Civil Penalties in SEC Enforcement Actions.

The SEC does not directly charge you or sentence you to any civil penalty. Instead, the SEC brings enforcement actions, which it formally terms civil enforcement proceedings, and, if it establishes liability in one of these proceedings, a Commission order or a federal court judgment enforces the penalties. The SEC is the civil enforcement arm of the U.S. government. It does not have authority to pursue criminal enforcement. However, the Justice Department can intervene, and a joint SEC/DOJ investigation will leave you at risk of federal criminal prosecution. Additionally, the statutory tiers of civil penalties generally establish ceilings, not minimums, or mandatory amounts.

What is a Wells Notice?

A Wells notice is a letter notifying you that the SEC staff intends to recommend that the Commission impose a civil penalty. It is not a formal penalty imposed by the SEC. There is no guarantee that the Commission will approve the SEC staff’s enforcement recommendation. The Commission generally must approve the SEC staff’s enforcement recommendation before the SEC can file an enforcement action in federal court or initiate an administrative proceeding.

What is an SEC Formal Order?

A formal order is an internal commission order that authorizes the SEC staff to initiate an investigation and use the SEC’s subpoena authority to require the production of documents or testimony. It is not an enforcement action that involves an assessment of civil penalties.

How Much Will the SEC Seek to Assess in Civil Penalties?

The amount that the SEC seeks to assess in civil penalties will depend on whether the SEC staff has classified your alleged violation as “Tier 1,” “Tier 2,” or “Tier 3.”

How does the SEC Calculate My Maximum Civil Penalty?

1. What Federal Security Statutes Are Involved?

The four principal federal securities laws enacted in 1933, 1934, and 1940 all use parallel three-tier civil penalty structures. While their specific language differs slightly and the statutes refer to the specific penalties they authorize, the general framework is the same. These are the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Adviser Act of 1940, and the Investment Company Act of 1940.

2. What Are the Eligibility Requirements for the First-Tier Civil Penalty?

Generally, a civil monetary penalty falling into the first tier will apply to all types of SEC violations. For defendants not intending to challenge the basis for the SEC’s enforcement proceeding or to pursue settlement negotiations, the first tier may be their best option for resolution.

3. What Are the Eligibility Requirements for the Second-Tier Civil Penalty?

A defendant’s violation will generally trigger the second tier of civil penalty exposure if it meets any one of the following eligibility requirements. In an enforcement proceeding:

• The defendant’s alleged conduct involved fraud, deceit, manipulation, or plotting a deceptive scheme.
• The defendant alleged a violation that involves an intentional or reckless disregard of a regulatory compliance requirement.
• The Commission may assess a second-tier penalty for each such violation, and the gross amount of pecuniary gain to the defendant may be substituted for the statutory ceiling when that gain is greater.

The statutory ceiling for the second tier is five times larger than the first tier for entities and ten times larger for natural persons.

4. What Are the Eligibility Requirements for the Third-Tier Civil Penalty?

In addition to any of the eligibility requirements for the second tier, civil penalties in the third tier will apply when the alleged violation “directly or indirectly resulted in substantial losses or created a significant risk of substantial losses to other persons.” This typically applies when the defendant’s alleged violation resulted in substantial pecuniary gain to the defendant or when the defendant’s alleged violation created a significant risk of substantial pecuniary loss to others.

5. How Does the SEC Determine the Annual Inflation Adjustment Amount?

The Federal Civil Penalties Inflation Adjustment Act requires federal agencies to increase the civil monetary penalties established by statute each year based on changes in the Consumer Price Index.

6. What is the Rule About the Defendant’s Gross Pecuniary Gain?

If the defendant’s gross pecuniary gain exceeds the amount of civil penalty that would otherwise be applicable, federal law authorizes the SEC to seek civil penalties based on the gross pecuniary gain instead.

7. How Does the SEC Calculate the Maximum Amount of Civil Penalties that a Court May Order?

Federal law limits the SEC’s civil penalty authority to a maximum “per violation.” The SEC then calculates the maximum civil penalty as the number of violations found multiplied by the applicable statutory amount.

