SEC Disgorgement Constitutes a Penalty – How Far Will the Argument Go?

By: Carol Gerner

On June 5, 2017, Justice Sotomayor delivered the unanimous opinion in Kokesh v. SEC, 2017 U.S. LEXIS 3557 (June 5, 2017), holding that disgorgement collected by the Securities and Exchange Commission (SEC) constitutes a “penalty” under 28 U.S.C. §2462,[1] and thus subject to a five-year statute of limitations. In a relatively short, but thorough opinion, the Court overturned a Tenth Circuit decision finding that disgorgement was not properly characterized as a penalty within the federal statute and therefore not subject to the limitation period.

In the underlying case, the SEC sought civil monetary penalties, disgorgement, and an injunction barring Charles Kokesh, the owner of two investment-adviser firms, from violating securities laws in the future. After a 5-day trial, a jury found that Kokesh’s actions violated various securities laws. As to civil penalties, the district court determined that the 5-year limitations period precluded any penalties for misappropriation of funds prior to October 27, 2004 (i.e., prior to the date the Commission filed the complaint), but ordered a civil penalty of $2.3 million for the amounts Kokesh received during the limitations period. Regarding the Commission’s request for a $34.9 million disgorgement judgement ($29.9 million of which resulted from violations outside the limitations period) the court agreed with the Commission that because disgorgement was not a “penalty ” within the meaning of §2462, no limitation period applied. The court thereafter entered a disgorgement judgment in the amount of $34.9 million. On appeal, the Tenth Circuit affirmed, agreeing with the district court that disgorgement was not a penalty or a forfeiture, and therefore, the statute of limitations did not apply to the SEC’s disgorgement claims.

Thereafter, the Supreme Court granted certiorari to resolve disagreement among the Circuits regarding whether disgorgement claims in SEC proceedings were subject to the 5-year limitations period.  Applying legal principles governing the interpretation and meaning of a “penalty,” the court articulated three reasons why it concluded that SEC disgorgement constituted a penalty within the meaning of §2462. First, SEC disgorgement is imposed by the courts as a consequence for violating “public laws.” Second, SEC disgorgement is imposed for punitive purposes. Third, in many cases SEC disgorgement is not compensatory. Thus, the Court reasoned that SEC disgorgement “bears all the hallmarks of a penalty: It is imposed as a consequence of violating a public law and it is intended to deter, not to compensate.”

Since the Kokesh decision arose out of an SEC enforcement action, its impact will likely be seen in how the SEC chooses its targets for future enforcement actions. It remains to be seen, however, whether similar arguments that disgorgement is a penalty will be raised in other contexts. For example, the issue is often raised in insurance coverage disputes between insurers and insureds, as claims seeking disgorgement are generally not covered. Whether courts will be receptive to similar arguments in other contexts is an area insurers and their counsel should continue to monitor.

[1] 28 U.S.C. §2462, applies to “any action, suit or proceeding for the enforcement of any civil fine, penalty or forfeiture, pecuniary of otherwise.”
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