Tag: Statute of Limitations

District Court Invalidates Tolling Agreements in Criminal Securities Fraud Prosecution Case Due to Misunderstanding of Applicable Statute of Limitations

On January 30, 2017, the United States District Court for the District of New Jersey dismissed the government’s indictment against Guy Gentile for a pump-and-dump securities fraud scheme. After his arrest Gentile admitted to having engaged in the scheme and agreed to cooperate, which included signing two tolling agreements, each extending the statute of limitations for one year. In dismissing the indictments, the court held that the tolling agreements were invalid and the applicable statute of limitations for securities fraud was five years, not six years.

According to the opinion, Gentile engaged in a securities fraud scheme that indisputably ended in June 2008, at which time the statute of limitations for securities fraud was five years. In 2010, however, the Dodd-Frank Wall Street Reform and Consumer Protection Act extended the statute of limitations to six years for certain criminal securities fraud violations. Gentile was charged on June 25, 2012 and arrested on July 13, 2012, i.e. four years after the criminal conduct. Under interrogation, Gentile admitted to the fraud and agreed to cooperate with the government. Gentile entered into a tolling agreement with the government that tolled the limitations period from July 31, 2012 through July 31, 2013. Gentile subsequently signed a second tolling agreement, tolling the limitations period from July 31, 2013 through July 31, 2014. Gentile, however, refused to sign a third tolling agreement because he wanted all cooperation and criminal actions to be concluded by June 30, 2015. Critically, when entering the tolling agreements, both the government and Gentile assumed the statute of limitations was five years (the limitations period in effect at the time of the criminal conduct) and not six years (the limitations period in effect at the time of the arrest). Accordingly, at the time that the second tolling agreement expired, the government would have had to indict Gentile prior to July 31, 2015.

Unable to reach a plea deal, the government indicted Gentile in March 2016 and Gentile moved to dismiss. If the statute of limitations had been six years, the second tolling agreement would have presumably given the government until July 31, 2016 to indict. The court, however, disagreed. The court first found that, “limited to the specific facts of this case,” the tolling agreements were invalid because Gentile did not have a full understanding of the waiver. Slip Op. at 6. The court reasoned that “the waivers were executed unknowingly since Defendant clearly thought he was extending his exposure to criminal prosecution by two years when in fact, if the statute of limitations was six years, he was extending the period of exposure by three years.” Slip Op. at 7. That misunderstanding rendered the waivers invalid, with the effect that the statute of limitations was not tolled. Without a toll, the government’s deadline to indict was either June 30, 2013 (under the five-year limitations period) or June 30, 2014 (under the six-year limitations period). In either event, the March 2016 indictment was untimely.

After holding that the defendant’s ignorance of the potential six-year limitations period rendered the tolling agreements invalid, the court then held that the applicable statute of limitations is in fact five years, i.e., exactly what the Gentile had thought when he entered the tolling agreements. The court relied on the presumption against retroactivity absent express congressional intent. Since the applicable section of the Dodd-Frank act “contains no discussion nor mention of retroactivity, let alone clear intent that Congress intended th[e] section to apply to crimes committed prior to its enactment[,]” the six-year limitations period is not retroactive. Because the applicable statute of limitations was five years, even if the tolling agreements were valid, the indictment was untimely, as the tolling agreements would have only extended the statute of limitations until June 30, 2015.

Update: SCOTUS Will Consider Statute of Limitations on Disgorgement

We previously wrote about how the SEC urged the Supreme Court to grant certiorari in Kokesh v. SEC, and on Friday, January 13, the Court did just that. In an order without comment, the Court granted certiorari after both the petitioner and the SEC requested the Court’s review, albeit for different reasons. While the petitioner believes he should not be subject to disgorgement for ill-gotten gains that were obtained more than five years ago, the SEC wants the Court to bring clarity to the circuit split that has developed since the Eleventh Circuit’s decision in SEC v. Graham, which held that the five-year statute of limitations applies to disgorgement. As we previously noted, the SEC argued that Graham impedes its ability to achieve uniformity in the administration of securities laws.

