Charles R. Kokesh v. Securities and Exchange Commission

Issues 

Does the five-year statute of limitations in 28 U.S.C. § 2462 apply when the Securities and Exchange Commission compels offenders to disgorge the proceeds of their illegal activity?

Oral argument: 
April 18, 2017

In this case, the Supreme Court will decide whether the five-year statute of limitations on forfeitures and penalties in 28 U.S.C. § 2462 applies when the Securities and Exchange Commission (“SEC”) directs a wrongdoer to surrender proceeds stemming from his illegal activity (“disgorgement claims”). Petitioner Charles R. Kokesh argues that § 2462 applies to SEC disgorgement claims because these claims fell within the ordinary meaning of “forfeiture” at the time Congress enacted the statute. In addition, Kokesh contends that § 2462 applies because disgorgement claims are in part to punish the wrongdoer and are therefore penalties. Respondent SEC counters that disgorgement claims are not forfeitures under § 2462 because the term “forfeiture” was only intended to include procedures to take tangible property when Congress enacted the statute. The SEC also argues that disgorgement claims are not penalties because they do not make wrongdoers worse off financially than they would have been if they did not violate the law. This case will resolve a circuit split regarding whether § 2462’s statute of limitations applies to SEC disgorgement claims. In doing so, this case will also determine whether the SEC can enforce U.S. securities laws through disgorgement orders without regard to when the alleged violation occurred.

Questions as Framed for the Court by the Parties 

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”?

Facts 

In 2009, the Securities and Exchange Commission (“SEC”) brought an enforcement action against Charles R. Kokesh, alleging that two investment advisory firms (“Advisers”) that he owned had mishandled the money of four clients (“Funds”). The SEC claimed that, from 1995 to 2006, Kokesh had violated the terms of the Advisers’ contracts with the Funds and breached his fiduciary duty to the Funds by directing the Advisers to collect payments from the Funds “that were not expressly specified” in the contracts. The SEC asserted that Kokesh had ordered the Advisers to route $34.9 million of the Funds’ assets to cover the operational expenses of the Advisers, including salaries, bonuses, tax distributions, and rent. The SEC also alleged that Kokesh diverted the Funds’ money for his personal use, such as to maintain his “extravagant lifestyle.”

The district court found Kokesh guilty of “misappropriating” the Funds’ money and thereby violating the Investment Company Act of 1940, the Investment Advisers Act, and the Exchange Act of 1934. The district court found that the Advisers’ amendments to the contracts in 2000, to include more flexible means of allocating money, failed to mitigate the fraud. As such, the district court ordered Kokesh to pay a penalty of $2.4 million, equivalent to what he had personally received as a result of the fraud within 28 U.S.C. § 2462’s five-year statute of limitations. Under the district court’s initial calculation of the penalty, Kokesh was personally responsible for only $2.4 million. However, the SEC sought to recover the full $34.9 million of misappropriated money (plus interest) from Kokesh under the damages theory of disgorgement, arguing that Kokesh had been unjustly enriched from the fraud and that the statute of limitations should not apply. The district court agreed with the SEC and ordered Kokesh to pay $34.9 million in disgorgement, plus $18 million in interest.

On appeal, the Tenth Circuit affirmed. The Tenth Circuit ruled that disgorgement was a proper estimate of damages as it was neither a “penalty” nor “forfeiture,” and thus was not subject to the statute of limitations in § 2462. The Tenth Circuit also held that if § 2462 is ambiguous as to the proper measure of damages, then the court should resolve that ambiguity in favor of the SEC. The United States Supreme Court granted certiorari on January 13, 2017.

Analysis 

DO DISGORGEMENT CLAIMS CONSTITUTE “FORFEITURES”?

