What Happens to the Fines Collected by the SEC?

Fact checked by Hans Daniel JaspersonReviewed by Somer AndersonFact checked by Hans Daniel JaspersonReviewed by Somer Anderson

In most cases, fines are imposed when the U.S. Securities and Exchange Commission (SEC) brings a civil action against a corporation or an individual. These fines, meant to deter others from engaging in similar acts, supplement awards meant to repay those who have been victims of securities law violations. Previously, this money went to the U.S. Treasury, but much of it now finds its way back to those wronged in these crimes.

For a long time, many fines were meted out through administrative proceedings overseen by administrative law judges (ALJs)—the kind found within many federal agencies. However, a June 2024 Supreme Court decision, SEC v. Jarkesy, significantly altered the SEC’s ability to enforce its regulations against fraud and similar crimes administratively, impacting when and if these fines can be imposed, Cary Coglianese, professor at the University of Pennsylvania Carey Law School, told Investopedia. Below, we review how the SEC imposes its fines and where these funds go once they are collected, especially given the shift marked by the 2024 Supreme Court decision.

Key Takeaways

• The U.S. Securities and Exchange Commission (SEC) is America’s regulator for the securities markets, establishing and enforcing regulations to protect investors (especially retail investors) and the American public.
• Securities violations include insider trading, accounting fraud, and securities fraud.
• Traditionally, the SEC had two ways of securing fines: through civil actions in federal court and administrative hearings.
• A 2024 Supreme Court decision requires the SEC to pursue these penalties in federal court, where the defendant has a right to trial by jury.
• Penalties and disgorgement from SEC actions go to the U.S. Treasury, the SEC, targets of financial crimes, and whistleblowers.

What Is the SEC?

The SEC is an independent regulatory agency created by the federal government through the U.S. Securities Act of 1933 and the Securities Exchange Act of 1934. It was formed in response to the 1929 stock market crash and public anger over the speculative mania and outright frauds that led up to the Great Depression.

The SEC regulates the securities markets, issuers, and brokers. It’s meant to protect investors (especially retail investors) and give the public greater transparency about the workings of the country’s financial markets.

Given wide-ranging powers over the securities industry and markets, the SEC can impose fines based on SEC regulations or bring civil or criminal action—the latter in coordination with the U.S. Department of Justice (DOJ).

Note

In fiscal year 2023, the SEC obtained orders for $4.95 billion in financial remedies, the second highest after 2022. The financial remedies comprised $3.37 billion in disgorgement and prejudgment interest and $1.58 billion in civil penalties.

How SEC Investigations Result in Fines

Since its beginnings in the 1930s, the SEC has had two primary avenues for enforcing securities laws and regulations, with criminal actions brought by the DOJ:

1. Civil action in federal court: In a civil action, the SEC files a complaint in a U.S. District Court seeking remedies such as injunctions (a legal act to stop someone from doing something), civil fines, and disgorgement (repayment of ill-gotten profits). These cases are heard by federal judges and may involve jury trials.
2. Administrative actions: ALJs within the SEC hear these cases. These proceedings can result in sanctions like cease-and-desist orders, bans from working in the securities industry, civil penalties, and disgorgement.

The Supreme Court’s June 2024 ruling in SEC v. Jarkesy significantly altered the SEC’s ability to avoid bringing charges to a federal court. The Supreme Court held that defendants have a constitutional right to a jury trial in federal court when the SEC seeks to impose civil penalties for securities fraud. “A defendant facing a fraud suit has the right to be tried by a jury of his peers before a neutral adjudicator,” Chief Justice John Roberts wrote for the court’s majority.

The decision severely limited the SEC’s ability to pursue civil penalties through administrative proceedings. As a result, while the SEC may still use administrative actions for specific purposes, such as issuing cease-and-desist orders or imposing industry bars, it must now bring cases involving civil penalties to federal court. This might seem a relatively unimportant side point—who cares where these cases are heard as long as wrongdoers face some form of penalty and the innocent have a way to defend themselves fairly? Let’s set this question aside because the answer becomes clearer once we understand a bit more about the kinds of penalties the SEC seeks.

