In Charles R. Kokesh v. Securities and Exchange Commission, 581 U.S. ____ (2017), the US Supreme Court, reversing the Tenth Circuit, has held that the five-year statute of limitations period under Section 2462 applies to a disgorgement claim imposed as a sanction for violating a federal securities law and the limitations period begins from the date the claim accrued.

Facts

Charles Kokesh owned two investment-adviser firms that gave investment advice to business-development companies. In 2009, the Securities and Exchange Commission (SEC) brought an enforcement action in the Federal District Court against Charles Kokesh for violating several securities laws. The SEC alleged that Kokesh concealed the misappropriation of $34.9 million from four of the development companies from 1995 to 2009 by filing false and misleading SEC reports and proxy statements. The SEC sought monetary civil penalties, disgorgement and an injunction to bar Kokesh from future violations of securities laws.

A jury found that Kokesh violated various securities laws and the District Court then determined the penalties sought by the SEC. The District Court ruled that the five-year statute of limitations period under Section 2462 applied to the monetary civil penalties and the five-year period began on the date the claim accrued. Therefore, monetary civil penalties could not be imposed for misappropriations occurring before October 27, 2004 — five years before the date the SEC brought an enforcement action. However, the Court also ruled that Section 2462, which applies to any proceeding for the enforcement of a civil fine, penalty, or forfeiture, did not apply to the $34.9 million disgorgement judgment because disgorgement is not a penalty. The Tenth Circuit affirmed, finding that disgorgement is not a penalty or forfeiture.

The Supreme Court granted certiorari to resolve disagreement among the circuits over how the five-year statute of limitations period applies to disgorgement claims.

Holding

The Court found that SEC disgorgement is imposed for violating public laws (i.e., violation is committed against the United States instead of an individual). The Court also observed that "disgorgement is imposed for punitive purposes." Citing several cases, the Court found that the primary purpose of disgorgement claims is to prevent violations of the securities laws by depriving violators of their profits. In Bell v. Wolfish, 441 U.S. 520, 539, n. 20 (1979), the Court stated that "[s]anctions imposed for the purpose of deterring infractions of public laws are inherently punitive because 'deterrence [is] not [a] legitimate nonpunitive governmental objectiv[e].'"

Additionally, the Court concluded that disgorgement is not compensatory. Citing SEC v. Fischbach Corp., 133 F. 3d 170, 175 (2d Cir. 1997), the Court observed that "disgorged profits are paid to the district court, and it is 'within the court's discretion to determine how and to whom the money will be distributed,'" which means investors may not receive the funds as restitution. The funds could be paid to victims, to the U.S. Treasury, or both. The Court further pointed out that, "[w]hen an individual is made to pay a noncompensatory sanction to the Government as a consequence of a legal violation, the payment operates as a penalty." See Porter v. Warner Holding Co., 328 U. S. 395, 402 (1946).

Accordingly, the Court held that the five-year statute of limitations period under Section 2462 applies to disgorgement claims because disgorgement "bears all the hallmarks of a penalty: It is imposed as a consequence of violating a public law and it is intended to deter, not to compensate."

Implications

The Court held that, as the disgorgement served a punitive and not a compensatory purpose, it is a penalty under Section 2462. Although Section 162(f) was not addressed in this case, this holding potentially may have implications under Section 162(f), which disallows a deduction "for any fine or similar penalty paid to a government for the violation of any law." Treas. Reg. Section 1.162-21(b)(2) clarifies that the amount of a fine or penalty does not include compensatory damages paid to a government, i.e., a compensatory settlement payment to the government is deductible for federal tax purposes, but a punitive payment is not. Absent clear statutory intent, courts generally look to the text of the settlement agreement to determine if a payment is compensatory or punitive and thus whether it is deductible.¹ Further, the Tax Court has previously found that disgorgements in SEC proceedings are not penalties within the context of Section 162(f).²

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ENDNOTES

¹ See, e.g., Talley Industries, Inc. v. Commissioner, 116 F.3d 382 (9th Cir. 1997); Fresenius Med. Care Holdings, Inc. v. United States, 763 F.3d 64 (1st Cir. 2014).

² See, e.g., Wang v. Commissioner, T.C. Memo. 1998-389 (1998).