BREAKING NEWS: SEC Loses Supreme Court Kokesh Disgorgement Case

June 5, 2017

On June 5, 2017, the United States Supreme Court ("SCt") issued a unanimous Opinion in Kokesh v. Securities and Exchange Commission and reversed the Court of Appeals for the Tenth Circuit.  The Opinion clarifies that SEC enforcement actions seeking disgorgement must be commenced within the five-year statute of limitations set forth in  28 U.S.C. § 2462.


District Court

As set forth in the United States District Court for the District of New Mexico's ("DNM's") "Summary" portion of Securities and Exchange Commission, Plaintiff, v. Charles R. Kokesh, Defendant (Complaint, 09-CV-1021, DNM / October 27, 2009), the Securities and Exchange Commission ("SEC") alleged:

1. From at least 1995 through July 2007, Kokesh systematically misappropriated approximately $45 million from four Commission-registered business development companies ("BDCs")-Technology Funding Medical Partners I; Technology Funding Partners III, L.P.; Technology Funding Partners IV, L.P.; and Technology Funding Partners V, L.P. Kokesh controlled two now-defunct Commission-registered investment-adviser firms, Technology Funding Ltd. ("TFL") and Technology Funding, Inc. ("TFI") (collectively, the "Kokesh Advisers"), which, in turn, controlled and provided investment advice to the BDCs pursuant to advisory contracts. Acting by and through the Kokesh Advisers, Kokesh misappropriated the funds by causing the BDCs to pay illegal distributions, performance fees, and expense reimbursements to the Kokesh Advisers. To conceal the scheme, Kokesh caused the Kokesh Advisers to distribute misleading proxy statements to BDC investors and to file false Commission reports on behalf of the BDCs.

2. By reason of the foregoing, Kokesh violated Section 37 of the Investment Company Act of 1940 ("Investment Company Act") [15 U.S.C. § 80a-36] or, in the alternative, Section 57 of the Investment Company Act [15 U.S.C. § 80a-56] and aided and abetted violations of Sections 13(a) and 14(a) of the Securities Exchange Act of 1934 ("Exchange Act") [15 U.S.C. §§ 78m and 78n] and Rules12b-20, 13a-1, 13a-13, and 14a-9 [17 C.F.R. §§ 240.12b-20, 13a-1, 13a-13, and 14a-9] thereunder and Sections 205, 206(1), and 206(2) of the Investment Advisers Act of 1940 ("Advisers Act") [15 U.S.C. §§ 80b-5, 80b-6(1), and 80b-6(2)].

3. In the interest of protecting the public from any further violations of the federal securities laws, the Commission brings this action against the Defendant, seeking permanent injunctive relief, disgorgement plus prejudgment interest, civil money penalties, and all other equitable and ancillary relief deemed necessary by the Court.

DNM Jury Verdict

Following a five-day jury trial in November 2014, the jury returned a verdict against Defendant on all claims and DNM enjoined the Defendant from violating federal securities laws, and ordered a $34.9 million disgorgement and payment of $18.1 million in prejudgment interest; and further imposed a $2.4 million civil penalty.

10Cir Appeal

Defendant Kokesh appealed to the United States Court of Appeals for the Tenth Circuit ("10Cir") SEC, Plaintiff/Appellee, v. Charles R. Kokesh, Defendant/Appellant (Opinion, 10Cir, 15-2087 / August 23, 2016):

Defendant appeals, asserting that the court's imposition of the disgorgement and permanent injunction was barred by 28 U.S.C. § 2462, which sets a five-year limitations period for suits "for the enforcement of any civil fine, penalty, or forfeiture." He also argues that the district court erred by precluding him from presenting evidence of attorney and accountant participation to show his lack of knowledge of the misconduct. Exercising jurisdiction under 28 U.S.C. § 1291, we affirm. We hold that both the permanent injunction and the disgorgement order are remedial and not subject to § 2462. And we reject the evidentiary claim.