Types of Penalties for Breaking Securities Laws

To understand where things stand since the 2024 Supreme Court decision, we need to distinguish the kinds of penalties often enforced in light of SEC decisions. Let’s start with the non-monetary penalties first:

Bars and suspensions: The SEC can bar or suspend individuals from working in the securities industry if they are found to have committed serious violations. This is often meant to be a career death penalty for those against whom such actions are brought, though that’s not always the case.

Compliance and other restorative remedies: In some cases, the SEC may seek additional remedies, such as requiring companies to carry out compliance programs or appoint independent monitors, which companies often prefer over being barred from working in the securities industry.

Criminal penalties: The SEC doesn’t bring criminal actions, but civil ones. Nevertheless, its investigators often work with those who do in different states, as well as the Federal Bureau of Investigation (FBI), U.S. Department of Justice (DOJ), and U.S. Secret Service, all of which have oversight of different kinds of fraud. Of the hundreds of cases each year, the SEC’s enforcement division makes formal criminal referrals in only a fraction of them, often offering to drop the referral as part of a future settlement. The threat is significant: The costs in money and negative publicity to defendants are dire—and that’s before accounting for the potential for prison time and significant criminal penalties.

Once the SEC makes a referral, the DOJ can pursue criminal charges for securities law violations if it hasn’t already. Criminal penalties can include fines, imprisonment, and restitution to victims. These cases are brought in federal courts, though states often bring cases under their laws.

Injunctions: The SEC often seeks court orders prohibiting individuals or companies from engaging in activities it thinks are illegal. Violations of injunctions can lead to added penalties, including contempt of court charges.

The vast majority of cases brought by the SEC involve the following monetary penalties:

Disgorgement: This involves forcing the violator to give up any ill-gotten gains obtained through illegal activities. The purpose is to prevent the wrongdoer from profiting from their misconduct and restore those who lost money. It’s meant to be remedial.

Civil fines: These are monetary penalties that the SEC can seek against individuals or companies found to have violated securities laws. The penalty’s severity depends on the violation, ranging from thousands to millions of dollars. Beyond simply repaying those who have lost money through the defendant’s criminal scheme, fines are to be punitive.

Most cases that the SEC brings involve both disgorgement and civil fines. For example, in February 2024, the SEC fined a subsidiary of the Teachers Insurance and Annuity Association of America (TIAA) $2.2 million for failing to follow Regulation Best Interest. The SEC argued that funneling retail customers through its platform’s “core menu” created conflicts of interest and cost about 6,000 retail customers about $900,000 in added costs over lower-fee alternatives. When TIAA’s subsidiary settled, it was forced to pay a disgorgement of $900,000 and fines of $1.2 million. The latter included interest on the extra costs assumed by its clients.

Under the Sarbanes-Oxley Act of 2002, the SEC can distribute disgorgement money and money from civil fines to the victims of securities law violations through the Fair Funds for Investors. The Dodd-Frank Act of 2010 expanded the SEC’s authority to impose civil penalties through its in-house administrative proceedings.

Following the Supreme Court’s 2024 decision, the SEC can only pursue these penalties in federal court with a jury trial, as the decision holds that the U.S. Constitution guarantees this right in such cases.

The Effects of SEC v. Jarkesy

The Supreme Court’s June 2024 ruling in SEC v. Jarkesy significantly altered how the SEC can seek fines. The court held that defendants have a constitutional right to a jury trial in federal court when the SEC seeks to impose civil penalties for securities fraud.

Imposing and collecting these penalties has become more complex since the SEC can no longer rely on in-house tribunals without juries for enforcement actions. As a result, while the SEC may still use administrative actions for specific purposes, such as seeking injunctions or imposing bars from practicing in the industry, it must now bring cases involving civil penalties to federal court. The ruling essentially restricts the SEC’s enforcement options, making federal court the primary avenue for seeking monetary penalties against alleged violators of securities laws.

