More than six months have passed since the Supreme Court held, in Kokesh v. SEC, 137 S. Ct. 1635 (2017), that the Securities and Exchange Commission’s (SEC or Commission) disgorgement power constitutes a penalty subject to a five-year statute of limitations.  As expected, the Supreme Court’s holding on the penal nature of SEC disgorgement has spurred  defendants to seek to broaden its application to other contexts.  Most fundamentally, this includes whether the SEC has the statutory authority to seek disgorgement at all.  To date, courts have mostly turned aside these challenges.  At the same time, however, litigants have grown more creative in their attacks, evidenced by a class action suit seeking reimbursement of nearly $15 billion from the SEC of certain historical disgorgement payments.[1]

Below, we look back at how the lower courts have handled post-Kokesh challenges to the SEC’s disgorgement power and other so-called equitable remedies to date. 

Early Challenges to Regulators’ Power to Seek Disgorgement

The most straightforward and fundamental challenge arising out of Kokesh—that all disgorgement even for conduct within the limitations period is tantamount to a penalty and thus is not within courts’ equity powers—has thus far been turned away.[2]  The Supreme Court had opened the door to this argument with its hostility to the SEC’s characterization of aged disgorgement as equitable, coupled with a footnote stating that “[n]othing in this opinion should be interpreted as an opinion on whether courts possess authority to order disgorgement in SEC enforcement proceedings or on whether courts have properly applied disgorgement principles in this context.”  137 S. Ct. at 1642 n.3 (emphasis added).  Indeed, during oral argument, two justices from different ends of the political spectrum—Justices Gorsuch and Sotomayor—questioned whether the SEC had the requisite statutory authority to seek disgorgement in district court.

Not surprisingly, defendants have pressed this challenge, essentially arguing that the writing is on the wall and that courts should take the next natural step and reject the disgorgement remedy altogether.  However, to date, every court to directly consider the issue has refused to roll back four decades of precedent finding that the SEC has the equitable power to seek disgorgement on the basis of a single footnote that itself expressly disclaimed the majority’s intention to broaden Kokesh’s holding.  See e.g.SEC v. Sample, 3:14-CV-1218-B, 2017 WL 5569873 at *2 (N.D. Tx. Nov. 20, 2017) (“Kokesh had no effect on how courts apply disgorgement principles.”); SEC v. Jammin Java Corp., 15 civ. 08921 (SVW) (MRWx), 2017 WL 4286180, at *3 (C.D. Cal. Sept. 14, 2017) (“As it presently stands, Kokesh is best seen as a decision clarifying the statutory scope of § 2462, rather than one redefining the essential attributes of disgorgement.”); CFTC v. Reisinger, No. 11-CV-08567, 2017 WL 4164197, at *1 (N.D. Ill. Sept. 19, 2017) (“The court declines Reisinger’s invitation to abrogate this text [of the Commodity’s Exchange Act] based on footnote three of Kokesh, which does not decide anything.”); FTC v. J. Williams Enterprises, LLC, 16 civ. 2123 (ORL) (DCI), 2017 WL 4776669, at *2 (M.D. Fla. Oct. 23, 2017) (“The Supreme Court’s deliberate avoidance of this different, if potentially analogous, issue provides no basis for this Court to disregard decades of precedent.”).  Given the centrality of disgorgement to the SEC’s enforcement mechanism,[3] and the clear language in Kokesh that the Supreme Court was not holding that disgorgement itself was unavailable, it is not surprising that the first wave of cases have held the line against attempts to extinguish the disgorgement remedy entirely.

Cracks In the Disgorgement Façade?

Despite these cases, developments have not been universally positive for the SEC.  For one thing, a number of district courts and appellate judges have been willing at least to acknowledge questions around the viability of the SEC’s disgorgement powers given the Kokesh footnote.  See Osborn v. Griffin, 865 F.3d 417, 470 n.1 (6th Cir. 2017) (Merritt, J. dissenting) (noting that the Supreme Court has questioned the viability of the SEC’s disgorgement powers); United States v. Latorella, 2017 WL 2785413, at *4 (D. Mass. June 27, 2017) (same); see also SEC v. Amerindo Investment Advisors, Inc., 05 civ. 5231 (RJS) 2017 WL 3017504, at *5 (S.D.N.Y. July 14, 2017) (in denying a vacatur request, the Court noted that it “relied on precedents that might subsequently have been abrogated by the Supreme Court in Kokesh”).