Page 2 of 10Cir Opinion

SIDE BAR:  

28 U.S.C. Section §2462: Except as otherwise provided by Act of Congress, an action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise, shall not be entertained unless commenced within five years from the date when the claim first accrued if, within the same period, the offender or the property is found within the United States in order that proper service may be made thereon.

Penalty

As to Defendant's argument that the permanent injunction entered against him by DNM was a "penalty," imposed beyond the five-year statute of limitations, 10Cir states:

[W]e fail to see how an order to obey the law is a penalty. Its purpose is not to penalize Defendant; after all, everyone has a duty to obey the law. It is to protect the public by giving Defendant an added incentive to conduct himself in accordance with the securities laws: violating the injunction would subject him to the court's contempt power . . .

Page 6 of the 10Cir Opinion

Future Opportunities

In response to issues of mitigation raised by Defendant, 10Cir found that:

Finally, Defendant argues that in light of his age, insolvency (and meager prospects of recovering from it), and the passage of time since his unlawful conduct, he is unlikely to engage in the conduct for which he is liable here, so the injunction must be intended solely to punish him. He further argues that the SEC did not allege any wrongdoing by him after the Funds and the Advisers were dissolved, so he is being punished for past conduct, as in Johnson. We are not persuaded. If Defendant is not going to engage in securities-related activity, the order does not punish him. And the absence of SEC allegations of recent misconduct did not preclude the district court from finding that he still poses a risk to the public. The court found that Defendant's occupation would "present opportunities for future violations" because of his extensive experience with owning and controlling investment-adviser firms and operating investment companies. Also, noting Defendant's work history, his extravagant lifestyle, and his demeanor, the court expressly rejected his statement that he would not engage in business activity that could present opportunities for future securities-laws violations. These are factual matters and the court did not clearly err in its findings. See Att'y. Gen. of Oklahoma v. Tyson Foods, Inc., 565 F.3d 769, 775-76 (10th Cir. 2009) (factual findings underlying injunction are reviewed for clear error).

Pages 8 - 9 of the 10Cir Opinion

As to Defendant's contention that a disgorgement was imposed beyond the five-year limit, 10Cir declines to characterize that as a "penalty"  because its function is remedial:

Defendant complains that the disgorgement order is punitive because he is being required to disgorge more than he actually gained himself (some of the misappropriated money went to others). But there is nothing punitive about requiring a wrongdoer to pay for all the funds he caused to be improperly diverted to others as well as to himself . . .

Page 10 of the 10Cir Opinion

In response to Defendant's again cited issue of his age and insolvency as factors requiring due consideration, the 10Cir states that:

Defendant also argues that the disgorgement order is punitive because in light of his age (late sixties) and insolvency, there is no prospect of his restoring the gains he 12 received. But the likelihood of the government's recovery is irrelevant to determining whether his disgorgement order is punitive or remedial because it does not change the nature of the sanction. The disgorgement order does not require Defendant to do more than he is capable of.

Pages 11 - 12 of the 10Cir Opinion 

As to the Defendant's assertion that the disgorgement is a forfeiture, 10Cir concedes a split in the circuits on this issue and notes that the 11Cir held that disgorgement is a forfeiture under Section 2462. SEC v. Graham, 823 F.3d 1357 (2016) but ultimately finds:

When the term forfeiture is linked in § 2462 to the undoubtedly punitive actions for a civil fine or penalty, it seems apparent that Congress was contemplating the meaning of forfeiture in this historical sense. The nonpunitive remedy of disgorgement does not fit in that company. See Antonin Scalia & Bryan A. Garner, Reading Law: The Interpretation of Legal Texts ch. 31, 195-98 (2012) ("Associated words bear on one 14 another's meaning (noscitur a sociis)."). In fact, construing a predecessor to § 2462, which imposed a five-year limitations period for a "suit or prosecution for any penalty or forfeiture," the Supreme Court said that "[t]he words 'penalty or forfeiture' in this section refer to something imposed in a punitive way for an infraction of a public law." Meeker v. Lehigh Valley R.R. Co., 236 U.S. 412, 423 (1915).

