Investment Management

Posted on Friday, October 13 2017 at 11:35 am by

Regulation S-K Amendments Promise FAST Relief for Advisers and Funds

By Paul Foley, John I. Sanders, and Lauren Henderson

On October 11, 2017, the SEC issued a Proposed Rule to modernize and simplify disclosure requirements in Regulation S-K.[1] The Proposed Rule, authorized by the Fixing America’s Surface Transportation Act (the “FAST Act”), is intended to reduce the costs and burdens on registrants while still providing investors with disclosures that are user friendly, material, and free of unnecessary repetition.[2]

The Proposed Rule, if adopted, would amend rules and forms used by public companies, investment companies, and investment advisers.[3] The most notable provisions of the Proposed Rule include the following:

  • Eliminating risk factor examples from Item 503(c) of Regulation S-K because the examples do not apply to all registrants and may not actually correspond to the material risks of any particular registrant;[4]
  • Revising requirements related to descriptions of property owned by the registrant in Item 102 of Regulation S-K to emphasize materiality;[5]
  • Eliminating undertakings that are unnecessarily repetitious from securities registration statements;[6]
  • Changing exhibit filing requirements and allowing flexibility in discussing historical periods in the Management’s Discussion and Analysis;[7]
  • Permitting registrants to omit confidential information (e.g., personally identifiable information and material contract exhibits) from Item 601 without submitting a confidential treatment request;[8] and
  • Using hyperlinks in forms to help investors access documents incorporated by reference.[9]

The SEC will accept public comments on the Proposed Rule for sixty days before determining whether to issue a final rule or amend the proposal and seek additional public comment.[10] We are hopeful the Proposed Rule will be well-received by all stakeholders and be finalized relatively quickly.

We invite you to contact us directly if you have any questions about the SEC’s Proposed Rule or Regulation S-K generally.

Paul Foley is a partner with Kilpatrick Townsend & Stockton’s Winston-Salem and New York offices.  John I. Sanders and Lauren Henderson are associates based in the firm’s Winston-Salem office.

[1] SEC, SEC Proposes Rules to Implement FAST Act Mandate to Modernize and Simplify Disclosure (Oct. 11, 2017), available at https://www.sec.gov/news/press-release/2017-192.

[2] Id.

[3] Id.

[4] SEC, Proposed Rule: FAST Act Modernization and Simplification of Regulation S-K,

Release No. 33-10425; 34-81851; IA-4791; IC-32858, available at https://www.sec.gov/rules/proposed/2017/33-10425.pdf.

[5] Id.

[6] Id.

[7] Id.

[8] Id.

[9] Id.

[10] Id.

Posted on Friday, September 8 2017 at 9:48 am by

ERISA Group Offers Insights into DOL Proposal to Extend Fiduciary Rule Transition Period

Kilpatrick Townsend & Stockton’s ERISA Law practice group has a new article with valuable insights into the DOL’s Proposed Rule that would extend the Fiduciary Rule transition period.  We encourage those impacted by the Fiduciary Rule to read it here.

 

Posted on Thursday, August 31 2017 at 5:45 pm by

DOL’s Proposed Rule Would Extend the Transition Period for Certain Fiduciary Rule Exemptions to July 2019

 By Paul Foley and John I. Sanders

Today, the text of a Department of Labor (the “DOL”) Proposed Rule we have been anticipating for several weeks was made available to the public.[i] The Proposed Rule would “extend the special transition period” for certain components of the Best Interest Contract Exemption (the “BIC Exemption”) and certain other exemptions to the Fiduciary Rule.[ii] Perhaps the most important aspect of the Proposed Rule is that it would maintain the current version of the BIC Exemption, which requires fiduciaries relying on it to merely “give prudent advice that is in retirement investors’ best interest, charge no more than reasonable compensation, and avoid misleading statements.”[iii] In making the proposal, the DOL stated that its purpose was to give the DOL “time to consider possible changes and alternatives” to the exemptions.[iv] If finalized, the Proposed Rule would extend the transition period of the effected exemptions to July 1, 2019.[v]

Please contact us if you have any questions about this article or the DOL Fiduciary Rule generally.

