Lucia, Kokesh, and the Supreme Court’s Not-So-Subtle Hints to the SEC, by Daniel B. Listwa and Charles Seidell
When the Supreme Court held in Lucia v. SEC that the Securities and Exchange Commission had appointed its administrative law judges in an unconstitutional manner, the focus among commentators was less on the particular agency at issue and more on the repercussions for the administrative state more generally. But, while it is true that the consequences of the decision are unlikely to be cabined to the SEC, it would be a mistake to overlook one key takeaway from the case: the Court remains vigilant in its policing of the SEC’s use of its authority.
In case after case in recent years, the Court has pumped the brakes on the SEC’s enforcement abilities. Lucia is no exception. In fact, as others on this blog have discussed, the Court’s opinion, though narrow in its reasoning, was unusually aggressive in its remedy—requiring that Lucia receive not only a new hearing, but also a new ALJ. Though surprising given the Court’s usual reluctance to give teeth to its remedies in Appointment Clause challenges, the decision should be seen as yet another warning to the SEC that the Court is going to watch carefully that the agency dots the i’s and crosses the t’s.
The Supreme Court’s warning is particularly relevant in light of an opinion handed down last term—and the subject of our Note just published in the Yale Journal on Regulation—Kokesh v. SEC. In that case, the Court held that judicial disgorgement orders—orders demanding defendants to hand over their ill-gotten gains—are penalties and thus subject to the five-year statute of limitation in 28 U.S.C. § 2462. The holding has had a major impact on the agency’s enforcement actions. Speaking to a panel of the House Financial Services Committee in May, co-director of SEC enforcement Steven Peikin said that the ruling last summer has since prevented the agency from disgorging more than $800 million that it otherwise could have sought.
But when the Kokesh opinion came down, it wasn’t the holding that attracted the most attention. Rather, something much smaller gripped commentators—a footnote. In footnote three of the opinion, Justice Sotomayor, writing for the Court, disclaimed that the opinion should not be read as either validating or invalidating the SEC’s usage of disgorgement. Despite the fact that Justice Sotomayor has warned against drawing conclusions from such disclaimers in the past, in the months following Kokesh speculation abounded that the Court was inviting a challenge to the SEC’s ability to seek disgorgement in judicial proceedings.
A flurry of litigation followed, including a putative class action, arguing that the SEC did not have the authority to pursue disgorgement. These argument boils down to two contentions: (1) the SEC was granted no explicit statutory authority to seek judicial disgorgement, only a general grant to seek “equitable remedies”; (2) disgorgement could not be an equitable remedy since it is, according to Kokesh, a penalty, and there are no penalties in equity (a view endorsed by the remedies scholar Sam Bray and securities scholar Stephen Bainbridge).
In our Note, which we blogged about last fall, we refute each of these arguments. We first explain that the Supreme Court’s precedent simply does not support the broad “there are no penalties in equity” claim. In fact, the Court, in Tull v. United States, specifically referred to disgorgement as both equitable in nature and a penalty. Second, we argue that not even the most textualist interpreter would deny judicial disgorgement’s statutory bona fides. Although Congress has never explicitly authorized the SEC to seek disgorgement in court (because no one thought Congress needed to), numerous statutes have been enacted that regulate—and thus assume—the SEC’s disgorgement authority, amounting to congressional ratification.
Thus far, these arguments in favor of disgorgement have been winning in the courts. To date, every court to consider the issue has refused to turn back the clock on decades of precedent by invalidating the SEC’s ability to seek disgorgement. But that does not mean that Kokesh will not have broader implications for the SEC in the future. As we explain in our Note, the SEC’s disgorgement authority is limited: since disgorgement is only authorized to the extent that it is equitable, it may only be used to achieve ends compatible with traditional equity powers, that is, to restore the status quo. The SEC has arguably exceeded those limits—and language in Kokesh suggests that the Court has noticed.
The courts have long been highly deferential to the SEC when it comes to calculating the amount to be disgorged, merely requiring the agency to provide a “reasonable approximation of profits causally connected to the violation.” See SEC v. Contorinis, 743 F.3d 296, 301 (2d Cir. 2014). The agency has used this blank check as a cudgel—deterring potential wrongdoers with the threat of losing far more than he or she actually gained. While plausibly good policy, using disgorgement in such an expansive way cannot be squared with its equitable origins. Justice Sotomayor’s opinion reflects this view, disapprovingly citing Contorinis and noting that the SEC’s disgorgement practice “does not simply restore the status quo; it leaves the defendant worse off.”
This is bad news for the SEC. Based on the language in Kokesh, it seems likely that the Court would be receptive to arguments that the agency has overstepped the bounds of its authority. That likelihood has only grown since the nomination of Judge Kavanaugh to fill Justice Kennedy’s seat. Concurring in Saad v. SEC, Judge Kavanaugh read Kokesh as broadly casting doubt on circuit court precedent regarding the SEC’s remedial powers. Given the arguments that disgorgement generally is within the scope of the SEC’s authority to seek equitable remedies, the most likely action would be for the Supreme Court to set clear limits to judicial disgorgement, delineating its bounds but without entirely taking away the remedy.
The SEC should be wary of such an outcome. Especially in light of the aggressive remedial steps taken by the Court in Lucia, it seems likely that—if called to do so—the Supreme Court would draw the lines of judicial disgorgement narrowly, restricting further the agency’s ability to disincentive violations of the securities law.
Commentators have suggested that, absent some legislative solution, the SEC’s ability to use disgorgement hangs in the balance. Many of these commentators have thus reasonably predicted that the SEC would seek such a legislative solution. And those predictions have been borne out—SEC Chairman Jay Clayton recently appeared before House lawmakers to ask that they extend the statute of limitations.
But lobbying is not the only action that the SEC can take to head off such a result. We suggest that the agency issue guidelines in which it sets out in relatively precise terms its policy for calculating disgorgement—including that it will limit the application of the penalty to doing no more than restoring the status quo. In fact, during oral argument, Justice Kagan noted that she found it “unusual that the SEC has not given some guidance to its enforcement department,” expressing discomfort that “everything is sort of up to the particular person at the SEC who decides to bring such a case.” The view reflects the fact that at least some of the Justices’ look skeptically upon an agency that does not define its discretion through guidance documents—as illustrated, for example, in Justice Breyer’s concurrence in Trump v. Hawaii. By reining in its use of its broad grant of authority, the SEC may be able to forestall further admonishment before the Supreme Court.
Daniel B. Listwa and Charles Seidell are students at Yale Law School