Pages 13 -14 of the 10Cir Opinion

Finally, as to Defendant's argument that he was not permitted to fully develop his reliance on professionals, 10Cir declined to review his challenge because

[H]is briefs fail to identify specific items of testimony that would have been offered and to state why each would have been relevant. . .

Page 16 of 10Cir Opinion

Petition for Cert

In his Petition for a Writ of Certiorari, Kokesh argued to the United States Supreme Court that: 

This case squarely presents the issue that has divided the circuits. The SEC did not bring its disgorgement claims against Petitioner until 2009, yet the district court entered a $34.9 million disgorgement order based on securities-law violations that occurred as far back as 1995. Pet. App. 3a, 21a. In the Eleventh Circuit, all the SEC's claims that arose before 2004 would be untimely under § 2462, and the SEC has conceded that this rule would preclude all but $5 million of the disgorgement order against Petitioner. Pet. App. 26a-27a. In the decision below, however, the Tenth Circuit expressly disagreed with the Eleventh Circuit and followed the contrary decisions of the First and D.C. Circuits, holding that disgorgement orders are "not subject to § 2462." Pet. App. 2a.

Page 3 of Petition for Cert

In Charles, R. Kokesh, Petitioner, v. SEC, Respondent (Brief for the Respondent, Petition for a Writ of Certiorari), the SEC argued that:  

In the Eleventh Circuit, where the SEC has two regional offices, see U.S. SEC, SEC Regional Offices, https://www.sec.gov/page/sec-regional-offices (last visited Dec. 9, 2016), the Commission is currently impeded by the decision in Graham from obtaining the full disgorgement remedies to which it is entitled. Graham affects SEC enforcement actions filed in nine federal judicial districts, as well as SEC administrative proceedings that are appealed to the Eleventh Circuit. The decision therefore stands as a significant obstacle to national uniformity in administration of the securities laws.

Page 11 of the Respondent's Cert Brief

Cert Granted

On January 13, 2017, the SCt granted cert:

QUESTION PRESENTED: Under 28 U.S.C. § 2462, any "action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise, shall not be entertained unless commenced within five years from the date when the claim first accrued." The question presented is: Does the five-year statute of limitations in 28 U.S.C. § 2462 apply to claims for "disgorgement"?

Syllabus of the SCt Opinion

In Kokesh v. Securities and Exchange Commission (Opinion, SCt, No. 16-529 ; 581 U. S. ____ (2017) / June 5, 2017), a unanimous court found SEC disgorgement to a penalty and, as such, was subject to the five-year limitation in  U.S.C. § 2462. As stated in the Opinion's  Syllabus:

The Securities and Exchange Commission (SEC or Commission) possesses authority to investigate violations of federal securities laws and to commence enforcement actions in federal district court if its investigations uncover evidence of wrongdoing. Initially, the Commission's statutory authority in enforcement actions was limited to seeking an injunction barring future violations. Beginning in the 1970's, federal district courts, at the request of the Commission, began ordering disgorgement in SEC enforcement proceedings. Although Congress has since authorized the Commission to seek monetary civil penalties, the Commission has continued to seek disgorgement. This Court has held that 28 U. S. C. §2462, which establishes a 5-year limitations period for "an action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture," applies when the Commission seeks monetary civil penalties. See Gabelli v. SEC, 568 U. S. 442, 454.

