SEC Commissioner Robert J. Jackson Jr. is not shy about expressing his opinions. In fact, as he quipped at the Practising Law Institute’s recent Securities Regulations Institute in New York, he is likely “not long for politics” because of his plain-spoken approach to his job. Commissioner Jackson has publicly criticized what he sees as excessive investment banking fees in connection with middle-market IPOs, raised other significant market structure questions, and, in his keynote address at the PLI event, called on his fellow commissioners to move quickly to finalize the still-unfinished Dodd-Frank Act rulemaking. Congress mandated SEC action in several areas in that statute, including pay versus performance disclosures, compensation clawbacks, and information on employee and director hedging practices, but final resolution is still lingering after eight years.
Given his frequent comments on market structure issues, the top of his wish list for the SEC might seem surprising. According to Commissioner Jackson, if he could have one wish, he would like to see a legislative fix to reverse the U.S. Supreme Court’s decision in Kokesh v. SEC. In Kokesh, the Supreme Court rejected the longstanding SEC position that disgorgement orders are remedial in nature and found that the remedy acted as a penalty. Accordingly, the court held that SEC claims for disgorgement are subject to the five-year statute of limitations in 28 U.S.C. §2462.
Commissioner Jackson told Bloomberg Law at the Securities Regulation Institute that he was frustrated because the ruling precludes the Enforcement Division from recovering millions of dollars that could be returned to harmed investors. As SEC Enforcement Co-Director Steven Peikin told the PLI attendees, just with regard to matters that have already been filed, the decision may cause the division to forego up to $900 million in disgorgement.
Kokesh is significant because disgorgement is a highly effective blunt instrument in the SEC’s enforcement arsenal. Under long-established case law, the SEC only needed to provide a reasonable estimate of a defendant’s ill-gotten gains in order to support a disgorgement order. The burden of proof then effectively shifts to defendants to demonstrate that the SEC figure is not reasonably related to gains from their misconduct. This is a difficult standard for defendants to meet because the SEC is not held to a mathematical degree of precision with regard to their estimates.
The SEC can also reach funds held by so-called relief defendants, third parties who are not necessarily wrongdoers but who are in possession of ill-gotten gains. Multiple wrongdoers may also be found jointly and severally liable to pay disgorged amounts, while penalties are personal and specific to the individual. Defendants with deep pockets often have a particular incentive to settle claims to avoid being left on the hook for the entire disgorgement amount.
Prior to Kokesh, defendants in long-running schemes faced tremendous financial exposure through the disgorgement remedy. After the decision, however, when the meter stops running after five years, the SEC’s bargaining chip suddenly becomes much smaller. In addition, as Joan McKown, a partner in Jones Day’s Washington, D.C., office told the Institute attendees, those charged by the SEC may be less willing to agree to settlements involving disgorgement orders, because the treatment of funds disgorged as penalties may result in adverse tax and insurance consequences.
The ruling also means that the Enforcement Division, in a period of scare resources, both human and financial, must move quickly to discover and prepare cases for filing. This is particularly challenging in instances such as complex and long-running financial frauds, and in Foreign Corrupt Practices Act cases and similar matters requiring the cooperation of foreign entities and governments and access to foreign documents. Co-Enforcement Director Stephanie Avakian said at the PLI event that it is “hard to think of a reason” to bring an old case nearing the end of the limitations period. While there may be some instances where policy reasons call for bringing a case with limited economic recovery, in most cases it is difficult to justify the allocation of resources to aging cases.
The Supreme Court did add a little mystery to the mix with footnote 3 to its unanimous opinion. According to the Court:
Nothing 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. The sole question presented in this case is whether disgorgement, as applied in SEC enforcement actions, is subject to §2462’s limitations period.
While the Supreme Court did not opine on the underlying authority of federal courts to order disgorgement, litigants will no doubt continue to raise the issue. To date, they have met with little success. As a federal district court said in an FTC case in June 2018, “we will not stretch Kokesh beyond its holding and will not read it to prevent the court from granting the well-established equitable relief of disgorgement.”
The Supreme Court spoke authoritatively in Kokesh, when Justice Sotomayor delivered the opinion for a unanimous Court. Similarly, in the 2013 decision in Gabelli v. SEC, another unanimous Court scaled back the Commission’s enforcement authority by holding that the limitations clock on penalty cases begins to run on the commission of the fraud, and not its discovery. In order for the SEC to be able to reach these amounts resulting from misconduct outside the five-year period, a legislative fix will be necessary. In the new Congress, the House may be open to such a suggestion, but it is difficult to imagine that the Senate would agree to an expansion of the agency’s enforcement and remedial powers.
While Kokesh will be a structural hurdle for the SEC to deal with in the long run, the impact of another Supreme Court decision is fading into the status of a bureaucratic annoyance. Kokesh fundamentally changed the way the Enforcement Division must review its case selection approach, but the decision in Lucia v. SEC has largely devolved into a short-term problem of resource allocation.
In Lucia, the high court found that the SEC’s administrative law judges, who were hired through a merit-selection process administered by the Office of Personnel Management, with the final decision made by the SEC’s Chief ALJ, violated the Appointments Clause of the constitution. The decision’s impact is largely limited to Lucia himself, and to the approximately 200 administrative cases pending either before ALJs or the Commission when the Court decided the case. The decision has been a significant burden on the Enforcement Division, as the SEC diverted many cases that would have been heard as administrative proceedings to federal district courts, increasing the required costs, time and resource demands.
In addition, the division must relitigate most of the ALJ cases that were nearing resolution at the SEC review stage before new administrative law judges. Once these cases complete their inexorable march toward closure, however, Lucia will likely fade away as a sharp but distant memory of judicial disruption. Administrative enforcement will likely return to normal, but the division staff may well want to put these remanded cases behind them. Ms. McKown, who prior to joining Jones Day in 2010 was the Enforcement Division’s longest serving Chief Counsel, told the Securities Regulation Institute attendees that settlements in these few resurrected cases may well be priced to move.
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