Equally important, other remedies historically categorized by the courts and the SEC as “equitable”, have come under fire because of Kokesh.  For example, one court has extended the five-year statute of limitations now imposed on SEC disgorgement to an action seeking both an “obey-the-law” injunction and an industry bar.  SEC v. Gentile, 16 civ. 1619 (JLL), 2017 WL 6371301 (D.N.J. Dec. 13, 2017).  And, in perhaps the most significant post-Kokesh development, the D.C. Court of Appeals recently remanded a case back to the Commission, instructing it to determine whether a lifetime industry ban is “excessive or oppressive”  and thus a penalty in light of KokeshSaad v. SEC, No. 15-1430, 2017 WL 4557511, at *1 (D.C. Cir. Oct. 13, 2017).  A separate concurrence revealed the view of at least one appellate judge that a lifetime ban probably is an impermissible penalty in view of KokeshId. at *6  (Kavanaugh, J. concurring) (“After the Supreme Court’s decision in Kokesh . . . our precedents characterizing expulsions or suspensions as remedial are no longer good law.”).  By contrast, in SEC v. Collyard, 861 F.3d 760, 764 (8th Cir. 2017), the Eighth Circuit rejected a challenge to the imposition of injunctive relief on Kokesh grounds.  Even there, however, the court left open the possibility that injunctions could, under the right circumstances, constitute penalties, simply noting that was not the case here.  Id. (“This court need not resolve whether an injunction can be a § 2462 ‘penalty.’  Under the facts here, the district court’s injunction is not a ‘penalty’”.).[4]

And other fissures in the SEC’s enforcement regime have been highlighted by the Kokesh decision, reaching beyond the mere application of the five-year limitation period.  At least one court has held that the use of the federal underpayment rate—a measure long used by the SEC to calculate prejudgment interest on disgorgement awards—“would be impermissibly punitive” under KokeshAmerindo Investment Advisors, Inc., 2017 WL 3017504, at *5.

The $15 Billion Dollar Question

Most of the cases addressing Kokesh have involved SEC defendants arguing that the case limits the regulator’s use of disgorgement prospectively.  However, this past fall private plaintiffs launched a much more aggressive salvo in the form of a class action arguing that certain historical awards are also at issue.  Jalbert v. SEC, 17-cv-12103 (D. MA. Oct. 26, 2017), ECF. 1.  The Jalbert plaintiffs argue that—because (1) the SEC can only collect penalties when specifically authorized by statute and (2) Kokesh held that disgorgement, which is not specifically authorized by statute, is a penalty—the SEC must return $14.9 billion in disgorgement that it has collected over the past six years.

Courts have been awarding disgorgement as an equitable remedy since the 1970s, on the assumption that securities laws provide courts with equity jurisdiction.  E.g., SEC v. Texas Gulf Sulphur Co., 446 F.2d 1301, 1308 (2d Cir. 1971).  Thus, plaintiffs are correct that there is no explicit statutory authorization for district court disgorgement.[5]  However, the SEC may argue that, in providing the Commission with greater enforcement tools, Congress assumed that the district court’s ability to grant disgorgement was settled as various provisions of the federal securities laws expressly refer to the SEC’s disgorgement power.  For example, after decades of courts ordering disgorgement in SEC actions, in 2002 Sarbanes-Oxley amended the securities laws to permit the creation of Fair Funds to reimburse victims with such collected monies.  15 U.S.C. § 7246.  Similarly, Sarbanes-Oxley explicitly authorizes the SEC to pursue in federal courts “any equitable relief that may be appropriate or necessary for the protection of investors.”  15 U.S.C. § 78u-6.

* * *

Half a year is too soon to draw firm conclusions about the future of SEC disgorgement.  Nonetheless, the landscape is changing rapidly in this area.  Securities practitioners are well-advised to stay on top of legal developments as they represent clients before the agency as the second half of 2017 alone has revealed significant areas of potential danger for the SEC’s enforcement program arising from the Kokesh decision.  Going forward, expect the SEC to pick its battles over remedies carefully because any extension of Kokesh to other enforcement remedies like industry bars or injunctions—let alone to the concept of disgorgement itself—would deal a devastating blow to the Enforcement Division.  And, at least in the near-term, it seems unlikely that Congress would ride to the SEC’s rescue to restore the judicial abrogation of any such authority.

[1] See Jalbert v. SEC, 17-cv-12103 (D. MA. Oct. 26, 2017), ECF. 1

[2] Although rejected by the courts, the IRS recently issued guidance clarifying that, in light of Kokesh, disgorgement payments made as a result of securities laws’ violations are not deductible.  IRS CCA 201748008, 2017 WL 5957033 (Nov. 17, 2017)

[3] For example in 2017, the SEC’s obtained total disgorgement awards worth more than three times the amounts of its obtained civil penalties.  SEC Division of Enforcement Annual Report 2017  (Nov. 15, 2017) at 7 (reporting disgorgement orders of $2.9 billion and civil penalties of $0.8 billion for fiscal year 2017).

[4] Even before Kokesh, the D.C. Circuit had determined that certain equitable remedies could constitute a “penalty” under 28 U.S.C. § 2462.  See Johnson v. SEC, 87 F.3d 484 (D.C. Cir. 1996).

[5] This is not the case in SEC Administrative Proceedings, however.  As part of the Securities Enforcement Remedies and Penny Stock Reform Act, Congress expressly added a provision allowing the SEC to enter disgorgement orders in administrative proceedings.  15 U.S.C. § 78u–2(e).