US Senate & House Take Up SEC Disgorgement After Kokesh: 2019
Year-In-Review Part 2
Congress took up SEC disgorgement during 2019
In today’s post, I discuss certain developments in 2019
that concern the continued viability of
SEC disgorgement
as a remedy against securities law violators.
These 2019 developments are of great relevance to both
SEC defendants and
SEC whistleblowers alike, and
are worth following as we head into 2020.
For decades it has been accepted that the SEC can seek
disgorgement in court actions.
However, in 2017, the U.S. Supreme Court ruled that SEC
disgorgement is a “penalty” and therefore subject
to a five-year statute of limitations. That case was
Kokesh v. Securities and Exchange Commission, 137 S.
Ct. 1635 (2017).
The SEC estimates that as a result of the Supreme
Court’s Kokesh decision and the five-year
statute of limitations, it has already been prevented from
recovering approximately $1.1 billion from securities law
violators that otherwise might have been returned to harmed
investors.
Following on the heels of the Kokesh case, in 2019
the Supreme Court agreed to hear a different case to decide
whether the SEC even has the authority to seek and obtain
disgorgement at all. (Liu v. SEC, No. 18-1501 (U.S.
2019).)
During 2019, in response to both the Supreme Court’s
Kokesh ruling and its agreeing to hear the
Liu case, both houses of the U.S. Congress introduced
bills to clarify and formalize the SEC’s disgorgement
powers.
First Some Background: What Is The Difference Between SEC
Disgorgement And Civil Restitution?
In an SEC enforcement action, the SEC sues a fraudster on
behalf of the U.S. government for breaking the law, not
because the fraudster swindled the SEC or stole money from the
SEC. Rarely if ever is the SEC the “victim” in a
typical SEC enforcement action.
“Disgorgement” has traditionally referred to
making wrongdoers give up something they got that they are not
entitled to, sometimes referred to as “ill-gotten
gains” or “unjust enrichment”. In an SEC
disgorgement case, if the SEC wins, the court may order the
fraudsters to “disgorge” or turn over their
ill-gotten gains to the SEC.
By contrast, in some private lawsuits, a person (the
plaintiff) might sue a wrongdoer for defrauding them or
stealing from them. In these types of cases, the person (the
plaintiff) is the victim.
In a private lawsuit, if the plaintiff wins, the court may
order the fraudster to make “restitution” or
return the victim’s money or property back to the
victim.
One of the big differences between SEC disgorgement and
restitution is that in restitution the money goes back to the
victim, not to the SEC.
When the SEC wins “disgorgement”, it may put the
money into a fund from which it tries to repay the investors
who lost money in the fraudster’s scam. But what the SEC
got from the court in the first place was disgorgement.
Setting up an investors fund and returning investors’
money to them from out of that fund does not magically
transform the SEC disgorgement that it got from the court into
restitution.
While this “disgorgement” and
“restitution” language may sound like a bunch of
technical legalese, it can have significant ramifications.
Some of those ramifications became apparent as a result of the
Supreme Court’s 2017 Kokesh decision.
According To The U.S. Supreme Court, SEC Disgorgement Is A
Penalty
The US Supreme Court’s Kokesh Opinion
28 U.S.C. § 2462 says that in any “action, suit or
proceeding for the enforcement of any civil fine, penalty, or
forfeiture”, the statue of limitations is five (5)
years.
According to the Supreme Court, when the SEC seeks
disgorgement in an enforcement action, the SEC disgorgement
operates as a “penalty”. Therefore, the Court
said, because SEC disgorgement is a penalty, it falls under 28
U.S.C. § 2462. (Kokesh at 1.)
As a result of that ruling, the SEC has since been required to
bring its disgorgement actions within five years from the date
on which its cause of action accrued.
Implications For SEC Defendants And Securities Attorneys
As a result of the Kokesh decision, the SEC may have
to investigate and file its cases faster than it did before.
The Kokesh ruling gives
securities attorneys another
tool in defending their clients in SEC investigations and
cases. It means that if the SEC takes too long to investigate
and file its case in court, a
securities lawyer might be
able to ask the court to throw out the SEC disgorgement claim
against his or her client.
Furthermore, some securities lawyers have since argued that
SEC disgorgement is a common law equitable remedy not
explicitly authorized by any statute, and therefore the SEC
should not be allowed to pursue disgorgement in court. For
example, compare Jalbert v. SEC, Civ. Action No.
17-12103-FDS (D. Mass. Aug 22, 2018) with
Saad v. SEC, 873 F.3d 297 (D.C. Cir. 2017).
There is even a case before the U.S. Supreme Court right now
asking the Court to rule that the SEC should not be allowed to
seek disgorgement at all, because SEC disgorgement is a
“penalty”. (See Brief for Petitioners
in Liu v. SEC, No. 18-1501 (U.S.), Brief filed on
Dec. 16, 2019.)
While these might be interpreted as potentially positive
developments for
defense lawyers and their
clients, it could also cause them some practical difficulties.
For example, the five-year statute of limitations could lead
the SEC to drive its investigations harder and faster, giving
defendants less time to gather their own evidence and prepare
their defenses, and less ability to delay the moment of truth
if/when the SEC files a case against them.
Faster and harder investigations might also lead to SEC
defendants having less ability to spread their costs and legal
fees out over time. If the SEC conducts its investigations and
brings its cases faster, defendants without insurance coverage
or large up front war chests may find it more of a struggle to
keep up with rapidly mounting legal costs during the
SEC’s accelerated investigations.
Implications For SEC Whistleblowers And Whistleblower
Attorneys
The five-year statute of limitations also has important
implications for SEC
whistleblowers and
SEC whistleblower attorneys.