Paul Foley is a partner with Kilpatrick Townsend & Stockton’s Winston-Salem and New York offices.  John I. Sanders is an associate based in the firm’s Winston-Salem office.

[i] DOL, Notice of proposed amendments to PTE 2016-01, PTE 2016-02, and PTE 84-24, 82 Fed. Reg. 41365, available at https://www.federalregister.gov/documents/2017/08/31/2017-18520/extension-of-transition-period-and-delay-of-applicability-dates-best-interest-contract-exemption-pte.

[ii] Id.

[iii] Id. at 41367.

[iv] Id. at 41365.

[v] Id.

Posted on Friday, August 25 2017 at 9:51 am by

Second Circuit Clarifies its Post-Salman Position, Affirms Insider Trading Conviction

By Paul Foley and John I. Sanders

On August 23rd, the Second Circuit issued its much-anticipated opinion in U.S. v. Martoma, affirming the 2014 insider trading conviction of S.A.C. Capital Advisors portfolio manager Matthew Martoma.[1]  In doing so, it clarified an important point regarding what is required to convict a person who trades on a tip received from an insider.  We believe this decision will have an immediate impact on how hedge fund portfolio managers and other investment advisers interact with third party resources.

Section 10(b) of the Securities Exchange Act of 1934[2] and Rule 10b-5[3] promulgated thereunder prohibit insider trading.  The basic elements of insider trading are:  (i) engaging in a securities transaction, (ii) while in possession of material, non-public information, (iii) in violation of a duty to refrain from doing so.

Under the classic theory of insider trading, a corporate insider trades in shares of his employer while in possession of material, non-public information (e.g., advance notice of a merger).  In addition to the classic theory of insider trading, case law has extended the liability to persons who receive tips from insiders (i.e., individuals whose duty to refrain from trading is derived or inherited from the corporate insider’s duty).  Thus, not only may insiders be liable for insider trading, but those to whom they pass tips, either directly (tippees) or through others (remote tippees) may be liable if they trade on such tips.

The seminal case involving tippee liability is Dirks v. SEC.[4]  In Dirks, the U.S. Supreme Court held the following:

In determining whether a tippee is under an obligation to disclose or abstain, it is necessary to determine whether the insider’s “tip” constituted a breach of the insider’s fiduciary duty.  Whether disclosure is a breach of duty depends in large part on the personal benefit the insider receives as a result of the disclosure.  Absent an improper purpose, there is no breach of duty to stockholders.  And absent a breach by the insider, there is no derivative breach.[5]

The question of what constituted a “personal benefit” was left ill-defined until the Second Circuit gave it shape in U.S. v. Newman.[6]  Newman held that a tipper and tippee must have a “meaningfully close personal relationship” and that the insider information be divulged in exchange for “a potential gain of a pecuniary or similarly valuable nature” for the court to find the tipper had breached his fiduciary duty to the source.[7]  For a period of time after the Second Circuit issued its opinion in Newman, it seemed that Martoma’s conviction was likely to be overturned.

Unfortunately for Martoma, the U.S. Supreme Court issued its opinion in U.S. v. Salman while Martoma’s appeal was pending.[8]  In Salman, the U.S. Supreme Court flatly rejected certain aspects of the Newman holding and called others into question.[9]  Accordingly, the Second Circuit held in Martoma that “Salman fundamentally altered the analysis underlying Newman’s ‘meaningfully close relationship’ requirement such that the ‘meaningfully close personal relationship’ requirement is no longer good law.”[10]

In Martoma, the court held that rather than looking at objective elements of the relationship between tipper and tippee, the proper inquiry is now whether the corporate insider divulged the relevant information with the expectation that the tippee would trade on it.[11]  This is “because such a disclosure is the functional equivalent of trading on the information himself and giving the cash gift to the recipient.”[12]

Please contact us if you have any questions about the Second Circuit’s opinion in Martoma or the law concerning insider trading generally.