Kokesh argues that the five-year statute of limitations in 28 U.S.C. § 2462 applies to Securities and Exchange Commission (“SEC”) disgorgement claims because these claims fall within the term “forfeiture” in the statute. Kokesh first contends that, based on precedent, the Supreme Court should interpret the term “forfeiture” by looking at its ordinary meaning at the time that Congress enacted § 2462. Kokesh accordingly invokes the 1828 dictionary definition of forfeiture—“the losing of some right . . . or effects, by an offense, crime, breach of condition or other act”—and argues that this definition includes SEC disgorgement orders because they are losses of effects due to an offense, breach of condition, or other act. Kokesh also invokes Congress’s use of “forfeiture” in other statutes it enacted around the same time as § 2462 to argue that legislators had this definition in mind when they legislated. Kokesh contends that although disgorgement did not exist until the 1970s, it is still a form of forfeiture because Congress has called other new remedies “forfeitures” and did not limit § 2462 to the specific forms of forfeiture that existed in 1839, and because early statutes included mechanisms that achieved the same results as SEC disgorgement claims. In addition, Kokesh argues that the Tenth Circuit’s holding—that disgorgement claims do not fall within the term “forfeiture” because it historically only included procedures to take tangible property—is incorrect because the U.S. Code section immediately preceding § 2462 discusses forfeitures of money rather than tangible property. Further, Kokesh asserts that the Tenth Circuit was incorrect when it reasoned that § 2462 only covers sanctions meant to punish a wrongdoer and that disgorgement actions are not such a sanction. Instead, Kokesh contends that the statute of limitations in § 2462 covers sanctions meant to both punish or remedy wrongdoing, and thus it covers SEC disgorgement claims even if disgorgement is remedial, not punitive.

The SEC counters that the statute of limitations does not apply to disgorgement claims because they are not “forfeitures” under § 2462. The SEC first argues that the Supreme Court has already interpreted “forfeiture” for purposes of § 2462 to mean a punishment. Thus, the SEC asserts that disgorgement is not a forfeiture for the same reasons that it is not a penalty, as discussed below. The SEC also contends that when Congress enacted what would become § 2462, “forfeiture” would have been a procedure to take tangible property because this was the only kind of forfeiture that the United States adopted from English law. Further, the SEC argues that Kokesh’s broad definition of “forfeiture” does not withstand scrutiny because the statutes that he relies upon are better understood as either penalties or liquidated damages. Lastly, the SEC maintains that, because disgorgement did not exist until the 1970s, the word “forfeiture” in § 2462 would not have included a remedy like disgorgement.

DO DISGORGEMENT CLAIMS CONSTITUTE “PENALTIES”?

Kokesh argues that, in addition to falling within the term “forfeiture” in § 2462, SEC disgorgement claims also fall within the term “penalty.” To support this argument, Kokesh first notes that the Supreme Court has held that if a sanction “serv[es] in part to punish,” it is a penalty. Kokesh asserts that disgorgement claims clearly serve in part to punish, and are thus penalties. Kokesh further maintains that disgorgement claims are penalties because they fit the dictionary definition of the term at the time that Congress included it in § 2462, and because they deter wrongdoing, which is a hallmark of punishment. In addition, Kokesh notes that many Supreme Court cases have held that sanctions that are not meant to compensate victims are penalties. Thus, Kokesh contends that disgorgement claims are penalties because, according to the SEC, courts, and Congress, the purpose of disgorgement claims is not to compensate victims. Kokesh also maintains that three features of disgorgement claims reinforce the fact that they are penalties—the wrongdoer must disgorge gains that third parties incurred as well as gains that the wrongdoer incurred, the wrongdoer may not deduct any expenses from their gains to reduce the disgorgement, and disgorgement is not subject to the causation principles that apply to sanctions meant to compensate victims. Lastly, Kokesh notes that the SEC has argued that disgorgement claims are penalties in other contexts.

