RIA Compliance Blog
On January 13, 2017, the United States Supreme Court agreed to examine a case involving the Securities and Exchange Commission’s (“SEC’s”) ability to seek disgorgement of ill-gotten gains in fraud cases, including fraud cases involving investment advisers. The case, Kokesh v. SEC, raises the issue of whether claims for disgorgement are subject to a five-year statute of limitations on civil penalties. Oral arguments were heard by the Supreme Court in April.
The underlying case involves a New Mexico investment adviser named Charles R. Kokesh (“Kokesh”), who acted as an investment adviser to various funds organized as limited partnerships. The SEC filed suit against Kokesh, alleging that from 1995 through 2006, Kokesh ordered the funds’ treasurer to take money from the funds to pay various expenses, including $23.8 million for salaries and bonuses to the funds’ officers, including Kokesh, $5 million for office rent, and $6.1 million characterized as “tax distributions.” According to the Tenth Circuit, the payments violated the funds’ contracts because the contracts did not permit payments for salaries of the funds’ controlling persons, including Kokesh, until 2000. The contracts also did not address bonus payments, and they only permitted payment of tax obligations if certain prerequisites were present. A jury found that Kokesh violated the Investment Advisers Act of 1940, among other statutes, and the District Court ordered Kokesh to pay a $2.4 million civil penalty, plus disgorgement of $35 million based on amounts going back to 1995.
In response, Kokesh appealed to the Tenth Circuit Court of Appeals, arguing that the disgorgement was a penalty subject to a five-year statute of limitations under 28 U.S.C. § 2462. The SEC argued that the disgorgement was remedial and not punitive, and therefore not a penalty subject to the statute of limitations. The Tenth Circuit agreed with the SEC and held that disgorgement was not a penalty.
In reaching this decision, the Tenth Circuit became the third United States Court of Appeals to hold that disgorgement is not a penalty subject to the five-year statute of limitations, the other two being the D.C. Circuit and the First Circuit. However, SEC v. Graham, an Eleventh Circuit decision, came to the opposite conclusion. The Graham case held that disgorgement was a form of forfeiture, which is subject to the five-year statute of limitations. As a result, there is a split in the circuits over whether disgorgement is subject to the five-year statute of limitations. The Supreme Court has agreed to hear the case to resolve the split and establish a uniform rule in regards to the statute of limitations’ applicability to disgorgement cases.
On April 18, 2017, the SEC heard an oral argument in the Kokesh case. The justices expressed concern over whether the SEC has the power to ask for and impose disgorgement against wrongdoers. There is no known statutory authority that permits the SEC to seek disgorgement. Moreover, the SEC has not given guidance on how to implement a disgorgement remedy. Some of the justices also seemed to be of the opinion that whether disgorgement is a penalty or forfeiture depends on what is done with the ill-gotten proceeds. For example, Justice Kagan and Justice Ginsburg expressed the view that if the government keeps the proceeds, disgorgement should be considered a penalty and subject to the statute of limitations. If the proceeds are returned to the victims, disgorgement should be considered a compensatory remedy and not subject to the statute of limitations. It is expected that the Supreme Court will issue a decision in this case on June 30, 2017.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others. Our regulatory practice group assists financial service providers with complex issues that arise in the course of their business, including compliance with federal and state laws and rules. Please visit our website for more information.