Could Injunctions Become the SEC's Next Headache?

Welcome to the 8th edition of “On SECond Thought...,” an endeavor to provide short doses of my unconventional thinking about securities enforcement on a more regular monthly schedule. Feedback and comments are encouraged, especially if you think I’m either really onto something or completely off-base, and please consider clicking “Subscribe” so you'll be automatically notified when each month's new post appears.

This month's essay discusses the SEC's recent abandonment of a long-running enforcement case and questions whether that unusual outcome could portend future challenges for the agency when seeking its historical bread-and-butter remedy – the “obey-the-law” injunction.

As Will Rogers famously quipped, when you find yourself in a hole, stop digging.

The Securities and Exchange Commission recently learned this lesson the hard way in its long-running and ill-fated pursuit of New York-based stock trader Guy Gentile, who – unlike many others similarly situated – apparently had the resources, fortitude, and skilled legal representation to fight back. In October the SEC put down the shovel and abandoned its four-year-old case after a federal district court ruled, for the second time, that the case had no chance of success. Kudos to Mr. Gentile and his able counsel (Adam Ford of the Ford O'Brien law firm) for securing much-needed judicial precedent along the way that could significantly clarify the law governing SEC injunctions and perhaps even cause the agency to rethink its habitual approach to demanding them.

The SEC Injunction Habit

Injunctions against future misconduct have been the SEC’s core weapon against securities law violators since the agency's creation in 1934. It was not until the early 1970s that courts began also awarding the SEC monetary relief in the form of “disgorgement” of illicit gains, and not until the 1980s and early 1990s that Congress gave the SEC statutory authority to seek monetary penalties against violators. 

Yet even after being empowered to obtain these often-draconian monetary remedies, the SEC has continued to reflexively demand injunctions in virtually every enforcement case it files in federal court. Worse yet, in most cases the agency demands overly broad, time-unlimited “obey-the-law” injunctions that essentially require defendants to do nothing more than what the law already requires but carry severe practical and reputational consequences.

The SEC generally treats these obey-the-law injunctions as non-negotiable prerequisites for settling federal court proceedings, and courts typically grant them with little or no independent scrutiny. Even in contested cases, although there are plenty of exceptions, courts routinely grant SEC requests for obey-the-law injunctions based primarily on SEC-favorable precedent set decades ago, before the agency had any other meaningful remedies in its arsenal.

The recently abandoned case against Mr. Gentile renews hope that the SEC might reconsider its historically rigid approach to these injunctions. 

The Gentile Saga, Scene I

The SEC waited until 2016 to charge Gentile based on allegedly fraudulent transactions that had occurred in 2007 and 2008. In its complaint, the SEC sought an obey-the-law injunction, a penny-stock bar, “disgorgement” of Gentile’s allegedly illicit gains, and a civil monetary penalty. 

The penalty demand was especially curious given the Supreme Court’s unanimous ruling, in Gabelli v. SEC (2013), that the agency must file its complaint within five years of a violation whenever it seeks monetary penalties. The agency abruptly abandoned this untimely demand (as well as its demand for disgorgement of illicit gains, which by then had been similarly rendered untimely by the Supreme Court’s unanimous ruling in Kokesh v. SEC (2017)) as soon as Gentile moved to dismiss the complaint in mid-2017.

With the case then reduced solely to a demand for an obey-the-law injunction and a penny-stock bar – both predicated on decade-old transactions – the federal district court in New Jersey ultimately granted Gentile’s motion to dismiss the case in December 2017, reasoning that these remaining sanctions sought by the SEC were penal in nature and thus time-barred no less than a monetary penalty or disgorgement. But the SEC appealed to the U.S. Court of Appeals for the Third Circuit, which vacated the dismissal in September 2019 and sent the case back to the district court in what was widely viewed at the time as a victory for the SEC.

Scene II: The SEC's Pyrrhic Victory

For the SEC, the Third Circuit decision was a Pyrrhic victory at best. To be sure, the court agreed with the SEC that “properly issued and framed” injunctions prohibiting future securities law violations are not penal, and thus are not subject to the five-year time limit applicable to SEC monetary penalties and disgorgement. But in remanding the case to the district court, the Third Circuit set an extraordinarily high bar for the SEC to clear in seeking a “properly issued and framed” injunction against Gentile – or, for that matter, against a substantial percentage of other defendants sued by the SEC in federal courts.

The Third Circuit repeatedly emphasized that an injunction is “properly issued and framed” only if its “sole function . . . is to forestall future violations.” That is, “injunctions may properly issue only to prevent harm – not to punish the defendant.” In a rare breath of fresh air, the court actually quoted the text of the statute that permits SEC injunctions, which evinces clear congressional intent to allow them only in cases that involve ongoing or imminent misconduct, not merely a theoretical possibility of future misconduct:

Whenever it shall appear to the Commission that any person is engaged or is about to engage in acts or practices constituting a violation . . . , it may in its discretion bring an action in the proper district court . . . to enjoin such acts or practices, and upon a proper showing a permanent or temporary injunction or restraining order shall be granted without bond [emphasis added in bold].