In 2009, the Commission brought an enforcement action, alleging that petitioner Charles Kokesh violated various securities laws by concealing the misappropriation of $34.9 million from four business-development companies from 1995 to 2009. The Commission sought monetary civil penalties, disgorgement, and an injunction barring Kokesh from future violations. After a jury found that Kokesh's actions violated several securities laws, the District Court determined that §2462's 5-year limitations period applied to the monetary civil penalties. With respect to the $34.9 million disgorgement judgment, however, the court concluded that §2462 did not apply because disgorgement is not a "penalty" within the meaning of the statute. The Tenth Circuit affirmed, holding that disgorgement was neither a  penalty nor a forfeiture.

Held: Because SEC disgorgement operates as a penalty under §2462, any claim for disgorgement in an SEC enforcement action must be commenced within five years of the date the claim accrued. Pp. 5-11.

(a) The definition of "penalty" as a "punishment, whether corporal or pecuniary, imposed and enforced by the State, for a crime or offen[s]e against its laws," Huntington v. Attrill, 146 U. S. 657, 667, gives rise to two principles. First, whether a sanction represents a penalty turns in part on "whether the wrong sought to be redressed is a wrong to the public, or a wrong to the individual." Id., at 668. Second, a pecuniary sanction operates as a penalty if it is sought "for the purpose of punishment, and to deter others from offending in like manner" rather than to compensate victims. Ibid. This Court has applied these principles in construing the term "penalty," holding, e.g., that a statute providing a compensatory remedy for a private wrong did not impose a "penalty," Brady v. Daly, 175 U. S. 148, 154. Pp. 5-7.

(b) The application of these principles here readily demonstrates that SEC disgorgement constitutes a penalty within the meaning of §2462. First, SEC disgorgement is imposed by the courts as a consequence for violating public laws, i.e., a violation committed against the United States rather than an aggrieved individual. Second, SEC disgorgement is imposed for punitive purposes. Sanctions imposed for the purpose of deterring infractions of public laws are inherently punitive because "deterrence [is] not [a] legitimate nonpunitive governmental objectiv[e]." Bell v. Wolfish, 441 U. S. 520, 539, n. 20. Finally, SEC disgorgement is often not compensatory. Disgorged profits are paid to the district courts, which have discretion to determine how the money will be distributed. They may distribute the funds to victims, but no statute commands them to do so. When an individual is made to pay a noncompensatory sanction to the government as a consequence of a legal violation, the payment operates as a penalty. See Porter v. Warner Holding Co., 328 U. S. 395, 402. Pp. 7-9.

(c) The Government responds that SEC disgorgement is not punitive but a remedial sanction that operates to restore the status quo. It is not clear, however, that disgorgement simply returns the defendant to the place he would have occupied had he not broken the law. It sometimes exceeds the profits gained as a result of the violation. And, as demonstrated here, SEC disgorgement may be ordered without consideration of a defendant's expenses that reduced the amount of illegal profit. In such cases, disgorgement does not simply restore the status quo; it leaves the defendant worse off and is therefore punitive. Although disgorgement may serve compensatory goals in some cases, "sanctions frequently serve more than one purpose."  Austin v. United States, 509 U. S. 602, 610. Because they "go beyond compensation, are intended to punish, and label defendants wrongdoers" as a consequence of violating public laws, Gabelli, 568 U. S., at 451-452, disgorgement orders represent a penalty and fall within §2462's 5-year limitations period. Pp. 9-11.

834 F. 3d 1158, reversed.  

Bill Singer's Comment

Did you hear that sound? No? Okay, listen a bit more carefully. That's the sound of $34.9 million in disgorgement evaporating. I'm guessing that Kokesh is a lot happier today than the legal team at the SEC. On the other hand, if you also listen carefully, you will hear a fairly loud sucking sound. What's that, you ask? Oh, that's the sound of eight years of legal bills being presented to Kokesh by his legal team for the work from NDM to 10Cir to SCt. I'm not quite sure which of the two sounds is louder but I'm guessing there's not all that much difference.

Finally, I'm not sure if you noticed but the United States Supreme Court actually issued a UNANIMOUS Opinion. Not sure if we'll see that again in this decade, so you might want to print out the ruling and frame it for posterity. 

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