Paul Foley is a partner with Kilpatrick Townsend & Stockton’s Winston-Salem and New York offices.  John I. Sanders is an associate based in the firm’s Winston-Salem office.

[1] U.S. v. Martoma, available at http://www.ca2.uscourts.gov/decisions/isysquery/71a89161-eec1-457e-b79b-a0d9503765c1/2/doc/14-3599_complete_opn.pdf#xml=http://www.ca2.uscourts.gov/decisions/isysquery/71a89161-eec1-457e-b79b-a0d9503765c1/2/hilite/.

[2] 15 U.S.C. 78j (2016).

[3] 17 CFR 270.10b-5 (2016).

[4] Dirks v. SEC, 463 U.S. 646 (1983).

[5] Id. at 647.

[6] U.S. v. Newman, 773 F.3d 438 (2d Cir. 2014).

[7] Id. at 452.

[8] Salman v. U.S., available at https://supreme.justia.com/cases/federal/us/580/15-628/opinion3.html.

[9] Id. at 10.

[10] U.S. v. Martoma, supra note 1, at 24.

[11] Id. at 25.

[12] Id.

Posted on Tuesday, August 22 2017 at 2:05 pm by

Adviser Settles with SEC over Insider Trading Controls for Political Intelligence Firms

By Paul Foley and John I. Sanders

Yesterday, the SEC announced a settlement under which Deerfield Management Company L.P. (“Deerfield”), a hedge fund adviser, agreed to pay more than $4.6 million.[i]  The SEC charged Deerfield with failing to “establish, maintain and enforce policies and procedures reasonably designed to prevent the illegal use of inside information”[ii] as required by Section 204A of the Investment Advisers Act of 1940 (the “Advisers Act”).[iii]

The SEC cited Deerfield for failing to tailor its policies and procedures “to address the specific risks presented by its business.”[iv]  In particular, Deerfield’s reliance on third-party political intelligence firms to provide insight into upcoming legislative and regulatory action created the risk that Deerfield would receive and illegally trade on inside information (e.g., a regulator’s unannounced decision to finalize a rule that would materially affect certain industries and publicly traded companies).[v]

The SEC’s settlement with Deerfield serves as a warning for advisers utilizing investment strategies dependent on obtaining or correctly predicting non-public information (e.g., unannounced mergers and acquisitions or the governmental approval of a pharmaceutical product), particularly those advisers partnering with third party consultants and analysts.  Such advisers should consider whether their current policies and procedures address the specific risks likely to arise under such strategies and partnerships.

Please contact us if you have any questions about the SEC’s recent settlement with Deerfield or an adviser’s obligations under the Advisers Act generally.

Paul Foley is a partner with Kilpatrick Townsend & Stockton’s Winston-Salem and New York offices.  John I. Sanders is an associate based in the firm’s Winston-Salem office.

[i] SEC, Hedge Fund Adviser Charged for Inadequate Controls to Prevent Insider Trading (Aug. 21, 2017), available at https://www.sec.gov/news/press-release/2017-146 (hereinafter SEC Release).

[ii] Id.

[iii] 15 USC 80b-4a (2017).

[iv] SEC Release, supra note 1.

[v] Id.

Posted on Thursday, August 17 2017 at 8:39 am by

DOL Proposes an Extension of the Fiduciary Rule Transition Period

By Paul Foley and John I. Sanders

When the DOL Fiduciary Rule became effective on June 9th, it marked the start of a transition period that was scheduled to end on January 1, 2018 (the “Transition Period”).[i]  During the Transition Period, compliance burdens under the Fiduciary Rule are relaxed.  For example, those seeking to rely on the Best Interest Contract Exemption (the “BIC Exemption”) will face less stringent requirements.[ii]  Also, the DOL stated that it would not bring enforcement actions during the Transition Period against “fiduciaries who are working diligently and in good faith to comply with the new rule and exemptions.”[iii]

