The Third Circuit handed the SEC a win in finding that a penny stock bar and an "obey the law" injunction are not "penalties," but cautioned the SEC to make sure the injunctions they seek are narrowly tailored and serve a preventive purpose.
In an issue of first impression in the Third Circuit that fills in unmapped areas following Kokesh v. SEC, an appellate panel found that, unlike disgorgement, penny stock bars and "obey the law" injunctions in SEC enforcement actions are not "penalties" for purposes of the 5-year statute of limitations in 28 U.S.C. § 2462. Accordingly, the panel vacated and remanded the dismissal of an SEC enforcement action involving penny stock manipulation, which a district court had deemed untimely (SEC v. Gentile, September 26, 2019, Hardiman, T.).
"Because an injunction must be fully supported by threatened harm, we reject Gentile’s argument that a properly issued and framed SEC injunction can be a ‘penalty’ as defined by Kokesh," wrote the panel.
Remedies barred by lower court. From 2007 to 2008, Guy Gentile, the owner of an upstate New York broker-dealer, was involved in two pump-and-dump schemes to manipulate penny stocks. In an enforcement action brought in the District of New Jersey, the SEC initially sought several remedies: disgorgement of wrongful profits; a civil monetary penalty; an "obey the law" injunction prohibiting Gentile from violating the federal securities laws; and an order barring him from the penny stock industry.
Following the Supreme Court’s ruling in Kokesh v. SEC that disgorgement is a "penalty" for purposes of the five-year statute of limitations in 28 U.S.C. § 2462, the SEC dropped its requests for disgorgement and a civil monetary penalty but pressed on with the other requested injunctions. The district court dismissed the case, finding that the penny stock bar and "obey the law" injunction were also "penalties" for purposes § 2462, so were barred by the 5-year statute of limitations.
Remedies were not "penalties." In this issue of first impression, a three-judge panel of the Third Circuit disagreed with the district court that the penny stock bar and "obey the law" injunction were "penalties" for purposes of § 2462. The case turned on whether the remedies, found in 15 U.S.C. § 78u(d) (Exchange Act Section 21), were imposed for punitive reasons.
First, the panel found that the §78u(d)(6) penny-stock industry bars are a species of injunction. The statute’s structure, use of the term "prohibit," and findings by at least two courts of appeal all pointed to this conclusion.
Next, the panel looked at the equitable principles governing injunctions. Under a core tenet of equity jurisprudence, the historic injunctive process was designed to deter, not to punish. The primary goal of prevention of future harm most sharply distinguished SEC injunctions from the disgorgement remedy at issue in Kokesh, said the panel.
Ruling does not open the door inappropriately. The court puzzled briefly over a question: if SEC disgorgement is both an equitable remedy and a § 2462 penalty, could an injunction be both also? The court concluded that it could not. Unlike § 78u(d)(1) and (6) injunctions, SEC disgorgement is not explicitly authorized by statute, but has instead been justified as part of courts’ inherent equity power to grant relief ancillary to an injunction. Also, because the aim of injunctions is to deter, not punish, the panel did not believe that Kokesh opened the door to punitive injunctions.
The panel allowed the possibility that in its zeal for enforcement, the SEC has recently tended to seek injunctions in part for their general deterrent effect. However, any tendency in that direction would be at odds with the SEC’s own understanding of the limits on its powers, said the panel. Also, although there is a difference of opinion as to whether "obey the law" injunctions should be issued generally, the issue here was confined to the applicability of the statute of limitations, and the appropriate scope of an injunction against further lawbreaking depends on the facts and circumstances of each case.
Be careful about use of injunctions. Finally, the panel noted that SEC injunctions have serious collateral consequences, including possible administrative sanctions and disabilities, collateral estoppel of defendants in subsequent private litigation, and harm to personal and business reputations. Given this, the panel reinforced the parameters within which an injunction is properly issued and framed. The panel cautioned that "the harsh effects of an SEC injunction demand that it not be imposed lightly or as a matter of course, that it be imposed only upon a meaningful showing of necessity, and when it is imposed, that it be as short and narrow as reasonably possible."
Vacated and remanded. Accordingly, the panel vacated the district court’s order dismissing the SEC’s enforcement action and remanded the case for the district court to decide whether the injunctions sought are permitted under § 78u(d). The panel stressed that on remand, the district court should not rubber-stamp the SEC’s request for the injunctions but should analyze whether they serve a preventive purpose and are carefully tailored.
The case is No. 18-1242.
Attorneys: Nancy A. Brown for the SEC. Adam C. Ford (Ford O'Brien, LLP) for Guy Gentile.
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