The Jarkesy majority bases its holding on a significant distinction between cases that required jury trials and those that didn’t. The types of cases affected by the ruling include those involving what’s called “common law fraud.” The Supreme Court emphasized the historical and constitutional importance of the right to a jury trial for cases that resemble traditional common law actions. “A defendant facing a fraud suit has the right to be tried by a jury of his peers before a neutral adjudicator,” Roberts wrote in the court’s opinion.

The distinction rests on the Seventh Amendment’s right to a jury trial in civil cases, which is preserved for “suits at common law.” Legal claims seeking monetary damages were typically tried by a jury because they are seen as punitive and aimed at redressing wrongs. The historical context, the majority argued, shows that common law fraud cases required jury trials, which reflects the framers’ intent to protect this right in the Constitution.

Meanwhile, cases involving “equitable remedies” can likely continue to be handled in-house by the SEC. That includes administrative sanctions without monetary penalties, like industry bars and suspensions or revocations, and administrative actions, such as regulatory compliance actions and procedural violations. This distinction dates to common law as well. England and early America had common law courts with the power to award monetary damages to winning plaintiffs. In addition, they also had courts of “equity” that could issue injunctions and other non-monetary relief. American law has long since folded equity courts into others—the 1938 Federal Rules of Civil Procedure mandates this at the federal level—but some still exist (e.g., bankruptcy courts).

Putting this together, under the Jarkesy ruling, the SEC must bring the following cases to federal court:

• Civil penalty cases for violations similar to common law offenses, particularly fraud.
• Cases where the SEC seeks monetary penalties for statutory violations that are like common law offenses.

The critical factors in determining whether a case must go to federal court appear to be whether the SEC is seeking civil monetary penalties and whether the alleged violation has a close analog in common law, like fraud. As such, these are the cases the SEC should still be able to handle through administrative proceedings:

• Cases that involve revoking securities licenses
• Cases that don’t include civil monetary penalties
• Enforcement actions that don’t have a clear common law equivalent

Coglianese notes that it will take time to see to what extent the pre-2024 administrative workings of the SEC remain in play. For now, it seems likely that not every SEC defendant will need to have the right to trial by jury, though Coglianese cautioned that greater certainty on these and other questions will only come after a few years of rulings. The Jarkesy case involved civil penalties. “Will it also extend to disgorgement or revocation of licenses and so forth? I think, based on the court’s rationale, it shouldn’t because there wasn’t an equivalent of these types in the common law,” he said.

The Supreme Court’s ruling in SEC v. Jarkesy requires that cases involving common law fraud and civil penalties for securities fraud be tried in federal court with a jury. As such, the table above tries to follow the court’s rationale to distinguish between cases that likely need to be brought to federal court and those that can stay within the SEC’s administrative processes. These include cases involving insider trading, accounting fraud, market manipulation, and violations under the Securities Act of 1933, the Securities Exchange Act of 1934, and the Investment Advisers Act—when civil penalties are sought.

Why Is SEC v. Jarkesy Significant?

The Supreme Court’s decision in SEC v. Jarkesy is significant because it fundamentally alters the landscape of securities law enforcement. At its core, this ruling is about more than just the venue of punishment; it’s about the efficiency and effectiveness of the entire regulatory system. The SEC’s in-house tribunals were designed to streamline the enforcement process, allowing for quick and efficient resolution of cases without the need for lengthy federal court procedures. This system enabled the SEC to address securities violations promptly, maintaining market integrity and protecting investors in a timely manner. By requiring many of these cases be brought in federal court, the ruling could make SEC enforcement more cumbersome, costly, and time-consuming.

Moreover, this shift has broader implications for the entire judicial system. Federal courts are already burdened with heavy caseloads, and adding a significant number of SEC enforcement actions to their dockets will almost certainly exacerbate existing backlogs and delays. “These cases can go on for years already,” Coglianese said. “For a lot of white-collar defenses, that’s the name of the game, really, to put up a lot of roadblocks and make it more costly [for the SEC], and delay, delay, delay.”