Last week, the DOL submitted proposed amendments to the BIC Exemption and certain other exemptions to the Fiduciary Rule.[iv]  We learned of this development through a 2-page filing the DOL made in relation to ongoing litigation.[v]  Unfortunately, the filing provided little detail, and the full text of the proposed amendments will not be available to the public until the conclusion of an interagency review.[vi]  However, what seems apparent, based upon the title of the proposed amendments in the filing, is that the proposed amendments include an extension of the Transition Period from January 1, 2018 to July 1, 2019.[vii]

In the long term, we believe that the DOL’s proposed amendments foreshadow either significant modifications to or a full repeal of the Fiduciary Rule and its exemptions.  In the near term, we believe the extension of the Transition Period, coupled with the temporary non-enforcement policy, provides fiduciaries with a reason to breathe easier.

Please contact us if you have any questions about this article or the DOL Fiduciary Rule generally.

Paul Foley is a partner with Kilpatrick Townsend & Stockton’s Winston-Salem and New York offices.  John I. Sanders is an associate based in the firm’s Winston-Salem office.

[i] Department of Labor, Conflict of Interest FAQs (Transition Period) (May 2017), available at https://www.dol.gov/sites/default/files/ebsa/about-ebsa/our-activities/resource-center/faqs/coi-transition-period-1.pdf.

[ii] Id.

[iii] Id.

[iv] Thrivent Financial for Lutherans v. Acosta, et al., No. 0:16-cv-03289 (D. Minn. Sept. 29, 2016), available at http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&cad=rja&uact=8&ved=0ahUKEwjTqJP_utzVAhWI7CYKHdKTDrcQFggrMAE&url=http%3A%2F%2Fmedia.thinkadvisor.com%2Fthinkadvisor%2Farticle%2F2017%2F08%2F09%2Fthriventvdolnotice8-9-2017.pdf&usg=AFQjCNFWeSsTSR6C69Z17yHF1q1a7bkDpg.

[v] Id.

[vi] Id.

[vii] Id.

Posted on Wednesday, July 26 2017 at 8:58 am by

Six Ways to Improve Cybersecurity Policies and Procedures

By Paul Foley and John I. Sanders

The SEC has declared cybersecurity to be an examination priority for financial institutions (i.e., broker-dealers, investment advisers, and registered investment companies) in each of the past four years.[1]  While the SEC’s comments in these examination priority releases are helpful for financial institutions, we believe that the SEC may have provided more useful guidance concerning cybersecurity practices through investor bulletins designed to help investors avoid online fraud.[2]  This guidance reveals helpful insights into the SEC’s evolving approach to cybersecurity.  Accordingly, based on the SEC’s most recently issued guidance to investors, we identify six ways financial institutions could improve their cybersecurity policies and procedures below.[3]

1. Passwords. The SEC has recommended that investors choose a strong password (e., one that includes symbols, numbers, and both capital and lowercase letters) for online access, keep their password secure, and change it regularly.[4]  Consistent with this recommendation, financial institutions may want to consider requiring clients to choose strong passwords and change them regularly.

2.  Biometric Safeguards. The SEC has recommended that investors contact their financial institutions to determine whether they offer biometric safeguards (g., fingerprinting, facial and voice recognition, and retina scans) for mobile device access.[5]  Although biometric safeguards are not currently a standard security feature, financial institutions may want to consider ways they can add biometric safeguards as a feature of mobile device access for their clients.

3.  Public Computers. The SEC has recommended that investors avoid using public computers to access investment accounts.[6]  When an investor does use a public computer, the SEC recommends investors take the following precautions:  disable password saving; delete files, caches, and cookies; and log out of accounts completely when finished.[7]  Financial institutions could help investors follow the SEC’s helpful, but often forgotten, advice by, for example, requiring them to proactively check a box to enable password saving on each new device and automatically logging users out of their online accounts after relatively short periods of inactivity.