We will continue to monitor developments in this case, which is sure to shape the timing of future SEC enforcement investigations and actions and the remedies it will seek.

SEC Urges Supreme Court to Consider Nature of Disgorgement

We previously posted about how the Southern District of Florida’s and Eleventh Circuit’s decisions in SEC v. Graham undermined the SEC’s long-held position that disgorgement was not subject to the five-year statute of limitations. The SEC recently asked the Supreme Court to examine that decision by joining the petitioner’s request for certiorari in Kokesh v. SEC, a case in which the Tenth Circuit affirmed an award of disgorgement, holding that the five-year statute of limitations did not apply.

In Kokesh, the SEC obtained a final judgment in 2014 that included nearly $35 million of disgorgement that covered ill-gotten gains obtained as far back as 1995. The Tenth Circuit affirmed the final award, diverging with Graham, and holding that disgorgement was not a penalty or forfeiture to which the five-year statute of limitations applied.  Kokesh applied for certiorari.

Last week, the SEC urged the Supreme Court to take the case. While briefly stating that the Tenth Circuit correctly ruled that disgorgement is not a penalty or forfeiture to which the statute of limitations applies, the SEC argued that “the issue is important to the administration of the securities laws, and the courts of appeals have reached conflicting conclusions” thereby warranting the Court’s review. Without the Supreme Court’s resolution, the SEC argued that it “is currently impeded by the decision in Graham from obtaining the full disgorgement remedies to which it is entitled” and described Graham as “a significant obstacle to national uniformity in administration of the securities laws.”

If the Supreme Court takes the case, the decision will directly impact the timing of SEC enforcement investigations and actions, as well as the types of remedies the SEC will seek. If the Court declines to grant certiorari, the SEC will likely try to seek different remedies in different jurisdictions for the same conduct. In the meantime, the SEC has increased its requests for tolling agreements in ongoing investigations in an apparent attempt to preserve its ability to seek the full range of remedies in the event that the investigation leads to the filing of an action.

Update: IRS, SEC, and Courts Diverge on Nature of Disgorgement

We previously wrote about decisions in SEC v. Graham from the Eleventh Circuit,  __ F.3d __, No. 14-13562, 2016 WL 3033605 (11th Cir. May 26, 2016), and the U.S. District Court for the Southern District of Florida, 21 F. Supp. 3d 1300 (S.D. Fla. 2014), considering whether disgorgement claims and other remedies were subject to five-year statute of limitations on actions “for the enforcement of any civil fine, penalty, or forfeiture” codified in 28 U.S.C. § 2462. The Eleventh Circuit affirmed the decision of the lower court that the SEC’s disgorgement claims were time-barred, holding that “disgorgement” is synonymous with the plain meaning of “forfeiture” as it is used in the statute.

On May 6, 2016—shortly before the Eleventh Circuit issued its ruling in Graham—the IRS published non-precedential Chief Counsel Advice (“CCA”) on whether Internal Revenue Code Section 162(f) bars business expense deductions for disgorgement paid to the SEC of profits stemming from alleged violations of the Foreign Corrupt Practices Act (“FCPA”). The disgorgement payments were part of a consent agreement between the SEC and the taxpayer, whose subsidiary allegedly falsified accounting records in order to conceal gifts it made to officials of a foreign government in exchange for business benefits. The taxpayer paid additional penalties for which it specifically agreed it would not seek a tax deduction in a parallel agreement with the DOJ relating to the criminal case against taxpayer’s subsidiary. The IRS concluded that the taxpayer’s disgorgement payments were not deductible business expenses under § 162(f), which prohibits deduction of any “fine or similar penalty paid to a government for the violation of any law” as a business expense.

