The Securities and Exchange Commission (S.E.C.) has authority to investigate violations of federal securities laws and commence enforcement actions if its investigations uncover evidence of wrongdoing. Initially, the S.E.C.’s statutory authority was limited to seeking an injunction barring any future violations. Beginning in the 1970’s, however, courts began granting the S.E.C.’s requests for disgorgement in enforcement proceedings. Disgorgement is a remedy which requires defendants to repay any unlawful monetary gains. Although Congress has since authorized the S.E.C. to seek monetary civil penalties, the S.E.C. has continued to seek disgorgement.

The United States Supreme Court recently ruled that claims for disgorgement in an S.E.C. enforcement action must be filed within a five-year statute of limitations. The Court’s decision turned on whether disgorgement is a penalty or an equitable remedy, and the court determined it was the former. The ruling will effectively require S.E.C. enforcement staff to complete investigations in a shorter amount of time. Moreover, the designation of disgorgement as a penalty could limit the amount the S.E.C. can seek as a civil monetary penalty on top of any money disgorged. However, the holding of the case and its direct implications are not the real headline.

A literal footnote in the decision could have a much greater impact than the decision itself. It states that “nothing in this opinion should be interpreted as an opinion on whether courts possess authority to order disgorgement in S.E.C. enforcement proceedings or on whether courts have properly applied disgorgement principles in this context.” As such, the Court made a point to say that it has not determined that courts should be ordering disgorgement at all in this context. Importantly, the federal securities law does not list disgorgement as one of the remedies available to the S.E.C.

In 1971, the Second Circuit Court of Appeals upheld an order requiring defendants to repay profits made by trading on confidential information, as an exercise of the equitable powers of a court to prevent wrongdoing. Ever since, the S.E.C. routinely seeks this remedy and courts routinely grant it. Nevertheless, the Supreme Court’s footnote may have opened the door to arguments by defense lawyers that disgorgement is not a permissible remedy in a S.E.C. enforcement proceedings.

The answer to whether disgorgement in securities cases is permissible will involve an inquiry as to whether an English chancery court in 1789 (when Congress adopted the Judiciary Act that gave federal courts the power to hear lawsuits “in equity”) had the power to order that remedy. If the remedy was not an exercise of a court’s inherent authority back in 1789, then disgorgement would not be a permissible exercise of the equitable powers of a court to prevent wrongdoing. However, Congress could resolve the question by specifically authorizing disgorgement as an available remedy in any S.E.C. enforcement action. If you have questions about this article or would like to speak to Attorney Sally P. McDonald, please call , or email her at . We welcome your comments, questions and suggestions.