Virtually every SEC enforcement proceeding includes a request for so-called “disgorgement” relief. Once upon a time, “disgorgement” meant that a wrongdoer should be denied benefits he or she gained from misconduct. As a matter of justice or fairness, that seemed hard to argue about. There seems no good reason why someone found liable for misconduct should be entitled to retain the benefits of that misconduct. And there would seem to be good reasons why that shouldn’t happen: otherwise one could argue we leave in place an economic incentive to commit wrongdoing, if the proceeds of misconduct exceed penalties imposed once liability is found (plus other costs of the proceeding).
But where the rubber meets the road, things get more complex. How exactly should we figure out what the “ill-gotten gains” really are? How do we take into account potential ongoing civil liabilities for that conduct? Is it really “disgorgement” of ill-gotten gains if victims of the misconduct can recover those amounts in civil actions, perhaps benefited by application of collateral estoppel against the wrongdoer on the issue of liability? Is it “disgorgement” to cause multiple liabilities for the same “ill gotten gains”? What about other possible governmental liability for the “ill-gotten gains”? If another governmental entity has a claim to recover some or all of those amounts, how many times should the government get to recover the gains, plus impose “penalties”? What if there are parallel criminal and civil government enforcement actions? Is it “piling on” to impose a “disgorgement” on top of a criminal fine, possible criminal forfeiture, and civil penalties, which together are much larger than any possible “ill-gotten gains”?
It gets even more complex. What rights does an accused have when he faces government actions for “disgorgement,” on top of civil penalties and other possible forms of relief? An accused has a right to a jury trial in any criminal action, but also has a Seventh Amendment right to a jury in many civil actions. As a relic of history, there is no Seventh Amendment right to a jury in a civil action that would, in former days, have been tried in courts of “equity.” Should disgorgement be treated as an “equitable” remedy for which there is no right to jury trial? Does that seem right (might one say “equitable”?) if the “disgorgement” calculation proposed by the government could result in a liability that vastly exceeds any possible civil penalty that is permitted by statute? Indeed, does it ever really make sense to allow a “disgorgement” theory that results in findings of liability that dwarf the statutory limits on penalties that can be awarded in a case? And what about time limits on seeking disgorgement relief? There are statutes of limitation for criminal and civil actions, but, again as a vestige of judicial history, those statutory time limits don’t apply to actions for so-called “equitable relief.” If actions for civil penalties are time-barred, should it really be possible to pursue stale liability claims solely for “disgorgement”? How about if the stale claims for “disgorgement” seek amounts that vastly exceed the possible penalties that are time-barred?
These are complicated and nuanced questions, which have multiple layers of issues of fairness and public policy. Unfortunately, the SEC has little patience for any such considerations. It not only takes a knee-jerk position that what it calls “disgorgement” should be pursued in every case, but it opposes any meaningful restriction on how it should calculate such “disgorgement,” and opposes allowing an accused procedural rights to fight disgorgement like other civil liabilities. Not only that, the SEC has also decided that “disgorgement” doesn’t really mean that a wrongdoer must give up his or her ill-gotten gains; to the SEC, it means that the wrongdoer must also pay amounts gained and retained by other persons as a result of the misconduct. (As an example, just look at the SEC’s most recent effort in SEC v. McGee to get an insider trader to be responsible for “disgorgement” that includes not only the $292,000 he earned in alleged illegal profits, but also more than $1 million in alleged profits earned not by him, but by the “downstream” tippees who traded.) And as to the calculation of “ill-gotten gains,” let’s just say that the only principle the SEC accepts in doing such calculations is that “more is better.”
