By Rodney F. Tonkovic, J.D.
The Supreme Court has denied certiorari for two petitions taking issue with how the SEC calculates monetary remedies. In Smith v. SEC, the petition took issue with what it described as an extra-legal disgorgement order, which the SEC had no power to obtain. In Murphy v. SEC, the petitioners challenged the SEC's practice of slicing violations into multiple components and then seeking maximum penalties for each piece. In the same order list, the Court also denied a motion by the Administrative Law Scholars to participate in oral argument in SEC v. Jarkesy.
Smith v. SEC. First, the court denied certiorari in Smith v. SEC, the petition for which was filed in September 2023. Petitioner David Smith was convicted of operating a long-term Ponzi scheme, served time in prison, and satisfied a $6 million restitution order. The SEC brough a parallel proceeding against Smith and his codefendants and successfully moved for summary judgment on disgorgement in 2015. The district court held Smith jointly and severally liable for $99 million, and the Second Circuit upheld the order.
Smith then moved for relief from the disgorgement order under the FRCP, arguing that the order exceeded the limits for equitable relief and was an unauthorized penalty. The Second Circuit ruled that relief was not available to Smith because he did not allege that the judgment was "void" within the meaning of the rule and that he failed to allege a jurisdictional error or a due process violation that would render the judgment void.
The petition argued that by ordering Smith to disgorge far more money than he actually received via the scheme, the SEC imposed an impermissible penalty. Under Liu v. SEC, Smith argued, the only disgorgement relief Congress authorized was in an order that securities violators give up their net profits, and the SEC was barred from seeking extra-statutory penalties that did not conform to the limitations on "equitable relief." Smith also raised arguments about the text of FRCP 60(b)(4), contending that the rule contains no language narrowing the meaning of "void" to specific defects and that the Court should refuse to allow an overly restrictive reading. Without the Court's intervention, the petition concluded, lower courts will continue to reward the SEC by extracting unauthorized, extra-legal penalties from civil defendants.
Murphy v. SEC. The petition in Murphy v. SEC, filed in June 2023, asked the Court to address how civil penalties are calculated in SEC enforcement cases. The petitioners were sued by the SEC in 2018 over an alleged scheme to flip municipal bonds while acting as unregistered brokers. The district court found that the petitioners were "brokers," and petitioner Jocelyn Murphy, in particular, was ordered to pay a civil penalty of $1,761,920 based on her providing 21 underwriters with false zip codes. A Ninth Circuit panel affirmed.
The petition took issue with how the SEC "slices and multiplies" violations. In this case, Murphy's penalty was arrived at by multiplying the applicable statutory cap by the number of times she had included inaccurate zip code information in her communications with securities brokers. For the other two petitioners, the court multiplied the statutory cap by the number of months they were not registered with SEC as brokers.
The petition argued that the "arbitrary and inconsistent" counting of violations exceeds the statutory caps set by Congress. If Congress wanted penalties based on units of time, it would have explicitly said so, as it has done elsewhere, and the most natural reading of "each violation," the petition argued, is as a single course of conduct. The petition argued further that the penalties were excessive under the Eighth Amendment because the fines levied were grossly disproportionate to the gravity of the petitioners alleged offenses.
The petition also asserted that the Ninth Circuit has expanded who must register as a broker-dealer. The Ninth Circuit found that the petitioners were brokers because they at times took direction and financing from, and shared profits and losses with, another person. This conflicts with the common understanding of "broker," the petitioners said, and greatly expands the universe of those required to register. Such an expansion should only occur through legislation, or, at a bare minimum, SEC rulemaking, the petition argued.
Jarkesy amicus rejected. In the same list, the Court also rejected, without explanation, a motion by the Administrative Law Scholars to participate in the SEC v. Jarkesy oral argument as amici curiae and for divided argument. Taking the side of the SEC, the Scholars agree that the for cause limitations on the removal of SEC ALJs are constitutional. Further, the rationale in Free Enterprise Fund does not apply in this case and the Fifth Circuit's ruling on that issue should be reversed. Oral argument in Jarkesy is set for November 29, 2023.
The Scholars disagree with the SEC on one point, however. The SEC believes that if Free Enterprise Fund does not apply, the Court should set aside limitations on ALJ removal. According to the Scholars, if double for-cause removals are unconstitutional, the problem can be solved by setting aside the removal restrictions applicable to the SEC Commissioners or those applicable to the ALJs. The Scholars would prefer to retain the express limits set out by Congress in the Administrative Procedure Act over the implied limits for SEC Commissioners. The motion for leave to participate argued that, unless the Scholars could have five minutes limited to the remedy argument, no other party would take this position.
Read the Docket. This case, and others before the Court, may be referenced in the latest version of the Supreme Court Docket, a regular feature of Securities Regulation Daily. Issued opinions, granted petitions, pending petitions, and denied petitions are listed separately, along with a summary of the questions presented and the current status of each appeal.