused on the source of the SEC’s authority to order disgorgement. Justice Kennedy bluntly asked if “it [is] clear that the district court has statutory authority to do this?”; Chief Justice Roberts later stated that “[o]ne reason we have this problem is that the SEC devised this remedy or relied on this remedy without any support from Congress”; and Justice Gorsuch commented that it seemed that the SEC had simply “ma[de] it up.”
Consistent with the discussion at oral argument, the amicus curiae brief filed by Brown Rudnick on behalf of Mr. Cuban asked where the SEC found its authority to seek disgorgement. Our answer: the SEC does not have the authority to order disgorgement. Instead, the authority to order disgorgement can only stem from two sources: the SEC has the federal statutory authority to order only (1) civil penalties and/or (2) equitable relief. Clearly, if disgorgement is a civil penalty, then the statute of limitations applies under its terms. If it is not a civil penalty must then be equitable relief, since if it is not one it must be the other. However, to determine if disgorgement is equitable relief, the Court must apply its own precedent from Great-West. There, the Court held that relief is equitable “where money or property identified as belonging in good conscience to the plaintiff could clearly be traced to particular funds or property in the defendant’s possession. . . . But where the property sought to be recovered or its proceeds have been dissipated so that no product remains” it is not equitable. 534 U.S. 204, 214 (2002). Thus, in the SEC context, where disgorgement is not traceable to “particular funds or property in the defendant’s possession,” it is a civil penalty because the SEC can only seek a civil penalty or equitable relief. Any other equitable relief that is traceable to the “particular funds or property in the defendant’s possession” is likely categorized as forfeiture because its nature as equitable relief for the benefit of investors is consistent with the nature of forfeiture as the recovery of specific property from a wrongdoer.
To answer the question presented to the Court, the approach set forth in this amicus curiae brief would find that the five-year statute of limitations applies to all monetary relief sought by the SEC (even that labeled “disgorgement”) where the money cannot be traced directly to the wrongdoing and thus functions as a civil penalty as opposed to equitable relief. If monetary relief can be traced, then it is equitable and the statute of limitations should apply because equitable relief functions as a forfeiture.
At oral argument, the Court also questioned both the petitioner and the SEC on which characteristics of penalties and forfeitures were or were not shared with disgorgement, whether and to what extent the government treasury or victims of the defendant’s wrongdoing receive the monetary relief taken from the defendant, whether differences exist between disgorgement and restitution, and why the penalty of criminal forfeiture functions similarly to disgorgement but is not treated the same for statute of limitations purposes.
While we are not sure that the Supreme Court will decide this case by reaching whether the SEC has any authority to order disgorgement, rather than just deciding whether disgorgement is or is not a civil penalty or forfeiture, it is clearly an issue that is in the forefront of the Justices’ minds. Simply put, the Court is sharply focused on whether the SEC has the congressional mandate to order disgorgement. Thus, in light of the Court’s hesitation to effortlessly grant the SEC authority to seek this debilitating remedy, it appears that the Court may be currently open to challenges and questions pertaining to the authority, nature, and potentially even the constitutionality of the SEC’s actions.