Risk Management and Crisis Response Blog

U.S. Supreme Court restrains SEC disgorgement powers

Jun 29, 2017 4 MIN READ
Lawrence E. Ritchie

Partner, Disputes, Toronto

Earlier this month, a unanimous Supreme Court of the United States held [PDF] that in SEC enforcement proceedings, claims for disgorgement must be commenced with five years of the date the claim accrued. In Kokesh v. Securities and Exchange Commission, No. 16–529, the SEC commenced an enforcement action in late 2009 in Federal District Court alleging that Charles Kokesh, an owner of two investment-adviser firms, misappropriated US$34.9 million through his firms between 1995 and 2009. The SEC also alleged the filing of false and misleading SEC reports and proxy statements in connection with such misappropriation. 

The SEC sought monetary civil penalties, disgorgement, and an injunction barring Kokesh from future violations. A jury found that Kokesh’s actions violated several securities laws and the District Court held that the 5-year limitation period in 28 U.S.C. § 2462 applied to the monetary civil penalties. In order to apply the limitation period to disgorgement, the remedy sought must qualify as either a fine, penalty or forfeiture pursuant to the provisions of the statute. The District Court decided (and the Tenth Circuit affirmed) that disgorgement is not a fine, penalty or forfeiture within the meaning of the statute and as such, is not subject to the 5-year limitation period. The lower courts thus ordered disgorgement of US$34.9 million and a civil penalty of US$2.4 million which represented the amount of funds that Kokesh had received during the five-year limitation period.

In contrast, the Supreme Court of the United States decided that disgorgement constitutes a “penalty”. The U.S. Supreme Court held the following:

SEC disgorgement thus 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. The 5-year statute of limitations in §2462 therefore applies when the SEC seeks disgorgement.

The Supreme Court confined its reasons to the limitation period on disgorgement, and explicitly refrained from giving an opinion on whether courts have authority to order disgorgement in SEC enforcement proceedings or whether courts have properly applied disgorgement principles in this context.

As a result of the Supreme Court’s decision, Kokesh does not face a US$34.9 million exposure. Rather, considering that $29.9 million resulted from violations outside the limitations period, Kokesh now faces a US$5 million disgorgement order.

Implications for Canadian market participants

U.S. courts have ordered disgorgement in SEC enforcement proceedings since the 1970’s. In 1990, the U.S. Congress authorized the SEC to seek monetary civil penalties, and in 2013, the U.S. Supreme Court held that the 5-year statute of limitations applies when the SEC seeks statutory monetary penalties (Gabelli v. SEC, 568 U.S. 442, 454 (2013)).

Unlike the United States, there is statutory provision in Ontario for limitation periods on disgorgement claims. A 6-year limitation period applies to certain proceedings under the Ontario Securities Act (the “OSA”) such as those involving monetary sanctions and disgorgement (see section 129.1 of the OSA).  

Historically, the OSC did not have the authority to order the payment of monetary sanctions, including disgorgement. Instead, the Commission relied on more prophylactic remedies within its public interest jurisdiction. In 2003, the OSA was amended to permit the Commission (as a tribunal) to order a respondent to pay an administrative penalty or disgorgement of monies directly earned by the conduct, where non-compliance with securities law is shown. Initially, these remedies were used sparingly by the Commission, since the primary focus of its remedial jurisdiction is to protect investors and the markets from harm, and not to punish. However, specific and general deterrence has always been a factor in regulators’ considerations, and the monetary sanction power has been recognized as an important tool to achieving that objective.

Although the U.S. Supreme Court decision signals a limit to the SEC’s powers of disgorgement and reduced financial exposure for current and prospective defendants in SEC proceedings, monetary sanctions imposed by securities regulators continue to be significant. In 2016, the SEC reported [PDF] approximately $2.809 billion ordered for disgorgement and monetary penalties of approximately $1.273 billion.

Notwithstanding this phenomenon, the recent U.S. Supreme Court decision may assist companies north of the border in securities proceedings as the U.S. Supreme Court has clearly held that disgorgement is considered a penalty and not independent of it. This opinion is in direct contrast to the seemingly traditional position of the OSC which aligns more with disgorgement as separate and in addition to other monetary sanctions such as administrative penalties. Considering the recent Supreme Court decision in the U.S., disgorgement as a penalty should be considered by securities regulators in determining an appropriate range for general and specific deterrence instead of as an additional monetary penalty.