Companies and individuals accused of securities law violations are increasingly pushing back on the SEC’s penalties and other remedies, testing the boundaries of the agency’s aggressive use of its enforcement tools.
The Securities and Exchange Commission’s enforcement expansion aligns with agency chair Gary Gensler’s investor protection priorities. The agency filed 434 new enforcement actions in fiscal year 2021, a 7% increase over the prior year.
The SEC’s assertiveness in seeking enforcement remedies has correspondingly emboldened defendants to question what is appropriate. Many of them have argued the agency is being overly punitive, latching onto a theme from recent US Supreme Court decisions that limited one such tool.
Courts have “been more involved in the SEC and how it’s doing remedies,” said Jeremiah Williams, a partner in Ropes & Gray LLP’s litigation and enforcement practice group. “There’s been more scrutiny, more litigation in this area.”
Defendants have accused the SEC of, among others, improperly seeking penalties in amounts beyond the law violator’s individual gains and pursuing injunctions that lack specifics.
Others also argue the government shouldn’t be able to pocket disgorgement payments—which the SEC uses to recover defendants’ ill-gotten gains—when securities fraud victims can’t be identified.
How lower courts decide these cases could help define the contours of the agency’s power when seeking disgorgement, injunctions, and other remedies. The SEC didn’t respond to a request for comment.
Reining in Remedies
The SEC’s enforcement division, led by former New Jersey Attorney General Gurbir Grewal, has taken a strong approach on remedies. During an October 2021 speech, Grewal said the agency will make “aggressive use” of various tools at its disposal, including barring individuals from being an officer or director of a public company.
The SEC has long enjoyed broad powers in enforcement remedies, attorneys said. But two US Supreme Court decisions, Kokesh v. SEC and Liu v. SEC, have provided defendants with ammunition in their challenges.
The Supreme Court in those cases considered whether disgorgement was improperly punitive. While the court said the SEC can continue to seek disgorgement, that type of concern has animated other challenges to SEC remedies, said Amy Jane Longo, a Ropes & Gray partner.
Island Stock Transfer Inc. argued in a recent case that the SEC’s disgorgement request against the stock transfer agent “bears all the hallmarks of a penalty.”
Ambassador Advisors LLC said in another case that an injunction requested by the SEC would “improperly serve punitive purposes” for its executives.
“It’s part of a trend to try rein in SEC enforcement and remedies by attacking the relief as punitive and framing it as overly penalizing the defendant,” Longo said.
Defendants in some cases have found traction. A federal judge in Pennsylvania recently denied the SEC’s requested injunction against Ambassador’s investment advisers. The judge noted the potentially career-ending consequences of such an order.
“Considering Defendants’ low likelihood of repeating their violations,” the judge wrote in a Sept. 7 opinion, “a permanent injunction would do little to protect the public and would instead venture into the territory of punishment.”
In another case focused on remedies, the US Court of Appeals for the Seventh Circuit this summer vacated a lower court injunction that required an investment adviser accused of fraud to “obey the law.” The court found the injunction lacked specifics.
It was at least the second circuit court to criticize these types of injunctions, which are routine in SEC cases.
A three-judge panel at the US Court of Appeals for the Ninth Circuit appeared sympathetic to arguments that securities law violators can’t be fined an amount beyond what they gained individually from their illegal scheme. Judges questioned the SEC about its view that any one defendant can be liable for the scheme’s entire gain.
“That’s not exactly what the statute says,” Judge Kim McLane Wardlaw said to an SEC attorney during an argument last week.
The Ninth Circuit hasn’t yet ruled in the case. The defendant, alleged shell company creator Imran Husain, pointed to Liu as support for the idea that courts must focus on funds that went to the defendant, “rather than to affiliates or the enterprise as a whole.”
Defendants also are expected to continue to test the SEC’s views on the types of business expenses that can be deducted from disgorgement. There are also questions, attorneys say, about when it’s appropriate for each defendant in a case to be responsible for the entire disgorgement amount.
“I think it falls to individual cases for parties to try to push the law further on areas like what kinds of business expenses can be deducted,” Longo said.
While defendants have been aggressive in pushing back, the SEC has also notched some key wins in its pursuit of remedies.
“It’s largely true that the case law after SEC v. Liu has helped the SEC establish a lot of the open questions in its favor,” Longo said.
District courts, for example, have approved the agency’s use of an expanded statute of limitations for disgorgement claims, a change enacted via amendments passed by Congress in 2021.
The agency got another important win last month, against Island Stock, when a Florida federal judge ruled the agency can pursue disgorgement even when it couldn’t identify victims of securities fraud. Island Stock has indicated an appeal is coming.
Another judge ruled similarly in a case against a Kansas man who allegedly violated an SEC trading suspension on penny stocks. Had the SEC lost, it could’ve faced the prospect of not being able to win disgorgement in certain cases, including insider trading.
That “is why I think you see the courts being very sympathetic to the SEC’s position,” said Elisha Kobre, a partner in Bradley Arant Boult Cummings LLP’s government enforcement and investigations and litigation practice groups. “They’re just not willing to allow disgorgement to escape.”