As such, there’s a reason the case was considered a victory to those who have wanted to pare back the SEC’s ability to regulate the securities market. The increased time and resources required for each case might limit the number of enforcement actions the SEC can pursue, potentially allowing some securities law violations to go unchecked. To repeat a quote from 19th-century British Prime Minister William Gladstone, for proponents of the regulator, this means that victims of securities fraud might find, “Justice delayed is justice denied.”

Note

The SEC’s Division of Enforcement was created in August 1972. It conducts investigations into possible violations of the federal securities laws and prosecutes the Commission’s civil suits in the federal courts.

SEC Penalty Examples

Insider trading is among the best-known charges the SEC brings. Perhaps the most famous case occurred after the celebrity home-and-garden maven Martha Stewart sold ImClone stock based on material information that wasn’t public and was given to her by her broker. She was ordered to disgorge $45,673, the amount that Stewart would have lost had she not made the insider trade, plus fines that brought her total to about $195,000. She also served several months in prison on charges brought in relation to the case.

Perhaps the second-best-known case of the 2000s involved charges against Jeffrey Skilling, Enron’s chief financial officer, for insider trading in 2006, among other crimes. Five years later, the SEC accused hedge fund manager Steven A. Cohen of SAC Capital of insider trading in 2013, resulting in almost $2 billion in fines and a two-year ban from managing outside money.

Here’s a look at other notable cases in recent years:

What Are the SEC’s Tier 1 Penalties?

Tier 1 penalties are the lowest level of civil monetary penalty that the SEC can impose for violations of securities laws. For individuals, Tier 1 penalties can be up to $7,500 per violation. For entities, the maximum penalty is $80,000 per violation. These penalties apply to any violation of securities laws, regardless of intent or harm caused. Tier 1 penalties are typically used for less severe infractions or technical violations without evidence of fraud or significant investor harm.

What Are the SEC’s Tier 2 Penalties?

A Tier 2 penalty represents a more severe level of civil monetary penalty imposed by the SEC. For individuals, Tier 2 penalties can reach up to $80,000 per violation, while entities may face penalties of up to $400,000 per violation. These penalties are applicable for violations involving fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement. Tier 2 penalties are used when the violation is more serious than a Tier 1 offense but doesn’t meet the criteria for the most severe penalties (Tier 3).

What Are the SEC’s Tier 3 Penalties?

A Tier 3 penalty is the most severe level of civil monetary penalty that the SEC can seek. For individuals, Tier 3 penalties can be up to $160,000 per violation, and for entities, the maximum penalty is $775,000 per violation. These penalties are reserved for the most serious violations involving fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement that also resulted in significant losses or created a significant risk of significant losses to other persons. Tier 3 penalties are typically applied in cases of egregious misconduct with significant investor harm or market impact.

How Much Does the SEC Make in Fines?

In 2023, the SEC settled or won cases bringing in almost $5 billion, the highest in its history, though less than a third of that was in fines, with the rest in disgorgement and interest.

The Bottom Line

The SEC collects fines, penalties, and disgorgements from individuals and companies that violate securities laws. Historically, these funds were primarily directed to the U.S. Treasury. However, since the Sarbanes-Oxley Act of 2002, the SEC has had the authority to distribute these funds to those harmed rather than simply transferring them to government coffers.

How to disseminate funds clawed back from securities fraudsters and others isn’t always straightforward. While the SEC aims to return money to harmed investors whenever possible, practical limitations arise. These can include difficulties in identifying all affected investors, the costs of distribution exceeding the amount collected, or cases where the violation didn’t result in direct investor losses. In such instances, the funds may still be directed to the Treasury. In addition, the 2024 Supreme Court decision in SEC v. Jarkesy may impact how these fines are imposed and collected in the future since it requires the SEC to pursue civil penalties in federal court rather than through administrative proceedings.

Read the original article on Investopedia.