4.  Secure Websites. The SEC has recommended that investors not log in to an account unless the relevant financial institution’s website has a secure “https” address.[8]  Many financial institutions have a secure website already, but those that do not may want to consider implementing one.

5.  Links. The SEC has recommended that clients never click on links sent to them by financial institutions with which they do not have a relationship, and to confirm the legitimacy of links sent to them by their financial institutions by calling or emailing the purported sender.[9]  In response to this advice, financial institutions may want to use links judiciously, and ensure that those who will receive calls and emails from clients know what links have been sent to which clients and under what circumstances.  Without such knowledge, financial institution employees may be unable to confirm or deny the legitimacy of the link, undermining client confidence in the financial institution’s cybersecurity policies and procedures.

6.  Review Account Statements. The SEC has recommended that investors regularly review statements and trade confirmations for suspicious activity and contact their financial institution with a written complaint if there is suspicious activity.[10]  In response, financial institutions may want to evaluate their security procedures with respect to redemptions and distributions.  Adopting reliable technological innovations can help prevent suspicious activity and create a business advantage (g., using biometric safeguards or two-factor authentication may be more reliable and less time-consuming than requiring signature guarantees).

Please contact us if you have any questions about this article or the SEC’s cybersecurity guidance.

Paul Foley is a partner with Kilpatrick Townsend & Stockton’s Winston-Salem and New York offices.  John I. Sanders is an associate based in the firm’s Winston-Salem office.

[1] SEC, Examination Priorities for 2014 (Jan. 9, 2014), available at http://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2014.pdf; SEC, Examination Priorities for 2015 (Jan. 13, 2015), available at http://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2015.pdf; SEC, Examination Priorities for 2016 (Jan. 11, 2016), available at http://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2016.pdf;  SEC, Examination Priorities for 2017 (Jan. 12, 2017), available at https://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2017.pdf.

[2] SEC, Cybersecurity, the SEC and You (last visited July 25, 2017), available at https://www.sec.gov/spotlight/cybersecurity (containing a library of resources of both investors and securities industry professionals related to cybersecurity).

[3] SEC, Updated Investor Bulletin:  Protecting Your Online Investment Accounts from Fraud (April 26, 2017), available at https://investor.gov/additional-resources/news-alerts/alerts-bulletins/updated-investor-bulletin-protecting-your-online.

[4] Id.

[5] Id.

[6] Id.

[7] Id.

[8] Id.

[9] Id.

[10] Id.

Posted on Monday, July 24 2017 at 2:41 pm by

Wyoming Mid-Sized Advisers Can No Longer Register with the SEC

By Paul Foley and John I. Sanders

Wyoming required investment advisers to register with the state for the first time on July 1, 2017.[i]  Wyoming’s decision primarily affects those Wyoming-based advisers with between $25 million and $100 million in assets under management (“Mid-Sized Advisers”).  Generally, Mid-Sized Advisers may not register with the SEC.[ii]  However, Wyoming-based Mid-Sized Advisers were required to register with the SEC pursuant to an exception to the general rule.[iii]  That exception requires a Mid-Sized Adviser to register with the SEC if its principal office or place of business is in a state that does not require it to register.[iv]  Wyoming’s lack of a registration requirement for Mid-Sized Advisers and the SEC’s exception made Wyoming a destination for Mid-Sized Advisers who wanted to tout SEC registration.[v]  Some Mid-Sized Advisers went as far as to fraudulently claim to be based in Wyoming so that they could boast SEC registration.[vi]  Wyoming’s decision to require investment advisers to register with the state means that Wyoming-based Mid-Sized Advisers (real and fictitious) are no longer permitted to register with the SEC.  Instead, they must register with Wyoming and comply with its new regulatory regime.[vii]  This continues a shift, which we first noted in 2011, of primary responsibility for the regulatory oversight of Mid-Sized Advisers to the states.[viii]

Please contact us if you have any questions about the new law or its potential impact on your investment advisory business.

