What makes the Federal Trade Commission (FTC) so feared among direct response and online marketers? It’s not a tough injunction or even a ban on involvement with a particular product category or marketing technique, though they certainly aren’t “pleasant” and can cramp a company’s competitiveness and bottom line. No, the answer, in a word, is money – the power to force someone to disgorge all “unjust gains” from an allegedly unfair or deceptive business practice. The FTC has been cold-bloodedly ruthless and enormously effective in the application of this power, having extracted hundreds of millions of dollars from defendants in just the past few years.
The FTC has been using the cudgel of disgorgement as an enforcement tool – and as a source of consumer restitution – for so long, and so successfully, that it has become an almost unspoken assumption within the FTC, the judiciary, and the business community that its right to separate a defendant from his money rests on legal bedrock and is beyond dispute. But what if it does not? What if the legal foundation is shakier than anybody thought, and could even sit on quicksand?
The U.S. Supreme Court’s recent decision in Kokesh v. SEC provides the gist for positing this “radical” question, creating an opening for FTC litigants to challenge the fundamental premises of the agency’s monetary authority. The narrow issue in Kokesh was whether a federal five-year statute of limitations for actions seeking a “civil fine, penalty, or forfeiture” applied to an SEC demand for disgorgement from an investment advisor charged with misappropriating funds from clients. Arguing that it didn’t apply, the SEC wanted to recover not only the $2.35 million that the defendant stole in the five years after the claim arose, but also the entire $35 million he took in from the beginning of the fraud.
The court, in a unanimous opinion by Justice Sonia Sotomayor, ruled against the government, holding that the SEC’s demand for “disgorgement” was in fact a penalty, and thus subject to the five-year limitations period. The court listed three reasons why SEC disgorgement is a penalty, and not equitable restitution. First, SEC disgorgement is a sanction for violating public laws, i.e., a violation committed against the United States rather than an aggrieved individual. Second, SEC disgorgement is imposed for punitive purposes to deter securities law violations by depriving violators of their ill-gotten gains. Sanctions to deter such public law violations are inherently punitive because “deterrence [is] not [a] legitimate non-punitive governmental objectiv[e].” Third, SEC disgorgement is often not compensatory because the district courts and the government have discretion to determine how the money will be distributed. It can go to victims or simply be disbursed to the U.S. Treasury. Non-compensatory sanctions paid to the government for a legal violation operate as a penalty, the court said.
Justice Sotomayor slapped away the SEC’s contention that disgorgement is remedial because it simply restores the status quo, by pointing out that it sometimes exceeds the illicit profits and doesn’t take account of a defendant’s expenses. Disgorgement thus may not simply restore the status quo, but can leave the defendant worse off – making it punitive.
While the holding in Kokesh is limited to the statute of limitations question that was presented there, the implications of its reasoning for the power of other federal law enforcement agencies, including the FTC, to levy monetary sanctions on wrongdoers is potentially profound. It even calls into question the ability of the FTC to seek consumer restitution at all.
Like the SEC, the FTC’s remedies of disgorgement and restitution derive not from an express statutory grant but from court decisions that have “read” those remedies into a general statutory provision – Section 13(b) of the FTC Act – that authorizes only injunctions. The courts accomplish this through the exercise of their inherent equitable powers, by fashioning the remedies as forms of ancillary equitable relief. FTC disgorgement and restitution, therefore, have always been characterized as, and thought to be, “equitable” remedies.
Now, however, the Supreme Court, in the analogous context of an SEC enforcement action, says they are not equitable but punitive, for reasons that apply, under Justice Sotomayor’s analysis, just as cogently to FTC disgorgement as to the SEC: FTC restitution is imposed for violating a public law; it is intended to deter; and it does not necessarily compensate, since the FTC has no obligation to make restitution to consumers and often merely hands over the funds to the U.S. Treasury. The government even conceded that “the adverse practical consequences of construing [the five-year statute of limitations] to encompass disgorgement would not be confined to securities-law cases, since the government regularly seeks disgorgement in other contexts as well, under general statutory grants of authority to give equitable relief.” Indeed, it pointed to FTC monetary relief as something that would be subject to the five-year statute of limitations if its argument didn’t prevail.
Under Kokesh, courts should begin to impose a five-year statute of limitations on FTC restitution claims that must now be understood to be punitive rather than equitable. And FTC defense counsel, with Justice Sotomayor’s unanimously endorsed reasoning as a guidepost, should not be bashful about questioning the authority of the FTC to seek disgorgement or restitution at all. Indeed, Justice Sotomayor veritably invites them to do so, with this statement: “Nothing in [its] opinion should be interpreted as an opinion on whether courts possess authority to order disgorgement in SEC enforcement proceedings or on whether courts have properly applied disgorgement principles in this context.”
The FTC’s power to demand and take money from defendants, for so long thought to be settled law, may not be so settled after all.