Week Ending June 9, 2017

Supreme Court Ruling on SEC Disgorgement Seen as Applicable to FERC

This Article Appears as Published in Foster Report No 3152
Supreme Court Ruling on SEC Disgorgement Seen as Applicable to FERC

Attorneys involved in FERC enforcement activities believe a June 5 U.S. Supreme Court decision involving the Securities and Exchange Commission (SEC) is directly applicable to FERC’s use of disgorgement rulings in enforcement and penalty cases.

FERC rulings that companies should disgorge what it deems unlawful profits under the Federal Power Act (FPA) or Natural Gas Act (NGA) would be subject to a five-year statute of limitations, based on the Supreme Court’s holding in the SEC case (Kokesh v. Securities and Exchange Commission, No. 16-529), the attorneys said. Even though the ruling involves the SEC, “this opinion applies directly to FERC,” said William Scherman, partner at Gibson Dunn and a former general counsel at FERC.

The level of applicability will be subject to litigation in individual FERC cases, especially about the timing of when the statute of limitations begins, said Michael Brooks, partner with Bracewell. But “there is a direct impact for FERC” that may influence how the Commission applies disgorgement rulings in future enforcement cases, Brooks said in an interview.

The way the SEC sought disgorgement in the case constituted a penalty under 28 U.S.C. §2462, which establishes a five-year statute of limitations, the Supreme Court concluded in its decision. The 9-0 opinion, written by Justice Sonia Sotomayor, reversed a U.S. Court of Appeals for the Tenth Circuit decision from 2016[1] that said SEC’s disgorgement directive is not a penalty and is not subject to the statute of limitations.

The decision leaves open the possibility that if disgorgement is limited to try and provide a remedy to a particular party harmed by an action, rather than as a punitive measure against a party that committed the action, there might be a different outcome and the statute of limitations would not be applied, Brooks said.

FERC’s Office of Enforcement (OE) has come under scrutiny following some high-profile penalty cases involving energy trading and charges of market manipulation at different firms, including Total Gas & Power North America Inc. (IN12-17), Powhatan Energy Fund LLC (IN15-3), BP America Inc. (IN15-13), and Coaltrain Energy LP (IN16-4), to name a few. In court petitions and FERC filings challenging the penalty cases, the companies involved have defended their actions and said FERC and its OE staff have been overly zealous about making charges of market manipulation.

In almost all the penalty cases pending in courts or at the Commission, there are FERC directives to disgorge what the Commission deems unjust profits, besides the financial penalties for violations of the FPA or NGA, with the dollar figures often higher for penalties. In the TGPNA proceeding, FERC is seeking civil penalties of $213 million against the company, $2 million and $1 million penalties against individual traders at the company, and $9.18 million in disgorgement of unjust profits.[2]

In the Powhatan case, which involved trading activity that took place from 6/1/10 to 8/3/10, Powhatan has said that by waiting until 7/31/15 to bring the case to court, FERC’s claims of penalties and violations are barred by the five-year statute of limitations for all but the last four days of the trading activity. “Where the statute of limitations bars a legal claim, it also bars concurrent equitable remedies like disgorgement,” the company said in a 10/19/15 filing at the U.S. District Court for the Eastern District of Virginia.

That is essentially what the Supreme Court said in the SEC case, ruling that the disgorgement ordered by the agency against investment advisory firm owner Charles Kokesh constituted a penalty within the meaning of §2462.

The Supreme Court decision is good news for Powhatan, said Kevin Gates, vice president of a managing member of the company. “It further highlights FERC’s incompetence” regarding the timing of when the Commission brought the case to court, in that “they couldn’t even act in a timely fashion” with a five-year statute of limitations, Gates told The Foster Report.

FERC can claim that its actions in bringing penalties and disgorgement rulings against companies for NGA and FPA violations are distinguishable from the SEC if it does not believe its disgorgement should be subject to a statute of limitations, but it would have to litigate that position in the court proceedings where the timing would be applicable, Brooks said.

Scherman, who represents TGPNA and other clients involved in challenging FERC enforcement rulings, held a stronger view that the statute of limitations will be a factor for FERC to address in disgorgement proceedings following the Supreme Court decision. “It is absolutely clear that Section 2462 applies to disgorgement in FERC cases,” based on the Supreme Court’s ruling, Scherman said.