8. How is the Number of Civil Penalty Violations Calculated?

Due to a split among federal courts, the calculation of the number of violations is subject to debate. For example, some federal courts treat a defendant’s alleged course of conduct as a single violation. Others, such as the U.S. Court of Appeals for the Sixth Circuit, treat separate transactions and separate communications as separate violations.

Will My SEC Penalty Case Go to Court or to an Administrative Agency?

1. Can the SEC Bring a Case for Civil Penalties in Federal Court?

Yes. The SEC can sue you in federal district court. It also has the authority to initiate administrative proceedings.

2. How Does the Supreme Court’s Recent Decision in SEC v. Jarkesy Affect the SEC’s Enforcement Authority?

The Supreme Court’s decision in SEC v. Jarkesy (2024) significantly limits the SEC’s enforcement authority. The decision specifically holds that, when the SEC seeks civil penalties in enforcement proceedings based on allegations of fraud, it must bring its case in federal district court before a jury. While this decision addresses only fraud claims, it will have substantial implications for all types of SEC investigations, including those targeting cryptocurrency-related misconduct.

3. What is the Main Procedural Difference Between Federal Court and Administrative Proceedings?

The main procedural difference is that defendants in administrative proceedings have more limited discovery rights. With regard to depositions, SEC Rule of Practice 233 limits discovery in the case of administrative proceedings to, among other things, sworn statements in lieu of depositions. The scope of discovery in federal district court is governed by the Federal Rules of Civil Procedure, and it differs substantially from the scope of discovery available to defendants in SEC administrative proceedings.

4. What happens at the Conclusion of an SEC Administrative Proceeding?

After the conclusion of an SEC administrative proceeding, the hearing officer (who is either an Administrative Law Judge or a Commission member appointed to conduct the proceeding) will issue an “initial decision.”

Within 21 days of service of that initial decision, either party can request a “review” by the SEC’s five Commissioners. Under Rule of Practice 900, the Commission ordinarily aims to issue its decision within several months of the completion of briefing, but that period is a guideline rather than a binding deadline. If the Commission reviews an administrative enforcement proceeding and an appeal is warranted, the Commission’s decision becomes the final agency decision in an administrative enforcement proceeding.

5. What happens at the Conclusion of an SEC Enforcement Action in Federal Court?

SEC judicial actions are adjudicated in the district courts of the federal judiciary. When the court determines that the defendant is liable under federal law, the presiding judge will enter judgment against the defendant.

6. Is the SEC’s Authority to Assess Civil Penalties in Administrative Proceedings Statutory?

Yes. Section 21B of the Securities Exchange Act of 1934 (which other federal laws, in turn, recognize by reference) provides the statutory basis for administrative enforcement proceedings based on monetary penalties.

Are Civil Penalties the Same as Disgorgement or Victim Compensation?

1. What are the Differences Between Disgorgement, Prejudgment Interest, and Civil Penalties?

Disgorgement, prejudgment interest, and civil penalties are different monetary remedies. While the SEC frequently seeks each in the same enforcement proceeding, it is not entitled to all three based upon an enforcement action alone. Disgorgement, prejudgment interest, and civil penalties each have distinct statutory or equitable authority and distinct calculations as well.

2. Can the SEC seek the return of “All Defendant Profits” Rather than Net Profits?

The Supreme Court’s recent decision in Liu v. SEC (2020) generally limits the scope of equitable disgorgement to “net profits,” and not the return of all “defendant profits.” Liu’s holdings generally apply to enforcement actions involving both civil penalties and disgorgement.

3. Is Disgorgement Considered a Civil Penalty?

In the landmark case Kokesh v. United States Securities and Exchange Commission (2017), the Supreme Court classified disgorgement as a “penalty”, but only for the purpose of determining the applicable limitations period. As discussed above, this differs from civil penalties in most respect.

4. What is the Scope of the SEC’s Authority to Seek Disgorgement, Prejudgment Interest, and Civil Penalties in Federal Court?

The SEC’s authority to seek disgorgement, prejudgment interest, and civil penalties in federal court is derived from Section 21(d)(7) of the Securities Exchange Act of 1934 (and from other statutes for other enforcement actions). The SEC’s civil penalty authority includes disgorgement (and prejudgment interest, as applicable) when the SEC is able to seek the recovery of “ill-gotten gains.”