A former Director of the SEC’s Enforcement Division gave
a speech about the
SEC whistleblower program. In that speech, he stated that whistleblowers should report
their information to the SEC as soon as they learn of
misconduct. In the context of the former Director’s
speech, he was referring to the “unreasonable
delay” factor that can cause the Commission to reduce,
sometimes drastically, the ultimate amount of an
SEC whistleblower award.
[Click
here
to read my post about the former
Director’s speech.]
The former Director’s warning is even more relevant
post-Kokesh. If an SEC whistleblower waits too long
to report a fraud to the SEC, the
SEC might not have enough time to investigate and bring all of
the possible charges against the fraudsters before the five
years runs out.
The five-year statute of limitations on SEC disgorgement, and
its classification as a “penalty”, could have
other very significant implications for whistleblowers and
SEC whistleblower lawyers.
For example, the SEC might not be able to recover in
disgorgement all of the money that investors lost, which means
that the SEC might not be able to return all of the defrauded
investors’ money to them.
This was confirmed on December 10, 2019, when the
SEC’s Chairman testified
before the U.S. Senate Committee on Banking, Housing, and
Urban Affairs about the impact of the Supreme Court’s
Kokesh ruling:
The Supreme Court’s decision in Kokesh v. SEC,
however, has impacted our ability to return funds fraudulently
taken from Main Street investors…. Said simply, the
Kokesh decision has had the anomalous effect of
allowing the most “successful” perpetrators of
fraud — those whose frauds are well-concealed and stretch
beyond the five-year limitations period — to keep their
ill-gotten gains. Since Kokesh was decided, an
estimated $1.1 billion in ill-gotten gains has been
unavailable for possible distribution to harmed investors,
much of which is tied to losses by investors. More recently,
the SEC’s ability to seek disgorgement in any district
court action has been questioned. (Underline added.)
In addition,
SEC whistleblower rewards
are based upon the amount of money that the SEC collects from
the wrongdoers. A large part of that amount consists of the
SEC disgorgement.
If a whistleblower delays too long in reporting to the SEC,
the SEC might not have enough time to investigate and bring as
strong of a case as it otherwise could have if the
whistleblower had reported promptly and given the SEC more
time. If that happens, the amount of the disgorgement that the
SEC is able to collect from the wrongdoers could be
significantly diminished, which could lead to a lower award
for the dilatory SEC whistleblower.
The US House Of Representatives’ Bill On SEC
Disgorgement
The House bill on SEC disgorgement
During 2019, both the U.S. Senate and the U.S. House of
Representatives introduced bills addressing the Supreme
Court’s Kokesh ruling.
On September 17, 2019, the “Investor Protection and
Capital Markets Fairness Act” was
introduced
in the U.S. House of Representatives. (H.R. 4344.) The bill was
co-sponsored
by Representative McAdams and Representative Huizenga.
The bipartisan House bill would authorize the SEC to obtain
disgorgement in any Federal Court action.
The bill also states that SEC disgorgement is not to be
construed as a penalty, civil fine, or forfeiture.
Moreover, the House bill would extend the statute of
limitations in SEC disgorgement actions to fourteen (14) years
after the alleged violation.
During the
debate on the House floor, several U.S. Representatives specifically discussed the
Supreme Court’s Kokesh decision. For example,
Representative Green stated:
In 2017, the Supreme Court, in Kokesh v. SEC, held that the
authority of the Securities and Exchange Commission, SEC, to
recover for investors the wrongful gains of securities law
violators, known as disgorgement, is effectively a penalty.
As a result, the SEC’s authority to obtain
disgorgement is time limited by the Federal statue of
limitations for penalties so that the SEC must bring its
case within 5 years of the violation.This ruling was a boon to white-collar criminals like Bernie
Madoff and Allen Stanford, who are now able to defraud
investors for a decade and keep their profits.Even worse, the SEC is currently in litigation before the
Supreme Court over whether it even has the authority to
obtain disgorgement for investors.
Representative McAdams added, “this legislation seeks to
fix the Kokesh decision and would address the recent case the
Supreme Court agreed to hear about whether the SEC has
disgorgement authority at all”.
On November 18, 2019, the House bill
passed by a vote of 314 – 95, with 21 not voting. The next day it was received in the
U.S. Senate and referred to the Senate’s Committee on
Banking, Housing, and Urban Affairs.
The House vote on SEC disgorgement
The US Senate’s Bill On SEC Disgorgement
The
Senate bill
is called the “Securities Fraud Enforcement and Investor
Compensation Act of 2019”. Senator Warner and Senator
Kennedy co-sponsored the bipartisan bill.
The bill was
introduced
on March 14, 2019 to amend the securities laws by clarifying
that the SEC “may seek disgorgement and restitution as a
result of a violation of the securities laws, to establish the
statue of limitations … and for other purposes”.
The Senate bill on SEC disgorgement
The Senate’s bill would give the SEC the explicit
authority to seek disgorgement “in any action or
proceeding brought by the Commission under any provision of
the securities laws”. The Commission would also be
authorized to seek restitution, in which case the amount of
the disgorgement ordered would be offset by the amount of the
restitution also ordered.
However, under the Senate bill, SEC disgorgement would
continue to be subject to a five-year statute of limitations.
Restitution, on the other hand, would have a ten-year statute
of limitations.
It should be kept in mind, though, that the Senate bill was
introduced approximately eight months before the Senate
received the House’s bill, and almost nine months before
the SEC Chairman’s testimony before the Senate Committee
on Banking, Housing, and Urban Affairs, so it is possible that
the Senate bill could be amended or reconciled with the
House’s bill.
<- For Part 1 of my 2019 Year-In-Review, click
here.
For Part 3 of my 2019 Year-In-Review, click
here. ->
* * *
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