On June 22, 2020, the Supreme Court preserved one of the most powerful enforcement tools in the Securities and Exchange Commission’s (the “SEC’s”) arsenal. In an 8-1 ruling, the Court held that disgorgement awards sought by the SEC in federal courts are an equitable remedy permitted by the federal securities laws if capped to the wrongdoer’s net profits and awarded for the benefit of wronged investors. The Court vacated and remanded the case for the lower courts to determine whether the disgorgement award previously imposed was consistent with its opinion.1
Without disrupting the SEC’s ability to obtain disgorgement, this decision limits the manner in which disgorgement has historically been awarded in SEC civil actions. In particular, the Court held that disgorgement must be awarded for the benefit of the wronged investor. Thus, lower courts must either return the funds to the victims or determine how sending the funds to the US Treasury benefits victims. In addition, lower courts can no longer automatically impose joint and several liability for disgorgement. However, lower courts may still decide that liability for disgorgement for partners engaged in concerted wrongdoing is appropriate under certain circumstances. Finally, rather than requiring wrongdoers to disgorge their total ill-gotten proceeds, lower courts must now deduct any legitimate business expenses from the amount of ill-gotten gains in order to calculate the amount eligible for disgorgement.
While the SEC has statutory authority to obtain civil monetary penalties, injunctions, and equitable relief in enforcement matters, no statute expressly grants the SEC with the power to seek disgorgement. Notwithstanding that, the SEC has often relied on disgorgement2 in enforcement cases. In 2019 alone, the SEC obtained $3.248 billion in disgorgement of ill-gotten gains, far exceeding the $1.101 billion obtained in civil penalties.3
In 2017, in Kokesh v. SEC, the Supreme Court invited the question whether the SEC has the power to seek such disgorgement. In that case, the Court considered whether SEC disgorgement should be subject to the five-year statute of limitations in 28 U.S.C. §2642, which applies to “any civil fine, penalty, or forfeiture.”4 The Court ruled that disgorgement is a “penalty” for purposes of 28 U.S.C. §2642 and should therefore be subject to the five-year limitation. In a footnote, the Court cautioned, however, that “[n]othing in this opinion should be interpreted as an opinion on whether courts possess authority to order disgorgement in SEC enforcement proceedings.”5
Petitioners, Charles Liu and Xin Wang, seized the opportunity left open in this footnote to challenge the SEC’s disgorgement authority. In May 2016, the SEC sued the Petitioners in federal court for violating the securities laws by defrauding foreign investors who participated in an EB-5 Immigrant Investor Program hoping to secure green cards. The SEC alleged that Petitioners had misappropriated for their own use $26.7 million that they had obtained from investors for the construction and development of a cancer treatment center.6
On April 20, 2017, the district court granted summary judgment to the SEC holding that Petitioners violated Section 17(a)(2) of the Securities Act of 1933 through their false statements in securities offerings. The district court ordered: (i) disgorgement of the total $26.7 million received from the investors, (ii) a civil monetary penalty of $8.2 million, and (iii) an injunction against Petitioners from violating Section 17(a)(2) of the Securities Act of 1933.7
Petitioners appealed to the Ninth Circuit arguing, inter alia, that the district court lacked the authority to grant disgorgement because, under Kokesh, SEC disgorgement is a penalty and not an equitable remedy. Petitioners reasoned that Congress only authorized the SEC to seek injunctions, civil monetary penalties, and equitable relief pursuant to 15 U. S. C. §78u(d)(5), but not other forms of penalties, such as disgorgement penalties. The Circuit court rejected Petitioners’ argument and held that “Kokesh expressly refused to reach this issue, so that case is not clearly irreconcilable with our longstanding precedent on this subject.”8
The Supreme Court Decision
Petitioners filed a petition for certiorari asking the Supreme Court “whether the Securities and Exchange Commission may seek and obtain disgorgement from a court as ‘equitable relief’ for a securities law violation even though this Court has determined that such disgorgement is a penalty.”9 In its opinion, the Court ruled that disgorgement is not a penalty for purposes of 15 U. S. C. §78u(d)(5) if the award is restricted to an individual wrongdoer’s net profits to be awarded for the victims, on the ground that such an award is consistent with common law principles of equity.10 The Court reasoned that equity courts routinely deprive wrongdoers from their ill-gotten gains.11
Petitioners also argued that the disgorgement award in their case was unlawful because it failed to return funds to the victims; imposed joint-and-several liability; and failed to deduct business expenses from the award.12 The Court agreed that the SEC’s disgorgement practices occasionally transgressed equity principles by “fail[ing] to return funds to victims, impos[ing] joint-and several liability, and declin[ing] to deduct business expenses from the award.”13 However, it declined to decide whether these practices rendered disgorgement unlawful (as Petitioners argued), and instead discussed principles to guide the lower courts in their own assessment of proposed disgorgement orders, including the Liu court on remand.
The Court’s ruling sought to reach a middle ground on the question of whether courts possess authority to order disgorgement. On the one hand, the Supreme Court offered an important victory to the SEC upholding one of its most powerful and frequently-used remedies. A ruling that the SEC could not obtain court-ordered disgorgement would have had major consequences for the SEC’s enforcement powers. In its annual report, the SEC had estimated that the Kokesh decision had already caused the SEC to forgo approximately $1.1 billion in disgorgement in filed cases.14
On the other hand, by clarifying that traditional principles of equity limit what the SEC may seek and obtain in federal court, the Supreme Court narrowed the SEC’s broad and rarely challenged discretion in the use of disgorgement. Notably, the Court noted the possibility that the SEC’s practice of depositing disgorgement funds with the US Treasury is inconsistent with equitable principles, and may be justified only where “it is infeasible to distribute the collected funds to investors.”15 Further, disgorgement could be considerably reduced if no net profit was made on the illegal activity, affording defendants a strong argument for lowering disgorgement amounts.
1 Liu v. SEC, No. 18-1501 slip. op. (US June 22, 2020), available at https://www.supremecourt.gov/opinions/19pdf/18-1501_8n5a.pdf
2 See Securities Enforcement Remedies and Penny Stock Reform Act, 104 Stat. 932, codified at 15 U.S.C. §77t(d).
3 2019 Annual Report of the Division of Enforcement, SEC, at 16 (2019), available at https://www.sec.gov/files/enforcement-annual-report-2019.pdf
4 Kokesh v. SEC, 137 S. Ct. 1635, 1644 (2017).
5 Kokesh, at 1642, n.3.
6 Petition for Writ of Certiorari, Liu v. SEC, No. 18-1501, 2019 US Ct. Briefs LEXIS 1995, *15-16 (Sup. Ct. filed May 31, 2019).
7 SEC v. Liu, 262 F. Supp. 3d 957, 976 (C.D. Cal., Apr. 20, 2017).
8 SEC v. Liu, 754 F. App’x 505, 508 (9th Cir. 2018) (internal citation omitted). The Ninth Circuit, as well as other circuits, had long upheld district court disgorgement orders. See SEC v. Jammin Java Corp., 2017 US Dist. LEXIS 157730, *5 (C.D. Cal. 2017) (“Thus, to date, the overwhelming weight of authority-- indeed the virtually unanimous consensus-- has been in favor of ordering disgorgement when appropriate.”)
9 Petition for Writ of Certiorari, Liu at i.
10 Liu v. SEC, at 1.
11 Liu v. SEC, at 6.
12 Id. at 14.
13 Id. at 9-11, 14.
14 2019 Annual Report of the Division of Enforcement, SEC, at 21 (2019), available at https://www.sec.gov/files/enforcement-annual-report-2019.pdf
15 Liu v. SEC, at 16.
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