5. What is the SEC’s Authority to Seek Restitution or Disgorgement in Administrative Proceedings?

The SEC’s authority to seek restitution or disgorgement in administrative proceedings has to be distinguished from the SEC’s authority to seek these remedies in federal court. While federal courts use disgorgement as an equitable remedy, the SEC has the authority to seek restitution and disgorgement in administrative proceedings based on statutory authority.

6. Can Civil Penalties Be Used to Compensate Harmed Investors?

While the SEC normally collects civil penalties for the general welfare of the federal government, Sarbanes-Oxley Section 308 permits the SEC to use civil penalties to fund disgorgement, prejudgment interest, and victim compensation when the Commission obtains both a disgorgement order and a civil penalty against the same person, in which case the penalty may be added to and become part of the disgorgement fund for the benefit of the victims of the violation.

7. Are Civil Penalties Tax Deductible?

Generally, IRC Section 162(f) precludes taxpayers from claiming tax deductions for payments made to the federal government, state governments, or foreign governments “that are paid for the purpose of settlement or as a penalty.”

8. Is the Maximum Amount of a Civil Penalty Tied to the Amount of Disgorgement?

No. There is no federal securities statute that universally ties the amount of a civil penalty to the amount of disgorgement. As a result, disgorgement amounts can be up to substantially higher than civil penalties in most cases.

If you are facing this situation, Spodek Law Group handles federal criminal defense matters nationwide, from offices in New York and Los Angeles.

How Long Does the SEC Have to Seek a Civil Penalty or Disgorgement?

1. Is the SEC’s Civil Enforcement Authority Subject to a Limitations Period?

Yes. 28 U.S.C. §2462(a)(1) generally provides a limitations period of five years for “any civil penalty, assessment, or fine,” that the government is authorized to assess. This applies to civil penalties in both federal enforcement actions and administrative proceedings.

There are two important qualifications to this general five-year rule. First, the period can be tolled by a defendant-signed agreement. Second, defendants with scienter-based securities claims can be subject to disgorgement under the longer ten-year statute of limitations discussed below.

2. How Does the Supreme Court’s Decision in Gabelli v. SEC Affect the Calculation of the SEC’s Civil Penalty Limitations Period?

The Supreme Court’s decision in Gabelli v. SEC (2013) affirms a strict adherence to the rules regarding limitation periods in SEC enforcement actions seeking civil penalties. The Supreme Court held that the period runs from the date that the violation occurs (and the enforcement proceeding is thereby triggered), rather than the date that the SEC identifies the violation. Importantly, the Supreme Court also rejected the applicability of a “discovery rule” for SEC cases involving civil penalties.

3. Can the SEC Impose Disgorgement Obligations and Other Penalties Ten Years After the Date of an Alleged Violation?

Yes, but only in cases where the underlying alleged violation triggers the statute of limitations provided in Section 21(d)(8) of the Securities Exchange Act. This is the case for scienter-based disgorgement claims, and for certain injunctive and equitable-bar relief.

Unlike other disgorgement claims and other enforcement action remedies, claims subject to the 10-year period in Section 21(d)(8) can be brought in either judicial or administrative proceedings. The long limitation period is available regardless of the enforcement action’s venue.

4. Does Section 21(d)(8) of the Securities Exchange Act Broadly Apply to Disgorgement Claims Not Involving Scienter?

No. In Kokesh v. SEC (2017), the Supreme Court held that SEC disgorgement claims are subject to the five-year limitations period of 28 U.S.C. § 2462, without regard to scienter; the separate five- and ten-year periods were created later by Section 21(d)(8), enacted in 2021 (under 28 U.S.C. §2462).

5. Can Defendants Prevent the SEC from Extending Its Limitation Period by Agreement?

Yes. Defendants in SEC enforcement actions can prevent the SEC from tolling its limitation period, and the SEC cannot legally demand that defendants sign tolling agreements.

Are Insider Trading Civil Penalties Calculated Differently?

1. What is the Maximum Amount of a Civil Penalty for Insider Trading?

Section 21A of the Securities Exchange Act caps the amount of a civil penalty for insider trading at “not more than three times the amount of the profit gained or loss avoided as a result of the violation.”