Paul Foley is a partner with Kilpatrick Townsend & Stockton’s Winston-Salem and New York offices.  John I. Sanders is an associate based in the firm’s Winston-Salem office.

[i] Wyoming Secretary of State, FAQs (March 14, 2017), available at http://soswy.state.wy.us/Investing/Docs/investment_faq_final.pdf.

[ii] 15 USC 80b-3a (2017); see also SEC, Division of Investment Management: Frequently Asked Questions Regarding Mid-Sized Advisers, available at https://www.sec.gov/divisions/investment/midsizedadviserinfo.htm (providing additional commentary related to the effect of certain Dodd-Frank Act provisions on Mid-Sized Advisers).

[iii] Id.

[iv] Id.

[v] See Danielle Andrus, ThinkAdvisor, Wyoming to Begin Registering RIAs (July 13, 2016), available at http://www.thinkadvisor.com/2016/07/13/wyoming-to-begin-registering-rias; see also Christine Idzelis, Investment News, Wyoming poised to scrutinize its RIA industry for the first time (July 6, 2016), available at http://www.investmentnews.com/article/20160706/FREE/160709978/wyoming-poised-to-scrutinize-its-ria-industry-for-the-first-time.

[vi] See In re Matter of New Line Capital, LLC and David A Nagler, IA-4017 (February 4, 2015), available at https://www.sec.gov/litigation/admin/2015/ia-4017.pdf; and In the matter of Wyoming Investment Services, LLC and Criag M. Scariot, IA-4014 (February 4, 2015), available at https://www.sec.gov/litigation/admin/2015/ia-4014.pdf.

[vii] Wyoming Secretary of State, Proposed Rules, available at http://soswy.state.wy.us/Investing/Docs/WyomingProposedRulesforIA.pdf.

[viii] Paul Foley, Kilpatrick Townsend & Stockton, LLP Investment Management Blog, Deadline for Meeting the New Investment Adviser Regulatory Requirements Under the Dodd-Frank Act is Quickly Approaching (Sept. 20, 2011), available at http://www.kilpatricktownsend.com/en/Knowledge_Center/Alerts_and_Podcasts/Legal_Alerts/2011/09/Deadline_for_Meeting_the_New_Investment_Adviser_Regulatory_Requirements.aspx.

Posted on Friday, July 14 2017 at 12:01 pm by

Broker-Dealers and Investment Advisers Exempted from CFPB’s Arbitration Agreement Rule

By Paul Foley and John I. Sanders

The Consumer Financial Protection Bureau (the “CFPB”) issued a final rule on July 10, 2017 that has received widespread attention.[1]  The rule, promulgated pursuant to section 1028(b) of the Dodd-Frank Act, generally regulates “arbitration agreements in contracts for specified consumer financial products and services.”[2]  More specifically, the rule prohibits the use of arbitration agreements by providers of certain financial products and services “to bar the consumer from filing or participating in a class action.”[3]  Despite the apparent wide sweep of the rule, it includes important exemptions for broker-dealers and investment advisers.

First, the rule expressly exempts from its prohibitions “broker-dealers and investment advisers, as well as their employees, agents, and contractors, to the extent regulated by the SEC.”[4]  Also, the rule exempts those “regulated by a State securities commissioner as a broker-dealer or investment adviser.”[5]  As a result of these exemptions, the use of arbitration agreements by broker-dealers and investment advisers will continue to be regulated by the SEC and state regulators.  So far, the SEC has not exercised its authority under section 921 of the Dodd-Frank Act to restrict the use of arbitration agreements as the CFPB has done, and there is no indication it will do so soon.[6]

Paul Foley is a partner with Kilpatrick Townsend & Stockton’s Winston-Salem and New York offices.  John I. Sanders is an associate based in the firm’s Winston-Salem office.

