A Tale of Two Supreme Court Cases—'Lucia,' 'Kokesh' and SEC Enforcement

Supreme Court Blog

At the Practising Law Institute’s recent SEC Speaks conference, the Commission’s Enforcement Division confirmed something that I have been kicking around for a while. Bridget Fitzpatrick, the agency's Chief Litigation Counsel, confirmed that the division is routing most of its contested enforcement to federal district courts rather than to its in-house administrative law judges (ALJs) until the U.S. Supreme Court resolves the appoints clause controversy later this year when it decides the case of Lucia v. SEC.

According to Ms. Fitzpatrick, unless the case is of a kind uniquely suited to ALJ adjudication, such as a failure to supervise associated persons in a regulated entity setting, Rule 102(e) cases involving the fitness of attorneys or accountants to practice before the Commission, or cases seeking broker-dealer bars, the division will likely file the matter in court rather than as an administrative claim. If the same remedies are available in court as before an ALJ, Ms. Fitzpatrick indicated that district courts will be the preferred venue for contested litigation until the constitutional status of the agency’s ALJs is resolved.

The decision to litigate a large percentage of enforcement cases in in district court is significant for a number of reasons. Court cases are more expensive to try than in-house proceedings and can take significantly longer to prosecute. The SEC also has a lower winning percentage away from its “home court” tribunals. From a procedural standpoint, defendants in court cases can also challenge the sufficiency of the division’s case at a much earlier stage through a Rule 12(b)(6) motion to dismiss than they can in ALJ cases, and parties charged by the Commission will have access to far more extensive discovery.A quick glance at recent cases brought by the division bears out the points made by Ms. Fitzpatrick.  The SEC sued an investment adviser and its owner in federal district court for operating an alleged "cherry picking" scheme that defrauded the firm's clients. This claim, based on alleged fraudulent conduct by a regulated entity, appears tailor-made for administrative enforcement, but the case ends up in district court due to the appointments clause uncertainty.

The Kokesh Impact

In Kokesh v. SEC, 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. Steven Peikin, co-director of the SEC’s Division of Enforcement, stated at the SEC Speaks conference that the division has had to adapt to the Kokesh ruling. The division has to be mindful of the five-year limitations period, and has to carefully consider the age of the claim in the case selection process. Given that cases must be well-vetted and prepared at the time of filing, Mr. Peikin observed that the division may not be able to pursue disgorgement claims in these instances if the division learns of them late in the limitations period, particularly in complex matters that take time to investigate and unravel.

The SEC is also likely to see other challenges from litigants as a result of Kokesh. As I previously discussed here, there is no express statutory authority for district courts to order disgorgement. Congress  specifically disgorgement orders in SEC administrative actions, but it has taken no such action with regard to the courts, in all likelihood because it saw no need to specifically authorize the remedy when it had been recognized at equity for decades. Similarly, the courts have regularly denied litigant requests for jury trials on disgorgement claims due to their equitable nature. Defendants in district court proceedings are likely to argue based on Kokesh that the SEC lacks the authority to seek disgorgement, and that such orders are legal penalties subject to trial by jury rather than equitable remedies. To date, lower courts have not been receptive to expanding Kokesh beyond a rather narrow limitations reading, but that present reticence will certainly not keep a determined defense bar from trying, particularly in light of the amounts of money at risk.