Fault Lines
20 April 2017
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SEC Dodges Statute of Limitations by Renaming the Punishment

March 10, 2017 (Fault Lines) — It’s been a great run for the SEC. In 2015, they collected $4.2 billion in sanctions. In that same year they brought a record number of actions, winning over 90%. They accomplish all of this in cases lasting an average of 22 months. That’s pretty effective for a bureaucracy.

Part of the incentive the SEC has in acting quickly is a five-year statute of limitations:

Except as otherwise provided by Act of Congress, an 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 if, within the same period, the offender or the property is found within the United States in order that proper service may be made thereon.

In a predictable outcome, the Supreme Court determined that the statute meant what it said. Before the Court, the SEC argued that the time should begin to run not at the point of the misconduct, but at the point of discovery of the misconduct:

But we have never applied the discovery rule in this context, where the plaintiff is not a defrauded victim seeking recompense, but is instead the Government bringing an enforcement action for civil penalties. Despite the discovery rule’s centuries-old roots, the Government cites no lower court case before 2008 employing a fraud-based discovery rule in a Government enforcement action for civil penalties. * * *

In a civil penalty action, the Government is not only a different kind of plaintiff, it seeks a different kind of relief. The discovery rule helps to ensure that the injured receive recompense. But this case involves penalties, which go beyond compensation, are intended to punish, and label defendants wrongdoers. (Citations omitted.)

Chief Justice Marshall used particularly forceful language in emphasizing the importance of time limits on penalty actions, stating that it “would be utterly repugnant to the genius of our laws” if actions for penalties could “be brought at any distance of time.” Adams v. Woods, 2 Cranch 336, 342, 2 L.Ed. 297 (1805). Yet grafting the discovery rule onto § 2462 would raise similar concerns. It would leave defendants exposed to Government enforcement action not only for five years after their misdeeds, but for an additional uncertain period into the future.

But you can’t keep a good agency down. The SEC decided to get what they wanted despite the statute and the Court’s opinion. Rather than continuing to seek civil penalties, it characterized its actions as equitable and thus outside the scope of the statute.

In this particular case, they wanted $34.9 million dollar from Charles Kokesh. Starting in 1995, he directed the business development companies he was involved in to transfer funds to pay for salaries. This payment violated the contracts in place; he underreported his salary; he failed to disclose these bonuses; and he violated several other terms of the contracts.

He was convicted of SEC violations and was ordered to disgorge $34.9 million dollars in ill-gotten gains. On appeal, Kokesh argued that the prosecution exceeded the statute of limitations. Specifically, he argued that both the injunctive relief and disgorgement were barred by the five-year limitation.

The Tenth Circuit found that disgorgement was remedial and not a penalty (internal citations omitted):

The reasons for this view are clear. Properly applied, the disgorgement remedy does not inflict punishment. “The object of restitution [in the disgorgement context] . . . is to eliminate profit from wrongdoing while avoiding, so far as possible, the imposition of a penalty.” Disgorgement just leaves the wrongdoer “in the position he would have occupied had there been no misconduct.” To be sure, disgorgement serves a deterrent purpose, but it does so only by depriving the wrongdoer of the benefits of wrongdoing.

The Tenth Circuit placed great weight on the apparent distinction between the word forfeiture, as used in the statute, and disgorgement. It acknowledged that both words reflect similar concepts, but found that they were distinguishable enough for disgorgement to lay outside the statute. Subsequently, Kokesh filed a cert petition on this issue, which was granted.

Statutory interpretation is not always straightforward. The Tenth Circuit largely treated ‘forfeiture’ as a term of art, rather than a broad concept. In its view, forfeiture referred to a specific legal remedy. But Congress could have intended the term to be construed more broadly, to capture all related remedies. This is what Kokesh argued in his merit brief:

“[F]orfeiture” cover[s] any obligation to pay money to the government, as sovereign, as a result of wrongdoing—including punitive or remedial sanctions, and in rem or in personam remedies.

The SEC responded by arguing that disgorgement is remedial, equitable, and thus outside the statute. Although the SEC argues that it meant to prevent unjust enrichment, it cites mostly cases where the plaintiff was private. As the Supreme Court noted in Gabelli, there are significant differences between the government and private plaintiffs.

So the question turns on whether Congress meant civil forfeiture, as used in the statute, to include disgorgement.  As Kokesh points out, the term forfeiture has historically been used broadly, capturing several mechanisms under the same name. But the concept of disgorgement, as used by the SEC, is a recent innovation, without historical analogue. Moreover, it is a practice that began only after the most recent amendment of the statute of limitations.

Plainly, Congress could not have meant to specifically exclude a practice that hadn’t yet come into existence. This, in part, seems to be why the Tenth Circuit treated forfeiture as a specific term of art. On the other hand, Kokesh argues that the word forfeiture was meant to apply broadly, capturing an entire class of governmental conduct, without regard for the specific mechanism used.

This represents a consistent problem in statutory interpretation, i.e. finding the sweet spot between a reading that is too broad and one that is too narrow. Interpretive devices such as the rule of lenity are supposed to help the court choose between the two, but that particular rule is largely out of favor. More recent suggestions have included Randy Barnett’s presumption of liberty. Ultimately, the Court must resolve the dispute; the Congress that passed the statute cannot be brought back into session to explain the meaning.

Here, prior precedent, along with the historical practice, strongly suggests that the SEC is trying to circumvent the statute by essentially calling a dog a cat. The essential character of the underlying action works like a forfeiture. Moreover, there is a growing discontent with forfeitures. And there are strong policy arguments for reading the statute the way Kokesh suggests, beyond nullifying the statute of limitations:

A purely punitive judgment payable to the government—i.e., a “fine”—has a statute of limitations. 28 U.S.C. §2462. The same is true of a purely remedial judgment payable to injured parties—say, a compensatory damages award to investors. Merck & Co. v. Reynolds, 559 U.S. 633, 637 (2010). But no limitations period applies to one that, in the government’s view, is right in between: A judgment that is (says the government) remedial, but payable to the government.

There are historical arguments for continuing to permit criminal forfeiture, and perhaps even civil forfeiture in the right circumstances. But even if civil forfeiture can be defended, an unlimited statute of limitations cannot be. This is all the more so when the action lacks other procedural safeguards like proof beyond a reasonable doubt. The statute of limitations exists for a reason, and civil forfeiture cannot fairly exist without it.

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  • clonedaddy
    10 March 2017 at 9:58 pm - Reply

    Speaking as someone who was once regulated by SEC and enjoyed paying $900 / hr legal bills to answer worthless questions where SEC assumed I personally caused the demise of Bear , Lehman, WAMU, AIG, and FNMA/FRE by spreading rumors they were failing, I’m never surprised by anything the SEC does.