As explained in the CCA, § 162(f) has been interpreted to bar deductions of civil penalties where they are “imposed for purposes of enforcing the law and as punishment,” but to allow deduction of civil penalties if “imposed to encourage prompt compliance with a requirement of the law”—for example, “late filing charges or other interest charges”—or “as a remedial measure to compensate another party.”  Emphasizing that disgorgement in securities cases has deterrent aims, is a discretionary remedy, and might be required even if there is no injured party or in amounts exceeding actual losses, the IRS determined that whether disgorgement is primarily punitive or primarily compensatory for the purpose§ 162(f) is a fact-specific inquiry. Additionally, disgorgement imposed as a “discretionary equitable remedy” or where the proceeds are used to compensate victims might still be primarily punitive if it resembles forfeiture, which remains non-deductible even when used to compensate victims. With respect to the FCPA disgorgement the taxpayer had made to the SEC, the IRS concluded that its purpose was primarily punitive, and therefore it could not be deducted, because there was no evidence that it was meant to compensate the government or some other party for loss.

The SEC, the IRS, and the Eleventh Circuit have thus articulated three distinct characterizations of disgorgement. To avoid the limitations period of § 2462, the SEC’s position, adopted by the D.C. Circuit in Johnson v. SEC, 87 F.3d 484 (D.C. Cir. 1996), has been that disgorgement is a non-punitive equitable remedy. In the IRS’s view, disgorgement to the SEC may—but perhaps does not always—have a punitive purpose that bars tax deduction. The Eleventh Circuit has equated the statutory definitions of disgorgement and forfeiture, without commenting on whether disgorgement to the SEC is a “penalty.”

Update: Eleventh Circuit Affirms Dismissal of Claims for Declaratory Relief and Disgorgement in SEC v. Graham, __ F.3d __, No. 14-13562, 2016 WL 3033605 (11th Cir. May 26, 2016)

We previously wrote about a decision out of the U.S. District Court for the Southern District of Florida in SEC v. Graham, 21 F. Supp. 3d 1300 (S.D. Fla. 2014), which involved claims by the SEC in connection with an alleged $300 million real estate Ponzi scheme. Echoing the Supreme Court’s reaffirmation in SEC v. Gabelli, 133 S. Ct. 1216 (2013), of the importance of statutes of limitation “to the welfare of society,” the district court had held that the five-year statute of limitations in 28 U.S.C. § 2462 is jurisdictional rather than a “claim-processing rule” and that the limitations period provided by § 2462 applies not only to civil penalties but also to equitable relief including injunctions, declaratory relief, and disgorgement. On May 26, 2016, the Eleventh Circuit affirmed in part, reversed in part, and remanded this decision for further proceedings.

The Eleventh Circuit disagreed with the district court’s characterization of injunctive relief as “nothing short of a penalty” and therefore subject to the § 2462 time limit on actions “for the enforcement of any civil fine, penalty, or forfeiture.” Noting that it was bound by its previous holding that “[t]he plain language of section 2462 does not apply to equitable remedies,” United States v. Banks, 115 F.3d 916, 919 (11th Cir. 1997), the court additionally explained that injunctions are not “penalties” because they are forward-looking rather than backward-looking relief.

Nevertheless, the court affirmed dismissal of the SEC’s claims for declaratory relief and disgorgement. The court reasoned that unlike injunctive relief, declaratory relief is backward-looking and “operate[s] as a penalty under § 2462” because “[a] public declaration that the defendants violated the law does little other than label the defendants as wrongdoers.” With respect to disgorgement, the court held that there is “no meaningful difference” between the plain-language definitions of “forfeiture” as used in § 2462 and “disgorgement,” and the court rejected the SEC’s distinction of the terms as “technical definitions” that Congress cannot be assumed to have meant to apply in the absence of clear indication in the statute. Having determined whether § 2462 applies to injunctive relief, declaratory relief, and disgorgement, the court declined to reach the issue of whether the limitations period is jurisdictional in nature.

Although the court agreed with the SEC’s position on injunctive relief, this holding is likely to be of little comfort to the agency. While reasoning that it would be “premature to review the precise nature of” an injunction the district court had not yet issued, the court noted that the injunction requested in the Graham complaint was the type of “obey-the-law” injunction—that is, an injunction prohibiting “the defendants from violating federal securities laws”—it has consistently held to be unenforceable. While the court reasoned that the issue was appropriate for consideration because it “is at least possible that the SEC could seek injunctive relief that would be specific and narrow enough that the parties would be afforded sufficient warning to conform their conduct,” it offered no opinion on what enforceable injunctive relief might look like.

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