This Week In Securities Litigation (Week ending April 21, 2017)

The Supreme Court heard argument this week in a case that may have a significant impact on remedies in SEC enforcement actions. In Kokesh v. SEC the High Court is considering whether the five year statute of limitations it previously held applies to penalties in SEC actions should also apply to requests for disgorgement. Application of the statute could speed Commission enforcement investigations and delimit the amount of disgorgement sought in enforcement actions.

The Division of Enforcement lost a proceeding in which Charles Hill had been charged with insider trading. ALJ Grimes concluded that there was no evidence Mr. Hill had received inside information in advance of a merger announcement despite the large and profitable trades he placed in the stock of the acquired company. Mr. Hill had previously challenged the Commission’s venue selection decision.

Finally, the Commission brought three civil injunctive actions this week. One was an offering fraud case in which much of the investor money was misappropriated, a second centered on false claims by an investment adviser regarding its AUM and a wholly fictitious fund and trading strategy and a third was a suspicious trading case.

Supreme Court

The Supreme Court heard argument in Kokesh v. SEC, No. 16-529. At issue is whether SEC claims for disgorgement are subject to the five year statute of limitations in Section 2462 of 28 U.S.C. If the remedy is time limited it would force the SEC to speed the initiation of its enforcement actions and preclude the agency from reaching back in time for years to increase the amount of money and the corresponding prejudgment interest it usually seeks as disgorgement in enforcement actions. Ultimately the statute would delimit the liability of those charged in SEC enforcement actions.

Throughout the oral argument the Justices questioned the predicate for the SEC’s disgorgement claims, probing the Commission’s contention that the remedy was beyond the reach of the statute of limitations. Much of the debate focused on how to categorize the remedy. Petitioner, citing the language of the statute which specifies that its five year time limit applies to any “civil fine, penalty, or forfeiture” sought by the Government, claimed that disgorgement fit squarely within the language of the statute. The SEC disagreed. Disgorgement is an equitable remedy designed to deny those who have acted wrongfully “ill-gotten” gains, according to the agency. Stated differently, the remedy is designed to ensure that those who violate the law do not profit from their wrongful conduct. Throughout the argument the Justices returned to the question of the SEC’s authority for seeking and imposing the remedy in an effort to assess the nature of the remedy, concluding ultimately that the agency implied it from the inherent power of the courts. Chief Justice Roberts may have summed up the case by noting that “it was utterly repugnant to the genius of our laws to have a penalty remedy without limit . . .” citing Chief Justice Marshall. A decision in the case is expected by the end of the Court Term on June 30, 2017.

SEC Enforcement — Litigated Actions

Insider trading: In the Matter of Charles L. Hill, Jr., Adm. Proc. File No. 3-16383 (Initial Decision April 18, 2017). The Order centers on the acquisition of Radiant Systems, Inc. by NCR Corporation, announced on July 11, 2011. The day after the deal announcement Mr. Hill sold shares he had purchased for his account and those of his daughters for more than $2 million, obtaining profits of over $740,000. The Order alleged that Mr. Hill was a third tier tippee and traded while in possession of material, non-public information. Specifically, the Order alleged that Andrew Heyman tipped Todd Murphy who in turn tipped Mr. Hill. Andrew Heyman, the younger brother of Radiant’s CEO John Heyman, was the firm’s COO. Mr. Murphy, an artist has no connection to the company. He is, however, a close friend of Mr. Hill, a commercial real estate developer. Mr. Hill has no connection to Radiant. John Heyman, Andrew Heyman and other senior corporate officials negotiated the acquisition deal. ALJ James Grimes concluded that “while Hill may have possessed certain information about Radiant, there is no evidence that he received any information from Murphy or that Murphy ever had any knowledge of the negotiations between NCR and Radiant. Nor is there any evidence that Andrew Heyman passed any information about those negotiations to Murphy.” The charges were ordered dismissed.

SEC Enforcement – Filed and Settled Actions

Statistics: Last week the SEC filed 3 civil injunctive cases and no administrative proceedings, excluding 12j and tag-along proceedings.

Offering fraud: SEC v. Fox, Civil Action No. 4:17-cv-271 (E.D. Tx. Filed April 19, 2017) is an action which names as defendants Wayne Energy, LLC and its sole member and manger, Matthew W. Fox. Beginning in March 2015 defendants raised about $950,000 from at least nine investors by selling interests in a joint venture formed to drill and operate an oil well. The offering materials, derived from an earlier failed venture, materially misstated material facts about the venture. Over half of the money raised was misappropriated. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). To resolve the action each defendant consented to the entry of a permanent injunction based on the Sections cited in the complaint and to pay disgorgement, prejudgment and penalties in amounts to be determined by the Court at a later date. Mr. Fox also agreed to a preliminary conduct based injunction prohibiting him or entities he controls from issuing or selling securities. See Lit. Rel. No. 23809 (April 19, 2017).

False statements: SEC v. Meadlin, Civil Action No. 1:17-cv-02752 (S.D.N.Y. Filed April 17, 2017) names as defendants Justin Meadlin, the founder and co-owner of defendant Hyaline Capital Management, LLC, at one time a registered investment company. Based on analytics from the Asset Management Group’s Aberrational Performance Inquiry, the complaint alleges that the firm falsely inflated its AUM. Investors were told that the firm managed between $17 and $25 million when in fact it never had more than $5.5 million under management. In addition, over an eighteen month period beginning in January 2013 defendants told investors about the successful results of a second fund based on a proprietary algorithm. In fact the second fund and algorithm did not exist. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Adviser Act Sections 206(1), 206(2) and 206(4). The case is pending. See Lit. Rel. No. 23808 (April 17, 2017).