[1] See e.g., Megan Leonhardt, Money Magazine, CFPB Just Issued a New Rule That Would Protect Consumers From Predatory Fine Print (July 11, 2017), available at http://time.com/money/4852123/cfpb-mandatory-arbitration-rule/; Maria LaMagna, MarketWatch, CFPB Announces Rule That Could Help Consumers Sue Financial Firms for Millions (July 11, 2017), available at http://time.com/money/4852123/cfpb-mandatory-arbitration-rule/; and Jessica Silver-Greenberg and Michael Corkery, The New York Times, U.S. Agency Moves to Allow Class-Action Lawsuits Against Financial Firms (July 10, 2017), available at https://www.nytimes.com/2017/07/10/business/dealbook/class-action-lawsuits-finance-banks.html.

[2] CFPB, Final Rule: Arbitration Agreements (July 10, 2017), available at https://www.consumerfinance.gov/policy-compliance/rulemaking/final-rules/arbitration-agreements/ (hereinafter “Arbitration Rule”).

[3] Id. at p. 1.

[4] Id. at p. 478.

[5] Id. at p. 479.

[6] 15 U.S.C. 78o(o) (authorizing the SEC to regulate broker-dealer arbitration agreements) and 15 U.S.C. 80b-5(f) (authorizing the SEC to regulate investment adviser arbitration agreements).

Posted on Tuesday, June 6 2017 at 12:13 pm by

Kokesh v. SEC:  The U.S. Supreme Court Limits SEC Disgorgement Powers

By Paul Foley and John I. Sanders

Since the 1970s, courts have regularly ordered disgorgement of ill-gotten gains in SEC enforcement proceedings.[1]  According to the SEC, this was done as a means to both “deprive . . . defendants of their profits in order to remove any monetary reward for violating” securities laws and “protect the investing public by providing an effective deterrent to future violations.”[2]  Disgorgement has been one of the SEC’s most powerful tools in recent years.[3]  Yesterday, the Supreme Court issued an opinion that significantly limits the SEC’s ability to disgorge ill-gotten gains.[4]

The question before the Supreme Court in Kokesh v. SEC was whether disgorgement, as it has been used by the SEC, constitutes a “penalty.”[5]  Under federal law, a 5-year statute of limitations applies to any “action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise.”[6]  The SEC has long argued that disgorgement does not constitute a “penalty” and, therefore, is not subject to a 5-year statute of limitations.  The Supreme Court unanimously rejected the SEC’s position by holding that disgorgement constitutes a “penalty.”[7]  As a result, the SEC will be precluded from collecting ill-gotten gains obtained by the defendant more than five years before the date on which the SEC files its complaint.[8]

In the Kokesh case, the Supreme Court’s decision means that the defendant may retain $29.9 million of the $34.9 million of allegedly ill-gotten gains because that amount was received outside of the 5-year state of limitations.[9]  The Kokesh decision is also likely to have a significant long-term impact on SEC enforcement proceedings by reducing the leverage the SEC can apply while negotiating settlements.

Paul Foley is a partner with Kilpatrick Townsend & Stockton’s Winston-Salem and New York offices.  John I. Sanders is an associate based in the firm’s Winston-Salem office.

 

[1] SEC v. Texas Gulf Sulphur Co., 312 F. Supp. 77, 91 (SDNY 1970), aff ’d in part and rev’d in part, 446 F. 2d 1301 (CA2 1971).

[2] Id. at 92.

[3] SEC, SEC Announces Enforcement Results for FY 2016 (Oct. 11, 2016), available at https://www.sec.gov/news/pressrelease/2016-212.html (illustrating that the SEC has obtained more than $4 billion in disgorgements and penalties in each of the three most recent fiscal years).

[4] Kokesh v. SEC, available at www.supremecourt.gov.

[5] Id. (“This case presents the question whether [28 U.S.C.] §2462 applies to claims for disgorgement imposed as a sanction for violating a federal securities law.”).

[6] 28 U.S.C. §2462 (2017).

[7] Kokesh v. SEC, supra note 4, available at www.supremecourt.gov.  (“SEC disgorgement thus 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.”).

[8] Id.

[9] Id.