Will SEC Enforcement Change in the Wake of Supreme Court’s Limitations on Remedies?

Featuring Baker & McKenzie attorneys

• George M. Clarke, partner
• Jason Dimopoulos, associate
• Marc Litt, partner
• Jerome Tomas, partner

The Securities and Exchange Commission (SEC) and the Department of Justice (DOJ) lost a bit of their punch when it comes to extracting money from those who violate securities regulations, thanks to two recent rulings from the U.S. Supreme Court.

In Kokesh v. SEC, the court said the SEC’s disgorgement orders in the case—which generally are intended to make sure wrongdoers do not benefit from their crimes—"go beyond compensation, are intended to punish, and label defendants wrongdoers" who broke the law. That means disgorgement is a penalty, the court held, and penalties are subject to a five-year statute of limitations. The court restricted its ruling to disgorgement "as it is applied in SEC enforcement proceedings." Kokesh v. SEC, 137 S. Ct. 1635, 198 L. Ed. 2d 86, 2017 U.S. LEXIS 3557, 85 U.S.L.W. 4308, Fed. Sec. L. Rep. (CCH) P99,733, 26 Fla. L. Weekly Fed. S 626, 2017 WL 2407471 (U.S. June 5, 2017)

Baker & McKenzie partner George M. Clarke and associate Jason Dimopoulos say that limitation is significant because it "does not affect all other disgorgement-related jurisprudence." They write that "the Court has left open a path for the SEC to continue to use disgorgement and have that use construed instead as an equitable remedy if the SEC can meet the test set forth in Kokesh.

"First," they write, "the SEC can no longer stand in the shoes of the public at large, but must instead act on behalf of the victims and compensate the victims, rather than the United States Treasury, from the disgorgement. In so doing, the SEC may successfully contend that disgorgements reflect mere compensation to aggrieved individuals and are, thus, non-punitive in nature.

"Second, the SEC will have to consider defendants’ expenses in calculating disgorgements.

"Third, the SEC must not use disgorgements to ‘label defendants wrongdoers,’" Clarke and Dimopoulos say.

What might we expect from the SEC in the wake of Kokesh? Baker & McKenzie partners Marc Litt and Jerome Tomas say it remains to be seen, but they anticipate the SEC will speed up pending investigations. "Until that time, Kokesh bars the SEC from continuing to administer disgorgement in its present manner for misconduct extending back more than five years."

Litt and Tomas also note the high court’s recent decision in Honeycutt v. U.S. which held that liability for criminal forfeiture is limited to the property the defendant acquired as a result of their wrongdoing. Under this ruling, the attorneys write, if a conspiracy mastermind obtained $2.9 million, and the co-defendant only actually received $100,000, the forfeiture order for the co-defendant could not exceed $100,000. United States v. Honeycutt, 816 F.3d 362, 2016 U.S. App. LEXIS 4104, 2016 FED App. 0056P (6th Cir.) (6th Cir. Tenn. Mar. 4, 2016)

"These two cases together have imposed significant limits on previously relatively unconstrained power of the government to seek financial penalties through disgorgement (by the SEC) and criminal forfeiture (by the DOJ)," Litt and Tomas write.

They say the Kokesh ruling, is very significant for pending investigations.

"Literally overnight," write Litt and Tomas, the SEC is now blocked from seeking countless years of disgorgement from companies and individuals in cases involving dated conduct. Moving forward, we believe the SEC will look to move investigations along quicker and as a result, companies conducting internal investigations may face increasing pressure to make disclosures to the SEC and DOJ sooner than they had in the past. Once an investigation has commenced, we expect that the SEC will be more anxious to rapidly collect evidence, including documents, emails, interviews and testimony."

The attorneys also say they expect the SEC to be more aggressive in seeking tolling agreements when it begins an investigation, which they say "will be a strong factor in determining cooperation credit." They say they don’t expect the SEC to give up on disgorgement, but, given how the Supreme Court criticized how the Commission "limits a defendant’s ability to offset expenses in calculating disgorgement, it will be worth watching whether the SEC becomes more flexible in allowing expense offsets." They also anticipate more litigation over what constitutes a violation for purposes of the SEC’s ability to seek per-violation civil penalties.

You can read more of what these attorneys had to say by following these links:

• http://www.bakermckenzie.com/en/insight/publications/2017/06/kokesh-v-sec/
• http://www.bakermckenzie.com/en/insight/publications/2017/06/supreme-court-limits