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Insight Center: Publications

3rd Circ: Injunctions in SEC Enforcement Actions Must Have a Preventive Purpose

Authors: Robert L. Hickok, Jay A. Dubow and Kaitlin L. O'Donnell

12/02/2019
3rd Circ: Injunctions in SEC Enforcement Actions Must Have a Preventive Purpose

Reprinted with permission from the December 2, 2019 issue of The Legal Intelligencer. © 2019 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.

Clarifying the scope of the U.S. Supreme Court’s 2017 decision Kokesh v. Securities Exchange Commission, the U.S. Court of Appeals for the Third Circuit has found that “obey the law” injunctions and industry bars in SEC enforcement actions are not “penalties” subject to the federal five-year statute of limitations. The court did, however, qualify this holding with a warning to the commission: In securities enforcement actions, injunction requests not narrowly tailored to a preventive purpose will be denied.

Under the applicable federal statute of limitations for SEC enforcement actions, 28 U.S.C. Section 2462, any “action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise” must be brought within five years of the date a cause of action accrues. In Kokesh, the Supreme Court held that disgorgement—a remedy frequently requested by the SEC, requiring individuals to repay funds received through insider trading, embezzlement, or other illegal business practices—constitutes a “penalty” under Section 2462. As a result, the commission is now barred from seeking disgorgement in the enforcement-action context outside Section 2462’s five-year window.

The Kokesh court relied on two principles to determine whether an equitable remedy like disgorgement is penal in nature. First, the court found that a remedy is properly understood as a penalty when “the wrong sought to be redressed is a wrong to the public,” rather than “a wrong to the individual.” Second, a remedy is penal in nature when it is imposed “for the purpose of punishment, and to deter others from offending in like manner,” rather than to “compensat[e] a victim for his loss.” Because disgorgement is a remedy sought for violations “against the United States rather than an aggrieved individual,” and is imposed to deter violation of public laws, the court found the remedy inherently punitive, and thus subject to the federal statute of limitations.

Defendants have since aimed to further limit the commission’s enforcement powers by extending the Kokesh court’s reasoning to a broader array of SEC equitable remedies. Lower courts are now left to determine if other forms of relief sought by the commission also constitute “penalties” under 28 U.S.C. Section 2462, and are therefore time-barred if not brought within five years of claim accrual.

The Third Circuit recently entered this fray. In Securities Exchange Commission v. Gentile, 939 F.3d 549 (3d Cir. 2019), the court considered whether to affirm the district court’s dismissal of the SEC’s request for an “obey the law” injunction against future violations of the federal securities laws and its request for a bar from participating in the penny stock industry. The district court (2017 U.S. Dist. LEXIS 204883 (D.N.J. Dec. 13, 2017)) held that these remedies—sought in connection with defendant Guy Gentile’s involvement in pump-and-dump schemes to manipulate penny stocks—were penalties, and thus subject to Section 2462’s five-year limitations period. Relying on Kokesh, the district court maintained that the SEC was seeking the injunction and bar in its enforcement action in order to punish the defendant accused of violating the federal securities laws. Accordingly, the district court found that the remedies sought were inherently punitive. Because the SEC filed its civil enforcement action eight years after Gentile’s participation in the pump-and-dump schemes at issue, the district court found the commission’s requested injunctive relief time-barred under Section 2462.

The Third Circuit disagreed. Looking first to the equitable principles governing injunctions, the court found that the injunctive process was designed not to punish individuals, but rather to “prevent them from doing wrong.” The court nevertheless noted that the historically preventive nature of injunctive relief might differ from how injunctions are used by the SEC in current practice. To determine whether the SEC’s contemporary use of injunctive relief is punitive in nature, the Gentile court examined both the text and history of the commission’s enforcement authority. It ultimately found that both text and history reinforce the fundamentally preventive, rather than punitive, character of injunctive relief: The commission can only obtain an injunction upon a meaningful showing of threatened harm. The Gentile court thus reversed and remanded the case to the district court to determine if the SEC made such a showing.

Though the Third Circuit ultimately found that “SEC injunctions that are properly issued and valid in scope are not penalties and thus are not governed by [Section] 2462,” the court nevertheless had strong words for both the SEC and lower courts considering SEC injunction requests. The court “stressed” that upon remand, the district court “should not rubber-stamp the commission’s request for an obey-the-law injunction simply because it has been historically permitted to do so by various courts.” Rather, the SEC is required to “carefully tailor” its injunctions “to enjoin only that conduct necessary to prevent a future harm.” If the commission fails to do so, the lower court “should, and must, reject the commission’s request.”

In so holding, the Third Circuit recognized that SEC injunctions involve “serious collateral consequences,” including loss of livelihood and significant harm to the personal and business reputations of enjoined defendants. The court also observed that industry bars, in particular, should be an extraordinary form of relief. As the Gentile court noted, quoting the D.C. Circuit, such bars can constitute “the securities industry equivalent of capital punishment.” Neither the commission nor the district courts should treat these requests lightly.

The Third Circuit’s reversal of the district court was a win for the SEC in finding that an injunction is not a penalty and therefore was not subject to the five-year statute of limitations. However, the Gentile decision could end up being a significant loss in holding that an SEC injunction may properly issue only when it is narrowly tailored to a preventive purpose, not when its practical effect is to punish a defendant. This could in turn open the door to courts limiting the scope and duration of injunctions in SEC enforcement actions, or even result in courts rejecting the imposition of an injunction in certain cases.

The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.

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