Unfortunately, courts have been much too willing to accept aggressive SEC theories of “disgorgement,” which naturally has led to increasingly more outrageous SEC disgorgement calculations on the “more is always better” theory of law enforcement public policy. The law in this area is now so prolix it is impossible to follow. Somehow, we have reached the stage where, contrary to every sense of fairness and due process, a defendant is required by some courts to bear the burden of proving that a proposed SEC disgorgement calculation is incorrect, as long as the SEC proposal is deemed by the court to be plausible. This judicial recognition of the concept “close enough for government work” as the rule of law in an enforcement proceeding is a mockery of due process, especially when what is at issue often may be amounts of supposed “disgorgement” that make the defendant bankrupt or destitute. And, in a bizarre rejection of jurisprudence on the issue of causation, although the courts agree that for disgorgement not to be a form of punishment, it must be “causally connected” to the wrongdoing, some courts now accept that the proceeds of misconduct can be determined by mere “but for” causation, notwithstanding what may be, at best, strained proximity between the wrongdoing and the ultimate proceeds. These are not just district court decisions, but influential appellate decisions in the Second and Third Circuits as well. See SEC v. Contorinis, 743 F.3d 296 (2d Cir. 2014); SEC v. Teo, 746 F.3d 90 (3d Cir. 2014). The SEC often takes the position that a company employee who commits or assists in a violation should “disgorge” all or portions of his or her salary, apparently on the bizarre (and, of course, unproven) theory that they were paid for the violations and not to perform actual duties as employees. Some courts actually accept this nonsense.
In short, a combination of SEC over-exuberance, to be kind, and judicial acceptance, has resulted in bringing the securities “disgorgement” remedy far from its origins as a means of divesting a wrongdoer of his or her ill-gotten gains. This departure raises serious questions about whether what is now labeled a “disgorgement” remedy is, in fact, a traditional form of equitable relief. See The Equity Façade of SEC Disgorgement, and Thinking about SEC Disgorgement. There is no doubt that Supreme Court consideration will ultimately be required.
The issue of disgorgement relief is so significant and complex, it is impossible to address in a single blog post. On several previous occasions, we have discussed the issue in specific enforcement contexts. The SEC v. Wyly enforcement action provided several opportunities to examine the issue. In that case, Judge Scheindlin issued one decision describing the current state of the law of disgorgement in the Second Circuit, and then refusing to follow it because the result was so plainly inequitable. See SEC v. Wyly: New Scheindlin Disgorgement Opinion Shows How SEC Remedy Has Gone Awry. Judge Scheindlin also rejected some of the SEC’s more far-fetched theories of unlawful proceeds — including the notion that all of the increased value of stock the Wylys over a 13-year period should be disgorged when the only violation found was that they failed to disclose those holdings in section 13(d) disclosure filings, which certainly did not drive the increasing value of the stock. See SEC v. Wyly III: SEC’s Overreach on Disgorgement Remedy Shot Down. On the other hand, Judge Scheindlin ultimately awarded as a “disgorgement” for securities law violations a supposed unlawful tax avoidance that, if it truly was an unlawful tax avoidance, could be recovered by the IRS — and was actively being investigated by the IRS. As a result, the defendants will be required to “disgorge” as supposed tax benefits either amounts the IRS do not allow them to retain (meaning there are no real “ill-gotten gains” to disgorge), or amounts the tax authorities determine were not, in fact and law, unlawful tax avoidances, in which case there also is no ill-gotten gain. (Judge Scheindlin’s disgorgement order tried to address this issue by allowing disgorged amounts to be “credited towards any subsequent tax liability determined in an IRS civil proceeding as a matter of equity,” but the effect of that determination is far from clear, since the IRS is not a party to the SEC case. She also tried to account for the possibility that tax was not really avoided by allowing a motion to vacate the judgment if another court rules that no taxes were owed — but not if the IRS itself determines not to assert any unlawful tax avoidance — which on its face is a half-baked approach to the issue, since much tax policy is determined without a court determination.) This is “Alice in Wonderland” jurisprudence. See Wyly Brothers Hit with More than $300 Million Securities Law Disgorgement Order for Unpaid Taxes. As a result of the huge “disgorgement” imposed by Judge Scheindlin, Sam Wyly, once one of the wealthiest men in America as a result of growing a huge retail and securities empire with his now-deceased brother, is in bankruptcy.
Another example of disgorgement without bounds discussed in earlier posts is the SEC’s outrageous calculation of a $2 billion disgorgement in SEC v. Life Partners Holdings, Inc., which we discussed here: SEC Again Runs Amok, Seeking $2 Billion in Texas Case. Fortunately, the district court rejected this absurd contention: see SEC Gets Reasonable Relief in Life Partners Case — but only 2.5% of $2 Billion Request. The combined penalties and disgorgement issued in that case still forced the company into bankruptcy. One wonders how “equitable” that felt to the company’s shareholders, whom the SEC presumably was trying to protect.