For good measure, the Third Circuit also noted it’s strictly literal and textualist interpretation last year of nearly identical statutory language governing Federal Trade Commission injunctions, although the Gentile court acknowledged (without attempting to reconcile) the less demanding approach courts have historically taken with SEC injunctions. In last year’s FTC case, the Third Circuit unequivocally held that the “clear text” of a statute that allows the FTC to seek an injunction against a person who “is violating, or is about to violate” the Federal Trade Commission Act requires the agency to allege that illegal conduct is “ongoing or imminent,” not simply that past illegal conduct is reasonably likely to recur in the future.

We conclude that this language is unambiguous; it prohibits existing or impending conduct. Simply put, [the statute] does not permit the FTC to bring a claim based on long-past conduct without some evidence that the defendant "is" committing or "is about to" commit another violation.

(Applying a similarly strict standard to SEC injunctions would cause a sea change in SEC enforcement, because the vast majority of SEC cases involve past conduct that ended many months (if not years) before any charges are filed, with very few presenting any plausible concern about ongoing misconduct or imminent recurrence. For example, in many first-offense "mom and pop" insider trading cases, the defendant is so humiliated, devastated, and financially ruined by the SEC investigation that a repeat offense is not only unlikely but utterly inconceivable, yet the SEC invariably demands – and in most cases gets – a lifetime obey-the-law injunction anyway.)

Making matters worse for the SEC, the Third Circuit in Gentile ruled that penny-stock bars are also a form of injunction and thus likewise are permissible only upon a “proper showing.” The court specifically found no congressional intent to authorize SEC injunctions or penny-stock bars “automatically on a finding of past violations or without a proper showing of the likelihood of future harm” – as too often happens in SEC cases, especially those that settle.

Finally, the Third Circuit indicated considerable skepticism about the propriety of the kind of vague, lifetime, obey-the-law injunctions typically sought by the SEC, although it stopped short of categorically prohibiting them. Instead, while noting the “serious collateral consequences” of SEC injunctions and the well-established principle that “injunctive relief should be no more burdensome to the defendant than necessary to provide complete relief to the plaintiff,” the court pointedly warned the district court on remand not to “rubber-stamp” the SEC’s request for an obey-the-law injunction simply because the agency has routinely gotten away with them in the past.

Scene III: Never Mind 

After Gentile unsuccessfully petitioned the Supreme Court for a writ of certiorari, the case was remanded to the district court. Now armed with plenty of new ammunition from the Third Circuit opinion, Gentile again moved to dismiss the case. Instead of acknowledging the nearly impossible burden the Third Circuit had imposed on it to secure an injunction against Gentile, the SEC dug in again. It insisted that its allegations of now 12-year-old violations could, if proven, justify an obey-the-law injunction because Gentile had more recently made public statements that he’d done nothing wrong and that the SEC case was a “witch hunt,” and because Gentile allegedly had not accepted responsibility for his alleged misconduct.

The district court disagreed in September 2020 and again dismissed the case, although it allowed the SEC one last chance to amend its complaint to add facts that might salvage its injunction demand. To its credit, the SEC declined to do so, and the case was officially closed on October 21, 2020. 

Post Mortem

Time will tell what lessons, if any, the SEC has learned from its loss in the Gentile case. More than 15 years ago, after an equally noteworthy (and rare) criticism of SEC injunctions from the Eleventh Circuit, I suggested a wholesale reconsideration of the SEC’s reflexive approach to obey-the-law injunctions, but that suggestion fell on deaf ears. 

It should not be lost on the SEC that the Third Circuit’s opinion in Gentile was authored by U.S. Circuit Judge Thomas Hardiman, a highly-respected jurist who, along with the Supreme Court’s three newest justices, was among those on President Trump’s “short list” of potential high court nominees, and thus might reasonably be considered a bellwether for how those new justices might react to a case that challenges the non-textualist approach to injunctions historically taken by the SEC and lower courts. Considering also Justice Kagan's acknowledgement in 2015 that "we're all textualists now," the SEC should consider itself forewarned. 

With anticipated leadership changes on the horizon at the SEC, and with an increasingly textualist federal judiciary on watch, the SEC might consider getting ahead of this issue before more courts have the chance to weigh in.

Russell G. Ryan, a partner with the law firm King & Spalding LLP, previously served as assistant director of enforcement at the SEC and deputy chief of enforcement at the Financial Industry Regulatory Authority (FINRA).

The opinions expressed by this author are his alone and do not necessarily reflect the views of his law firm, his colleagues, or his clients. His articles and postings are solely for general information purposes and are not intended to be, and should not be, read or interpreted as legal advice.