2. How is the Maximum Amount of an Insider Trading Civil Penalty Different for “Controlling Persons”?

A controlling person’s potential civil penalty exposure for insider trading is three times the illegal gains generated by the persons he or she controls, or up to $1 million, whichever is greater.

3. Does Section 21A of the Securities Exchange Act Give the SEC the Authority to Seek Disgorgement, Prejudgment Interest, and Other Remedies in Addition to Civil Penalties?

Yes. Section 21A of the Securities Exchange Act refers to disgorgement, prejudgment interest, and other civil monetary penalties under other sections of the Securities Exchange Act, as well as officer-director, industry, and professional bars. These are in addition to the SEC’s authority to seek disgorgement, prejudgment interest, officer-director, industry, and professional bars, injunctive relief, and criminal referral in cases involving other types of enforcement proceedings.

4. Can the SEC Seek Officer-Director, Industry, or Professional Bars in Insider Trading Enforcement Proceedings?

Yes. Like all civil monetary penalties, officer-director, industry, and professional bars are nonmonetary remedies available in SEC insider trading cases as well as in most other civil enforcement proceedings.

5. Can the SEC Imprison a Defendant in a Civil Enforcement Action?

No. The SEC cannot seek imprisonment in any of its civil enforcement proceedings. When necessary, it can refer a case to the Justice Department to seek criminal prosecution. The Justice Department can seek imprisonment in parallel criminal cases alongside the SEC’s civil enforcement proceedings.

6. Are Civil Penalties the Same as Restitution?

No. Restitution involves compensation to victims for their financial loss. Civil penalties are separate from restitution and are paid to the federal government. While some civil penalties can be used to fund restitution, civil penalties themselves are not restitution.

What Can Reduce an SEC Civil Penalty?

1. What Factors do Federal Courts Take into Consideration When Calculating a Civil Penalty in an SEC Enforcement Action?

Federal courts commonly consider the following factors when calculating civil penalties in SEC enforcement actions:

• Scienter.
• Egregiousness.
• Recurrence.
• Pecuniary gain or loss.
• Deterrence.

2. Can Financial Inability to Pay a Civil Penalty be Used to Avoid Liability?

A defendant’s inability to pay a civil penalty can sometimes be used to seek reduction of the amount of the civil penalty, but it will not eliminate a defendant’s liability if the defendant committed an enforceable violation of federal law.

3. What Other Factors Can the SEC Staff Take into Consideration?

The SEC staff can also take into consideration factors such as a defendant’s cooperation during an SEC investigation, efforts to remediate a potential violation, and a decision to self-report. All of these can be used by defense counsel to reduce either the SEC staff’s charging recommendation or its recommended civil penalty amount.

4. Do Corporations Also Have Additional Opportunities to Seek Reduction of Their Civil Penalty Exposure?

In 2006, the SEC published its current Corporate Penalty Policy, which outlines a corporation’s ability to seek reduction of its civil penalty exposure based on the extent of the harm caused to investors and the degree to which the corporation itself benefited from the alleged violation. Additionally, corporations can rely on defenses such as “good faith” and other equitable factors to reduce their exposure to SEC civil penalties.

5. What Other Potential Remedies Can be Included in a Settlement Negotiation with the SEC?

While the SEC normally calculates a defendant’s potential civil monetary penalty exposure, it can also seek prejudgment interest, disgorgement, and conduct-based remedies. Defendants in SEC enforcement proceedings can seek to negotiate settlements combining these remedies as well.

6. Can Defendants and Other Regulated Entities in SEC Enforcement Proceedings Resolve Their Potential Liability through an SEC Administrative Order?

Yes. The SEC also issues administrative orders in SEC investigations. If the SEC charges an entity or individual in its administrative order, the SEC and the charged individual or entity may settle the case in light of the alleged misconduct’s gravity, the defendant’s prior record (if any), the defendant’s cooperation during the SEC’s investigation, and any other mitigating and aggravating factors. In some cases, the SEC issues “no-action” letters or requires defendants to certify specific remedies without imposing civil penalties or other penalties.

Contact a Federal Criminal Defense Attorney

Nothing here is legal advice, and the details of your case matter. Todd Spodek and Spodek Law Group take federal criminal and white collar cases nationwide, from offices in New York, Brooklyn, Queens and Los Angeles. You can reach the firm at 212-300-5196.