The SEC argues, however, that disgorgement claims do not fall within the term “penalty.” The SEC asserts that the Supreme Court has interpreted “penalty” to mean a punishment, and this interpretation is consistent with nineteenth-century understandings of the term. Under this interpretation, the SEC contends that disgorgement does not punish wrongdoers because it does not make them worse off financially than they would have been if they did not violate the law. Instead, the SEC argues that disgorgement merely returns the wrongdoer to their position before the wrongdoing. The SEC maintains that this is not a punishment because it does not deprive the wrongdoer of anything to which they were rightfully entitled. In addition, the SEC asserts that Congress did not think of disgorgement as a penalty. To support this assertion, the SEC cites legislative reports stating that Congress expanded the SEC’s power to collect civil penalties from wrongdoers because disgorgement “does not result in any actual economic penalty.” The SEC counters Kokesh’s argument that disgorgement is not a remedy to compensate victims by asserting that, in a disgorgement action, the wrongdoer surrenders illegally-obtained funds to a district court, which may distribute the funds to the victims of the wrongdoing. The SEC also notes that district courts order distribution of disgorged funds to victims in a significant percentage of cases. Additionally, the SEC claims that Kokesh’s conclusion that non-compensatory remedies are penalties is logically flawed because Kokesh relies solely on cases establishing only that compensatory remedies are not penalties, not necessarily the inverse. Further, the SEC attempts to distinguish previous instances where the government has argued that disgorgement claims are penalties by asserting that those cases did not involve § 2462 and were governed by principles that do not apply in this case.

Discussion 

IS DISGORGEMENT AN EQUITABLE REMEDY?

Kokesh argues that disgorgement cannot be considered an equitable remedy. According to Kokesh, the issue of whether disgorgement is an equitable remedy is ultimately irrelevant to the issue at hand, but, if necessary, the Court should determine that a court of equity would never permit “the government, as enforcer, not the injured party, to obtain a retrospective money judgment based on a violation of public laws.” The American Investment Council, in support of Kokesh, maintains that disgorgement is instead a punitive remedy. The American Investment Council suggests that disgorgement allows the government to collect billions of dollars under the premise of victim compensation, but, rather than allocating money to victims, the SEC has the authority to route the recovered money directly to the U.S. Treasury. Likewise, the Washington Legal Foundation contends that the SEC uses disgorgement as a penalty. The Washington Legal Foundation argues that the SEC uses disgorgement as a deterrent against future breaches of federal securities law, as opposed to an equitable remedy to cure the unjust enrichment of the perpetrator and compensate the victim for incurred losses.

In contrast, the SEC claims that disgorgement is an equitable remedy, not a penalty. The SEC claims that disgorgement is a non-punitive remedy that is neither a penalty nor forfeiture. The SEC contends that the recovered money through disgorgement is allocated to victims in a “significant percentage of cases.” The SEC concedes that the government is not always able to allocate funds to victims, such as in instances where it would be wasteful to do, where the fraud is too dispersed, or where there is no way to locate the victims. The SEC argues that disgorgement has a primarily compensatory character, despite it serving to benefit the general public, rather than individual victims, by deterring future violations of federal securities law. The SEC also argues that disgorgement only remedies the perpetrator’s unjust enrichment, and the SEC does not use disgorgement to “punish either the [perpetrator] or his property.”

GOVERNMENT INTERESTS VS. PUBLIC INTERESTS

Kokesh claims that excluding disgorgement from the statute of limitations in § 2642 would favor the interests of the government over the interests of justice. Kokesh suggests that, in the absence of a functional statute of limitations, the SEC would have the unrestrained discretion to file disgorgement claims whenever it wanted, even in cases that occurred so far back as to pose discovery or evidence-collection issues. The Chamber of Commerce of the United States of America and the American Petroleum Institute, in support of Kokesh, argue that allowing the SEC to have the unlimited ability to collect on disgorgement claims could apply analogously to enforcement actions brought by other government entities, such as the Environmental Protection Agency, that have statutes lacking explicit statute of limitations periods. Furthermore, the Securities Industry and Financial Markets Association warns that finding an exception for disgorgement under § 2462 would promote enforcement actions against “stale claims” and threaten the stability and predictability of the financial system and securities markets.

In contrast, the SEC argues that excepting disgorgement from § 2642’s statute of limitations is consistent with how the Court has viewed equitable remedies to generally not be bound to a statute of limitations requirement. The SEC contends that finding an exception would not encourage the SEC to delay filing enforcement actions, especially given the SEC’s “strong incentives” to immediately act on misappropriation and fraud claims. The SEC also claims that it is free to bring disgorgement claims that are not time-barred by statute to further the government’s interest in protecting the public against “bad actors.” Additionally, the SEC contends that the doctrine of narrow construction applies here and supports a finding that an exception to the statute of limitations applies, furthering the government’s interest in preventing the perpetrators from gaining unjust enrichment.

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