Which brings us to the disgorgement dispute du jour: whether the SEC’s effort to obtain “disgorgement” in SEC v. Graham should be permitted because, unlike the civil remedies found time-barred in that case, the five year statutory statute of limitations under 28 U.S.C. § 2462 does not apply to the portion of an enforcement action seeking disgorgement. Section 2462 bars government civil claims for fines, penalties, or forfeitures, “pecuniary or otherwise” if they are not commenced “within five years from the date when the claim first accrued.” For years, the SEC argued for a restrictive reading of section 2462 which would allow it to pursue claims for five years after they were “discovered,” rather than five years from when they accrued. That position was finally put to rest by the Supreme Court in Gabelli v. SEC, 133 S. Ct. 1216 (2013). Since then, the SEC has been searching for other ways to pursue enforcement actions after the five-year period expires.
In Graham, the SEC alleged a classic Ponzi scheme, in which the alleged perpetrators promised wealth-creating returns to purchasers of condominium units that were to be renovated and rolled into a large, nationwide resort. As alleged, the returns paid to investors were funded by later purchases of new investors. Because the last condominium sale occurred in 2007, however, and the SEC didn’t commence any action until 2013, the district court held that section 2462’s five-year statute of limitations barred all of the SEC’s claims. District Judge King rejected the SEC’s argument that its claims should continue for the requested relief of disgorgement and an injunction because those were equitable claims and therefore not subject to any statute of limitations. On the issue of disgorgement, Judge King wrote: the “disgorgement of ill-gotten gains . . . can truly be regarded as nothing other than a forfeiture (both pecuniary and otherwise),” which is expressly covered by section 2462. “To hold otherwise would be to open the door to Government plaintiffs’ ingenuity in creating new terms for the precise forms of relief expressly covered by the statute in order to avoid its application.” See his opinion here: SEC v. Graham.
In our discussion of this case at the time (see SEC v. Graham: SEC’s Delay in Filing Causes Ponzi Scheme Claims To Be Dismissed) we said: “This last ruling is dagger for the SEC. Its litigation position is always that the non-penalty relief involves equities, not penalties, which relieves the SEC of unpleasant litigation burdens (including taking those issues away from a jury). To be fair, most courts have historically agreed with that view, although the analysis is typically thin. But in recent years the courts have tended to take a much more critical view of the relief the SEC always seeks because it often is highly punitive, even though the SEC portrays it as otherwise. But that is an issue for another day.” That other day has now arrived. The SEC’s appeal is now before the Court of Appeals for the Eleventh Circuit in SEC v. Graham, No. 14-13562-E.
Will the Eleventh Circuit look past SEC’s label of “disgorgement” and recognize that so-called “disgorgement” relief has, in reality, become a harsher form of penalty than the civil “penalties” the SEC is permitted to obtain by statute? Will the court accept the SEC argument that the “disgorgement” remedy is no more than long-standing ancillary equitable relief forcing divestiture of ill-gotten gains, and therefore not a penalty or forfeiture and not covered by section 2462? Or will the court take note of the myriad ways that the SEC has caused the disgorgement concept to mutate in one the most severe forms of punishment in its arsenal of punitive weapons?
The Securities Industry and Financial Markets Association (SIFMA) is hoping it can convince the Eleventh Circuit court to see things as they are, not as they are labeled. It filed an amicus brief in support of affirming the decision below, which seeks to explain why the SEC’s actions for these so-called “equitable” remedies are government enforcement actions that are, and should be, within section 2462’s actions for “civil fine, penalty, or forfeiture, pecuniary or otherwise.” SIFMA’s brief is available here: SIFMA Amicus Brief in SEC v. Graham.
Whichever way the Eleventh Circuit goes on this, the many disgorgement issues mentioned above will remain, and will have to be resolved over time. Let’s hope the courts will more consistently look at “disgorgement” on a case-by-case basis, and treat it in all respects for what it really is in each case, rather than allowing the SEC to label punishment as “disgorgement,” like a wolf in sheep’s clothing.
March 3, 2015
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