SEC Whistleblowers Have a Stake in Kokesh Case

On Tuesday the U.S. Supreme Court will hear arguments on a provision of law that has stood mostly unchanged since it was introduced more than 175 years ago — but that could, if interpreted badly, make it harder to maintain a pool of award money that’s been available to whistleblowers since the Dodd-Frank Act was implemented in 2011.

The provision in question is 28 U.S.C. § 2462, a catch-all that sets a five-year time limit for the enforcement of “any civil fine, penalty, or forfeiture” unless Congress specifies otherwise. In Kokesh v. Securities and Exchange Commission, the justices will consider whether this statute of limitations applies to disgorgements, a frequent remedy in SEC actions.

Disgorgements, in which offenders must return ill-gotten money, help to fill the coffers of the SEC’s Investor Protection Fund, from which Dodd-Frank whistleblowers are rewarded for providing tips that lead to successful enforcement actions.

The fund is adequately stocked right now: According to the SEC’s latest report, it stood at $368 million at the end of fiscal year 2016, above its targeted balance of at least $300 million. Payouts are accelerating as the Dodd-Frank whistleblower program matures, however. Over $57 million was paid out in fiscal 2016, more than all previous years combined.

The dispute in Kokesh is simple to state: If disgorgements are classified as either a “penalty” or a “forfeiture,” then they’re barred as a remedy if the underlying violation happened more than five years before the agency’s enforcement action — a standard that the Supreme Court interpreted strictly in Gabelli v. SEC, a decision from 2013.

In the case to be argued on Tuesday, a jury found that Charles Kokesh, an investment advisor, misused almost $35 million from small investors to support a lavish lifestyle that included a private polo ground and a stable of more than 50 horses. The trial court ordered him to disgorge the full amount, rejecting arguments that disgorgement was subject to Section 2462: The repayment order was remedial rather than punitive in nature, according to the court. The U.S. Court of Appeals for the Tenth Circuit agreed, and the Supreme Court granted Kokesh’s petition for review.

In addition to history, precedent, common sense, and several 19th-Century dictionaries, the SEC’s brief in Kokesh cites the collateral damage that would result if justices side with the fraudster — damage that extends well beyond securities cases, since the U.S. government regularly seeks disgorgement in other areas of law.

The SEC didn’t mention its Investor Protection Fund (IPF), but penalties and disgorgements — to the extent that they’re not set aside for victims of securities fraud — are the mechanism by which the whistleblower fund is stocked under Dodd-Frank. With the Gabelli decision already limiting the SEC’s ability to win penalties, any further restraint would be bad news.

An underfunded IPF wouldn’t hurt whistleblowers immediately: Under 15 U.S.C. § 78u-6(c)(1)(ii), the SEC can’t consider the fund’s balance when determining awards. Since all awards must ultimately be paid from the IPF, however, the agency’s ability to restock the fund is crucial — and certainly could be affected by Kokesh.

The SEC doesn’t estimate how many of its disgorgement actions might be subject to a five-year statute of limitations. In general, however, disgorgements provide a huge share of the agency’s recoveries via civil enforcement. In Dodd-Frank whistleblower actions, for instance, disgorgements accounted for more than 59% of the $584 million in financial sanctions that were ordered through fiscal 2016.

Whistleblowers and their advocates will be watching this case closely.

Tagged: Dodd-Frank Act, Securities and Exchange Commission (SEC)