Class Action Not Withstanding, the SEC’s Use of Disgorgement Is Here To Stay, by Daniel B. Listwa
This past summer, in Kokesh v. SEC, the Court scaled back the SEC’s power to recover the profits earned by defendants’ illegal activities, holding that judicial disgorgement brought by the agency constitutes a penalty for the purpose of the 5-year statute of limitations in 28 U.S.C. § 2462. While the holding attracted some headlines, a footnote grabbed even more attention. In footnote three of Kokesh, the Court disclaimed that the opinion should not be read as validating or invalidating disgorgement. If the intended effect was to reassure that SEC disgorgement was not under attack, then the Court was not successful. Since the Kokesh opinion, a cacophony of scholars and practitioners have swooped in to toll the bell of disgorgement’s impending doom.
It thus did not come as a surprise when a class action was filed against the SEC, seeking to recover $14.9 billion in ill-gotten profits that—the complaint alleges—were unlawfully disgorged. The suit, Jalbert v. SEC, has been brought by the liquidating trustee of an investment firm that, like the other members of the putative class, was found to have violated securities law and had their illicitly earned profits either taken by the district courts at the SEC’s behest or directly disgorged by the Commission through an internal proceeding. The theory put forward in the complaint regarding judicial disgorgement is precisely the one that has been circulating in the months since Kokesh: (call it the “no penalties in equity” argument): disgorgement is a penalty; there are no penalties in equity; SEC disgorgement bases its authorization on a statutory grant of equity jurisdiction; therefore, SEC disgorgement is not authorized. A simple and straightforward argument, it could have huge repercussions for the many agencies that rely on general equity powers to seek disgorgement, agencies like the EPA and the FTC—but, the argument is wrong.
In a forthcoming Note in the Yale Journal on Regulation, Charlie Seidell and I counter the argument that Kokesh spells the end for SEC disgorgement. Specifically, we refute the premise that there are no penalties in equity by looking at the Court’s precedents and its general approach to equitable remedies. We then offer an affirmative defense of the SEC’s authority to seek judicial disgorgement by pointing to congressional ratification.
One particular argument in the Note is worth highlighting in light of the Jalbert class action. Despite the claim that there are no penalties in equity, the Supreme Court has said otherwise. In Tull v. United States, a case involving a violation of the Clean Water Act, Justice Brennan, writing for the majority, explained that “disgorgement of improper profits [is] traditionally considered an equitable remedy.” Additionally, he noted that disgorgement is “a more limited form of penalty than a civil fine,” seemingly finding no contradiction in a remedy being both equitable and a penalty.
Tull is even more significant given the emphasis the Jalbert complaint puts on the non-compensatory nature of SEC disgorgement—that is, that the money does not go directly to the victims but instead goes to a fund managed by the district court, and, in some cases, it is deposited in the U.S. Treasury. But the type of disgorgement discussed in Tull would have been deposited in the U.S. Treasury as well. There is no particular victim when a defendant violates the Clean Water Act’s prohibition on filling material into wetlands adjacent to navigable waters. Thus, in such EPA-related cases, the Government does, in fact, direct the disgorged profits to the Treasury. In other words, the Court has already validated disgorgement as utilized by various agencies, finding it in line with its ideas of equitable remedies.
That is not to say, however, that Kokesh will have no impact on the SEC and beyond. As we discuss in the Note, Justice Sotomayor’s opinion in Kokesh included wide ranging dicta that rebukes the Commission for its aggressive and unprincipled use of disgorgement, focusing specifically on the agency’s failure to tailor the amount it seeks to disgorge to the profits actually derived from the misconduct. In light of both this harsh reprimand and some comments made by other Justices during oral arguments, we recommend that the SEC issue a new guidance responding to the Court’s concerns and limiting the use of disgorgement.
The manuscript of the Note, Penalties in Equity: Agency Use of Disgorgement After SEC v. Kokesh, including a discussion of the relationship between the Court’s holding in Kokesh and its more general approach to defining the boundaries of equity, as well as an overview of the statutory argument for SEC disgorgement, can be found here and will be in print this summer.
Daniel B. Listwa is a student at Yale Law School.