In its decision, the Court addressed SEC enforcement action that began in 2009 with allegations that between 1995 and 2009, Kokesh misappropriated $34.9 million from business development companies and that to conceal the misappropriation, filed false and misleading SEC reports and proxy statements. The SEC sought civil financial penalties, disgorgement, and an injunction barring Kokesh from violating securities laws in the future.

The federal district court, in a decision upheld by the appeals court, said that any penalties for misappropriations that occurred before 10/27/04 – which was five years before the date the SEC filed its action with the court – were precluded, resulting in a penalty of about $2.3 million. The courts agreed with the SEC that the agency’s disgorgement judgement of $34.9 million did not constitute a penalty and that the statute of limitations does not apply to SEC disgorgement charges.

The Supreme Court reversed the lower courts and shot down the SEC arguments that disgorgement is not a penalty but a remedial action to lessen the effect of a violation and restore the status quo as before any wrongful activity.

Referring to prior cases, including a 2013 ruling from the Supreme Court (Gabelli v. SEC[3]), the Court said, “we hold that SEC disgorgement constitutes a penalty.” The courts have consistently held that the primary purpose of disgorgement orders is to deter violations of securities laws by depriving violators of any ill-gotten gains. They have also held that disgorgement orders sometimes exceed the profits gained as a result of a violation, leaving a defendant worse off and not restoring the status quo, according to the decision.

While victims of SEC violations may receive some disgorged funds, courts have no statutory obligation to distribute disgorged funds to victims, and they are paid to the U.S. Treasury, distinguishing them from restitution paid to an aggrieved party, the Supreme Court said.

Because of those factors, disgorgement orders go beyond compensation and are intended to punish wrongdoers for violating public laws. “Accordingly, any claim for disgorgement in an SEC enforcement action must be commenced within five years of the date the claim accrued,” the Supreme Court said.

In a June 7 energy legal blog posting, Bracewell noted that the high court decision limited its finding to SEC enforcement proceedings, “but the same factors likely will be applied when considering disgorgement by other federal agencies, including FERC” and the Commodity Futures Trading Commission.

The blog posting, written by attorneys Brooks, Bob Pease, Sarah Rafie and law student Josh Robichaud, said one element of SEC disgorgement actions cited by the Supreme Court – that disgorgement is used as a deterrent – could apply to FERC. Courts have found FERC disgorgement orders are not penalties, but they often cite SEC precedent to support such rulings, and that precedent “has arguably been overturned” by the high court, they said.

The blog noted that to distinguish any disgorgement ruling from being subject to a statute of limitations, FERC could argue, as the SEC did unsuccessfully, that it is not seeking a remedy for the public at large but “standing in the shoes” of particular injured parties.

In addition, unlike SEC disgorgements, disgorgements ordered by FERC often do not go to the U.S. Treasury, the Bracewell blog posting continued. While such funds may not go to parties directly harmed due to alleged violations, they have been provided to programs to benefit energy consumers, such as a directive for BP to disgorge about $207,000 through payments to the Texas Low Income Home Energy Assistance Program.

In a FERC enforcement case (IN12-7) against Constellation Energy Commodities Group that resulted in a settlement, the company agreed to disgorge profits of $110 million which was used to set up a consumer advocate office within PJM Interconnection, noted Tyson Slocum, director of the energy program at Public Citizen.

The disgorgement directives can be put to good use for consumers in market manipulation cases being pursued by FERC, but “disgorgement is a limited and imperfect tool to try and make consumers whole,” Slocum said. FERC’s refund authority under the FPA and NGA is a better tool, and once an effective date for refunds is established by the Commission, there is no statute of limitations on such rulings, he said.

By Tom Tiernan TTiernan@fosterreport.com

[1]  834 F. 3d 1158.

[2]  See, Challenging FERC Enforcement Staff, TGPNA Asks FERC to Hold Off on Market Manipulation Findings, FR No. 3132, pp. 24-26.

[3]  568 U. S. 442, 451-452 (2013).

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