High Court Strikes Blow to SEC Power

Ruling puts limits on government recovery of ill-gotten gains. What boards need to know.

By Eve Tahmincioglu

In a major blow to the Securities and Exchange Commission’s (SEC) enforcement power, the nation’s highest court ruled this week that there are limits on how far back the government can go to recover ill-gotten gains.

The SEC has long taken the position that “disgorgement” – which is the legal term for giving back something you should not have had – is an equitable remedy for fraudsters, explains Dixie L. Johnson, a securities enforcement partner with King & Spalding.

Since the SEC argued disgorgement was not a punishment but merely a remedy for a violation, the agency did not believe it should be limited by the five-year statute of limitations on penalties.

In a unanimous decision by the U.S. Supreme Court, however, the justices said the practice was not equitable and that disgorgement was indeed a penalty and should be subject to the statute of limitations. “Disgorgement in the securities-enforcement context is a ‘penalty,’” the justices wrote, and “must be commenced within five years of the date the claim accrues.”

The case, Kokesh v. SEC, involved Charles Kokesh who owned investment-adviser firms that provided investment advice to business-development companies. In late 2009, the SEC alleged that between 1995 and 2009, Kokesh misappropriated nearly $35 million from the firms. The agency sought disgorgement as a result, in addition to the civil monetary penalties.

What does this pivotal decision mean for directors?

“In more than one respect good news for boards and directors,” maintains Johnson.

Boards, she explains, would rather not deal with legal matters that are five years old or older. “They would much rather, once an issue is identified, deal with it and get it done quickly,” she says.

The ruling, she continues, encourages the SEC staff to move quickly. Quick action is less likely to drag a company’s stock and functioning down. And it also encourages boards to get internal investigations done more quickly and efficiently.

As for past SEC actions and judgments that included disgorgement agreements going back more than five years, she advises boards to look into those cases even if some ended with settlements.  Directors should be asking, she says, “does this ruling provide a path for reopening prior actions?”