The Securities and Exchange Commission may have to rethink its approach to private fund enforcement action following a Supreme Court ruling, according to law firm Latham & Watkins.
The court found that disgorgement – a penalty that has been handed out to private funds managers for various violations – is subject to the five-year statute of limitations that applies to any civil fine, penalty or forfeiture.
This will have a significant impact on the SEC’s ability to conduct lengthy investigations tha because the statute of limitations will eliminate disgorgement claims as the investigation continues.
The law firm said the SEC may have to decide earlier in an investigation whether to recommend enforcement proceedings or to rely more on tolling agreements, which waive a right to claim that litigation should be dismissed due to the expiration of a statute of limitations.
“The SEC will need to reconsider its approach to enforcement in areas such as private equity, as the agency has brought actions based on alleged disclosure defects in governing documents executed many years prior to the enforcement action,” it said in a client note.
Latham & Watkins said the SEC had brought a number of enforcement actions against large private equity fund managers based on fund document disclosures, but documents drafted after the Dodd-Frank’s 2012-effective date typically include more specific disclosures.
“The evolution in fund documents toward greater specificity, coupled with the strict enforcement of the five-year statute of limitations may reduce the number of SEC enforcement actions focused on private equity,” the firm added.
The ruling was on a case involving investment adviser Charles Kokesh, who was sued by the SEC in 2009 for misappropriating investors' money. His penalties covered conduct within the five-year statute of limitations, but the disgorgement covered conduct that largely occurred outside that time frame.
Kokesh appealed to the Supreme Court and argued that a disgorgement in the case constituted a punitive “forfeiture” that is time-barred.
Writing for the court, Justice Sonia Sotomayor said that disgorgement counts as a penalty and is therefore bound by a five-year statute of limitations that already applies to “any civil fine, penalty or forfeiture.”
The SEC disgorgement process “bears all the hallmarks of penalty: It is imposed as a consequence of violating a public law and is intended to deter, not to compensate,” Sotomayor wrote.