A key U.S. Securities and Exchange Commission enforcement tool may soon be reined in by the U.S. Supreme Court, or so it seemed after the justices heard arguments Tuesday in the case of a New Mexico investment adviser convicted of fraud over more than two decades.
Before the court was Kokesh v. SEC, which zeroes in on the SEC’s use of “disgorgement”—ordering fraudsters to cough up their ill-gotten gains. The government has raked in billions of dollars through disgorgement—$2.8 billion in 2016 alone—with a portion going to the victims.
At issue is whether disgorgement actually counts as a penalty, a forfeiture, or neither—an important question because federal law requires that penalties or forfeitures be imposed within a five-year statute of limitations.
Lawyers for Charles Kokesh asked the court to include disgorgement under the five-year limit, to prevent the commission from ordering the disgorgement of funds “based on conduct dating back forever,” as Jenner & Block partner Adam Unikowsky put it Tuesday. Kokesh was ordered to pay $35 million in disgorgement for fraudulent acts dating back to 1995.
Critics of expansive SEC power sided with Kokesh in friend of the court briefs, including one from celebrity businessman Mark Cuban, who has tussled with the commission in the past. “When the SEC usurps power that has not been expressly delegated to it by Congress, capital formation is impeded,” Cuban stated in a brief by Stephen Best of Brown Rudnick.
The federal government, by contrast, wants to keep disgorgement outside the five-year limit. So it insisted before the court that engorgement is not a penalty, because it puts the fraudulent actor in the same financial state he or she was in before committing fraud. Disgorgement tells the fraudster, “We’re going to put the world completely back to the way that it should have been, if you hadn’t acted,” assistant to the solicitor general Elaine Goldenberg told the court.
The U.S. Court of Appeals for the Tenth Circuit sided with the SEC in its decision last year, asserting that disgorgement “does not inflict punishment.” Three other circuits have ruled in the opposite way.
Several justices seemed unimpressed by the government’s argument. Justice Elena Kagan, for one, said it seems “commonsensical” to view disgorgement as partly deterrence, and partly punishment, thereby placing it in the category of a penalty. “It’s a little bit artificial to try to tear them apart,” she said.
Goldenberg may have known she was in trouble when Chief Justice John Roberts Jr. read a statement made by John Marshall, his long-ago predecessor, to the effect that “it was utterly repugnant to the genius of our laws to have a penalty remedy without limit.” Wistfully, Roberts added, “Those were the days when you could write something like that and it’s about a statute of limitations.”
Justice Sonia Sotomayor also seemed hostile to the government position, asserting that disgorgement makes someone liable for a fixed money judgment that has to be given up. “How is that not the same as a penalty?” Sotomayor asked.
Drawing a comparison between civil and criminal forfeiture, new Justice Neil Gorsuch said both were “penal in nature.” It was Gorsuch’s second day on the bench, and he was as active as he was on Monday. As he did on Monday, Gorsuch also seemed frustrated that the law was unclear about the disgorgement, leaving the court the task of “just making it up.”