In April 2017, white collar and securities attorneys, as well as potential defendants, cheered the Supreme Court’s unanimous opinion in Kokesh v. SEC, which held that civil disgorgement, when imposed as part of a Securities and Exchange Commission (“SEC”) enforcement proceeding, is a “penalty” and therefore subject to a five-year statute of limitations. At the time, Kokesh was hailed as limiting the size of future disgorgement awards, in some cases dramatically. However, the court’s categorization of SEC disgorgement as a “penalty” may have much wider ripple effects that could jeopardize billions of dollars in potential future insurance recoveries. This ripple effect first manifested itself in J.P. Morgan Sec., Inc. v. Vigilant Ins. Co., where New York’s intermediate appellate court recently held that an SEC disgorgement settlement was no longer a covered “loss” under the defendant’s insurance policy, because Kokesh recategorized such disgorgements as non-covered “penalties.”
While Kokesh, on the one hand, may save SEC enforcement targets hundreds of millions of dollars, it also may greatly complicate their insurance claims for the amounts they do pay either in settlement or judgment. In response, potential SEC enforcement targets should:
be aware of the Kokesh decision and its potential effects on existing insurance policies;
- consider avoiding civil disgorgements in future settlement negotiations with the SEC; and
- contact their insurance brokers and insurance counsel to negotiate modifications to future renewals of their directors’ and officers’ liability (“D&O”) and errors and omissions (“E&O”) insurance policies.
The Kokesh Decision and Its Effects
In Kokesh, the defendant had been ordered to pay a $2.4 million civil monetary penalty, $34.9 million in disgorgement, and $18.1 million in prejudgment interest. Though the five-year statute of limitations of 28 U.S.C. § 2462 applied to the civil penalty, the district court held that the limitation period did not apply to the disgorgement remedy, because disgorgement is not a “penalty.” The Court of Appeals for the Tenth Circuit affirmed, but the Supreme Court unanimously reversed.
The court found that an SEC disgorgement is a “penalty” on three grounds: 1) disgorgement is often imposed in recognition of harms done to the general public, as opposed to harms committed against specific individuals; 2) disgorgement is used primarily for its deterrent purpose, which renders it punitive as opposed to remedial; and 3) because a court has discretion over where disgorgement funds are sent, such amounts are more of a penalty against the wrongdoer, rather than a tool for compensating injured parties.
In September 2018, the latest opinion was issued in the long-running Vigilant coverage action, which involves Bear Stearns’ attempts to secure insurance for liabilities arising from certain institutional investors being permitted to “market time” select investment funds. Decided before Kokesh, the Vigilant trial court held in April 2017 that Bear Stearns’ $140 million disgorgement settlement was a covered “loss” under its D&O insurance policies, because the amount was calculated based upon the money gained by third parties, which Bear Stearns agreed to reimburse to its other investors, and not on the amount of disgorgement of Bear Stearns’s own ill-gotten gains. However, in September 2018, the New York Appellate Division held that Kokesh had changed the law, and that disgorgement payments were a “penalty,” and thus not covered by Bear Stearns’s insurance policies, which exclude “fines or penalties imposed by law” from the definition of “loss.”
Given that the vast majority of analogous insurance policies with similar “loss” definitions exclude “penalties,” the Kokesh and Vigilant decisions may further complicate the already hotly contested question of whether “disgorgement” is a covered loss under D&O and E&O insurance policies. In fact, Kokesh may result in opening a completely new front in this long-running battle between insurers and their policyholders.
The law could, of course, change again: Vigilant is highly likely to be appealed again to the New York Court of Appeals. But until other courts issue more policyholder-friendly precedent, or the SEC refines how it applies disgorgement to remove the punitive aspects relied upon by the Supreme Court, companies and their counsel should take steps in the short term to limit their now arguably uninsured potential liabilities.
Consider Alternative Remedies in Negotiations with SEC
As a result of Kokesh, companies should look to alternative bases of settling with the SEC, besides disgorgement. In tying payments closer to compensation for the allegedly wronged parties, companies can distinguish such payments from the SEC disgorgement scheme that was considered punitive and thus a “penalty” in Kokesh. That distinction could well be the difference between obtaining hundreds of millions of dollars in insurance coverage or not. Of course, companies must weigh the insurance coverage implications of Kokesh and Vigilant against the beneficial five-year statute of limitations established by Kokesh.
Alternatively, Consider Requesting Modified Language in Future Renewal Policies
Companies also could attempt to negotiate with their D&O and E&O insurance carriers to amend future renewal policies to create a limited carve-out to the general exclusion for “penalties.” There is, in fact, precedent for such a modification, as many existing D&O and E&O policies already explicitly carve out certain penalties that can be imposed under Sarbanes-Oxley. Nonetheless, insurers may be cautious in modifying their policies in the coming months and years as they evaluate the potentially combined impact of Kokesh and Vigilant.
 Kokesh v. SEC, 137 S. Ct. 1635, 1639, 198 L. Ed. 2d 86 (2017).
 J.P. Morgan Sec., Inc. v. Vigilant Ins. Co., No. 600979/09, 2018 WL 4494692, at *3 (N.Y. App. Div. Sept. 20, 2018).
 Kokesh, 137 S. Ct. at 1641.
 Id. at 1639, 1641.
 Id. at 1643.
 Id. at 1643-44.
 Id. at 1644.
 Vigilant, 2018 WL 4494692, at *2.
 Id. at *3.
 Compare Level 3 Communications Inc. v. Federal Ins. Co., 272 F.3d 908 (7th Cir. 2001) with Mills, Ltd Partnership v. Liberty Mut. Inc. Co., No. C.A. 09C-11- 174 FSS, 2010 WL 8250837 (Del. Super. Ct. Nov. 5, 2010).