A unanimous ruling by the U.S. Supreme Court could affect the way the Securities and Exchange Commission obtains payment for ill-gotten gains, legal analysts say, though it could take some time to determine the full impact of the decision.

In a 9-0 ruling in Charles Kokesh v. Securities and Exchange Commission on June 5, the high court found that the SEC’s “disgorgement” recovery method is subject to a five-year statute of limitations. The justices sided with New Mexico-based investment adviser Charles Kokesh, who had been ordered to pay $2.4 million in penalties plus $34.9 million in disgorgement of illegal profits after the SEC sued him.

“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,” Judge Sonia Sotomayor wrote. “The 5-year statute of limitations … therefore applies when the SEC seeks disgorgement.”

The decision notes that disgorged profits “are paid to the district courts, which have discretion to determine how the money will be distributed.”

“They may distribute the funds to victims,” the decision said, “but no statute commands them to do so. When an individual is made to pay a noncompensatory sanction to the government as a consequence of a legal violation, the payment operates as a penalty.”
 
The SEC argued that disgorgement is not punitive but rather a remedial sanction that operates to restore the status quo. But the ruling said that “it is not clear, however, that disgorgement simply returns the defendant to the place he would have occupied had he not broken the law. “

“It sometimes exceeds the profits gained as a result of the violation,” the ruling said.

The SEC had charged Mr. Kokesh with misappropriating funds from four business development companies in violation of federal securities laws from 1995 through 2006. The U.S. District Court in Las Cruces, New Mexico, in 2014 ordered the disgorgement of $34.9 million plus prejudgment interest of $18.1 million and imposed a $2.4 million civil penalty.

In August 2016, the 10th U. S. Circuit Court of Appeals in Denver held the SEC was not subject to a five-year statute of limitations, and Mr. Kokesh appealed.

However, in May 2016 a three-judge panel of the 11th U.S. Circuit Court of Appeals in Atlanta had issued a contradictory opinion in Securities and Exchange Commission v. Barry J. Graham, in a case involving the sale of condominiums, which set up an appellate conflict that led to the U.S. Supreme Court agreeing to hear the Kokesh case.

An SEC spokeswoman declined to comment on the ruling, but the commission said in a Dec. 16 court filing that disgorgement “is intended to prevent unjust enrichment, not to punish a wrongdoer for having committed the violation.”

Kevin LaCroix, an attorney and executive vice president with RT ProExec, a division of R-T Specialty L.L.C., in Beachwood, Ohio, and the author of “The D&O Diary” blog, said the magnitude of the ruling could mean the SEC will file smaller or even fewer claims.

“There is no doubt that the ruling will help defendants in some cases to reduce or even defeat the SEC’s claims against them, but the magnitude of those changes will only become clear with the passage of time,” Mr. LaCroix wrote in an email. 
 
Regarding the potential impact on the directors and officers liability insurance marketplace, Mr. LaCroix wrote that “this development is largely neutral, as carriers typically would take the position that their policies do not insure disgorgement amounts.”

Saskia Zandieh, counsel at Miller & Chevalier Chtd. in Washington, said “there is no doubt that the ruling will help defendants in some cases to reduce or even defeat the SEC’s claims against them, but the magnitude of those changes will only become clear with the passage of time.”

“I think the impact for the SEC is that they’re going to have to go faster,” Ms. Zandieh said. “I’m assuming they’re not going to have more resources which means they’re going to have to execute discretion and drop the cases that aren’t easy to prove. The more difficult cases will be dropped more quickly if they actually want to close cases.”

Deborah Meshulam, a partner with DLA Piper in Washington D.C., said it was important to recognize that most of the SEC cases are within the five-year statute of limitations.

“This is a recognition that there are limits to the extent to which the government can punish wrongdoers,” she said. “The SEC can ask for tolling agreements, where the person involved with the investigation agrees that the statute of limitations won’t run for a particular period, and I would suspect that the SEC may seek to use tolling agreements earlier and more frequently in investigations. It can also seek a legislative fix, though it’s unclear how that would fare in Congress.”

Ms. Meshulam co-authored an analysis of the decision that appears on her firm’s website. The report noted that a footnote in the ruling may well invite further attacks against disgorgement orders.

The language of the footnote, the report said, “suggests that the Court may have some doubt about whether the SEC is authorized to seek — or courts are authorized to order — disgorgement at all, particularly since disgorgement is not a remedy contained in federal securities laws. Indeed, several justices posed skeptical questions along these lines during oral argument in the Kokesh case.”

“It’s a highly significant ruling, not only because of the statute of limitations, but because it puts into play whether the SEC has the power to obtain disgorgement from a federal court in any case,” said David Kornblau, a partner with Covington & Burling L.L.P. in New York.