Suspicious trading: SEC v. One or More Unknown Traders, Civil Action No. 17 CV 2659 (S.D.N.Y. Filed April 13, 2017). This action centers on the acquisition of General Communication, Inc. by Liberty Interactive Corporation, announced on April 4, 2017. General Communications provides residential and business telecommunications services in Alaska. Liberty competes in the video and digital commerce industries. The trading in the complaint took place through two accounts. One account was in the name of Cedrus Invest Bank SAL, Beirut, Lebanon. Trades were placed in the bank’s master account at Interactive Brokers, Inc. in the U.S. The master account had subaccounts. The other account was in the name of Nomura Securities plc, a UK based subsidiary of Nomura Europe Holdings plc. Nomura UK has a trading account at Nomura Securities International, Inc., in New York City. Liberty approached General Communication on December 2, 2016 about a deal in which the firm would be acquired. Several days later a non-disclosure agreement was executed. By January 21, 2017 a written proposal for a business combination was delivered to General Communication. Between the time of the initial proposal and the April 4 announcement date the deal progressed toward conclusion. All of the trading through the Cedrus and Nomura accounts was in options. None appears connected to events during the negotiations for the transaction. Overall there were five purchases through the Nomura account and three through the Cedrus account shortly before the deal announcement. The Nomura account purchased a total of 753 options at a cost of $21,434 while the Cedrus account acquired 540 option contracts at a cost of $26,675. All of the options purchased were out of the money. The option purchases represented a significant amount of the volume in those options. Neither account was hedged. Between October 1, 2016 and March 19, 2017, neither account purchased General Communication options. When the deal was announced the share price rose 62.4% compared to the prior day’s close. The initial investment in the two accounts, which totaled $48,109, was worth over $1 million. The complaint alleges violations of Exchange Act Section 10(b). The case is pending.

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Supreme Court Considers Time Limits On SEC Disgorgement Claims

Disgorgement, one of the SEC’s primary remedies, was the focus of intense debate during arguments before the Supreme Court in Kokesh v. SEC, No. 16-529 (S.Ct.) earlier this week. At issue was whether the remedy is subject to the five year statute of limitations in Section 2462 of 28 U.S.C. If the remedy is time limited it would force the SEC to speed the initiation of its enforcement actions and preclude the agency from reaching back in time for years to increase the amount of money and the corresponding prejudgment interest it usually seeks in enforcement actions. Ultimately the statute would delimit the liability of those charged in SEC enforcement actions.

The facts of the case highlight the potential impact of applying the statute of limitations to SEC disgorgement claims. Petitioner Charles Kokesh owned and controlled two registered investment advisers. In its enforcement action the SEC claimed that Mr. Kokesh improperly withdrew sums of investor money from the two advisers over a period of years. In the District Court Mr. Kokesh was found liable by a jury. The Court ordered him to pay, at the request of the Commission, $34.9 million in disgorgement (much of which was outside the five year time limit) and prejudgment interest. The SEC calculated the amount of disgorgement by reaching back in time over a long period of years. The Court also imposed a penalty of $2.3 million. The amount of that penalty was limited by the same five year statute of limitations at issue in this case – the Supreme Court previously held that the statute applied to SEC penalties despite contrary arguments by the agency. The Tenth Circuit Court of Appeals affirmed the decision of the District Court.

Throughout the oral argument the Justices questioned the predicate for the SEC’s disgorgement claims, probing its contention that the remedy was beyond the reach of the statute of limitations. Much of the debate focused on how to categorize the remedy. Petitioner, citing the language of the statute which specifies that its five year time limit applies to any “civil fine, penalty, or forfeiture” sought by the Government, claimed that disgorgement fit squarely within the language of the statute. The imposition of the remedy takes money away from those found liable and gives it to the SEC, according to Petitioner. The SEC then decides if the money should go to the U.S. Treasury or to repay those who may have suffered losses. Viewed in this context, the remedy is little more than a forfeiture Petitioner claimed and there is no doubt that such payments are penalties within the meaning of the statute. Newly seated Justice Gorsuch, in a series of questions, clearly seemed to agree with this point.

The SEC disagreed. Disgorgement is an equitable remedy designed to deny those who have acted wrongfully “ill-gotten” gains. Stated differently, the remedy is designed to ensure that those who violate the law do not profit from their wrongful conduct. While the Commission has repeatedly advanced this justification for its disgorgement claims over the years, as Petitioner noted and the Court indicated at certain points, the agency has taken inconsistent positions on the nature of the remedy. For example, the SEC has repeatedly stated that it is a penalty for tax purposes and under the bankruptcy code. This is permissible, according to the SEC, because the same word can have different meanings in different contexts.

Throughout the argument the Justices returned to the question of the SEC’s authority for seeking and imposing the remedy. As Justice Alito noted “Well, this case puts us in a rather strange position, because . . . to decide . . . we need to understand what this thing is. . . [and] know what the authority for it is . . .” Yet there is no express, statutory authority for the imposition of disgorgement. Rather, the SEC appears to have implied the remedy from the inherent equitable powers of the federal courts decades ago. The SEC has also failed to offer any guidance on the application of the remedy, as the response to a question from Justice Kagan made clear.

On the other hand, if the agency had not devised the remedy and Congress had passed a statute giving the SEC the authority to seek disgorgement, one would expect that a statute of limitations would have been imposed, Chief Justice Roberts noted. Indeed, “it was utterly repugnant to the genius of our laws to have a penalty remedy without limit . . .” the Chief Justice noted, citing the Chief Justice Marshall, the first Chief Justice of the Court. A decision in the case is expected by the end of the Court Term on June 30, 2017.

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