SEC Power to Recoup Illegal Profits Curbed by U.S. Supreme Court

SEC Power to Recoup Illegal Profits Curbed by U.S. Supreme Court

In early June, a unanimous Supreme Court handed down its ruling on whether “disgorgement,” or the repayment of ill-gotten gains, is subject to a statute of limitations. The court ruled that it is, and this has broad implications for any person or organization investigated by the Securities and Exchange Commission, experts say.

“This will be more advantageous to all proposed SEC defendants, including Wall Street,” says Marc Powers, leader of BakerHostetler‘s securities litigation and regulatory enforcement practice and its hedge fund industry practice. “They will be able to sleep at night, not fearing the SEC and forever looking over their shoulders for their questionable conduct in the securities markets.”

Here’s what you need to know about the ruling.

The Case

Charles Kokesh was found to have misappropriated funds from four investment companies. He was ordered to pay a civil penalty and disgorgement, dating back to 1995. Kokesh argued that the SEC should collect only $5 million in disgorgement, the amount he accumulated in the five years before the SEC brought its complaint. There is a five-year statute of limitations on penalties, and Kokesh argued that a disgorgement was similar to a penalty, so it should fall under the five-year rule.

The Ruling

In Kokesh v SEC, the Supreme Court unanimously held that in SEC enforcement actions, disgorgement operates as a penalty and is therefore subject to the five-year period, says attorney Dmitriy Ishimbayev.  “After Kokesh, the SEC can only use disgorgement to obtain money from defendants for claims that are brought within the five-year limitations period,” he says.

As Powers notes, “This is the second major setback for the SEC in the last five years.” In 2013 the Supreme Court held that the SEC cannot seek penalties for conduct more than five years old.

The Result

The SEC routinely employs the threat of disgorgement to persuade defendants and targets of SEC enforcement investigations to settle allegations of securities law violations, says Fabio Leonardi of Pillsbury Winthrop Shaw Pittman. “Indeed, in investment adviser fraud cases, the SEC has generally been able to extract large disgorgement amounts from companies and individuals that have settled allegations of Securities Exchange Act, Investment Advisers Act and Investment Company Act violations,” he says. “Moreover, in numerous enforcement actions against investment advisers, the SEC has often taken an expansive view of what constitutes the ill-gotten gains it seeks to disgorge. Thus, in limiting the SEC’s ability to seek disgorgement to the limitations period, the Supreme Court has effectively curbed the SEC’s negotiating power.”

The ruling will likely force the SEC to move more quickly on cases, Powers says. “That is good for everyone. Because of the cloud of an SEC investigation over a possible defendant, it should come to as fast a conclusion as possible,” he says. In addition, faster enforcement actions will have fresher facts and evidence, not faded memories and missing documents, he says.

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