Disgorgement on the Chopping Block Again: Supreme Court to Decide Whether the Federal Securities Laws Authorize the SEC to Seek Court Ordered Disgorgement
On Friday, November 1, 2019, the United States Supreme Court granted review in Liu v. SEC, which will resolve an important question regarding the scope of the Securities and Exchange Commission’s powers: “whether courts possess authority to order disgorgement in SEC enforcement proceedings.” Two years ago, the Supreme Court expressly left open this issue in Kokesh v. SEC, 137 S. Ct. 1635, 1642 n.3 (2017). Although several of the Justices during the Kokesh oral argument questioned whether there was any statutory authority permitting federal courts to impose disgorgement, the limited issue before the Court was whether disgorgement is a penalty subject to the five-year statute of limitations period under 28 U.S.C. § 2462. Liu v. SEC now squarely presents the Supreme Court with the opportunity to clarify—once and for all—whether a statutory basis exists for the Commission to ever seek disgorgement in federal court enforcement proceedings.
The SEC commenced a civil enforcement action in May 2016 against petitioners Charles Liu and Xin Wang, charging them with violations of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and SEC Rule 10b-5. According to the Commission, the petitioners misappropriated millions of dollars of investor funds. On April 20, 2017, the district court granted the SEC summary judgment, holding that the petitioners had violated Section 17(a)(2) of the Securities Act by failing to inform investors in the offering documents that petitioners would award themselves “exorbitant renumeration.” SEC v. Liu, 262 F. Supp. 3d 957, 970 (C.D. Cal 2017).
To address this wrongdoing, the SEC sought—and the district court imposed—a number of remedies. First, the district court enjoined the petitioners from further violations of Section 17(a)(2). Second, the district court imposed an $6,714,580 civil monetary penalty against Liu and a $1,538,000 penalty against Wang pursuant to 15 U.S.C. § 77t(d) and § 78u(d)(3)(B). Finally, the district court ordered the petitioners to disgorge approximately $26.7 million, an amount which the court determined was “a reasonable approximation of the profits causally connected to [petitioners’] violation.” Id. at 976. Notably, the disgorgement order did not require that any of these funds be returned to the alleged victims.
The U.S. Court of Appeals for the Ninth Circuit affirmed the district court’s order, holding that the “proper amount of disgorgement in a scheme such as this one is the entire amount raised less the money paid back to investors.” SEC v. Liu, 754 F. App’x 505, 509 (9th Cir. 2018). Although Kokesh had been decided before Liu and Wang brought their appeals, the Ninth Circuit concluded that because the Supreme Court “expressly refused to reach” whether a district court lacked the statutory authority to order disgorgement, “longstanding precedent” from the Ninth Circuit “on this subject” was not irreconcilable with the Kokesh decision. Id.
The Parties’ Arguments
For the first 55 years of its existence, the SEC lacked statutory authorization to obtain monetary relief in an enforcement action. To fill this gap, the “Commission urged courts to order disgorgement as an exercise of their ‘inherent equity power to grant relief ancillary to an injunction.’” Kokesh, 137 S. Ct. at 1635 (quoting SEC v. Texas Gulf Sulphur Co., 312 F. Supp. 77, 91 (S.D.N.Y. 1970)). Courts routinely accepted this theory, and the Commission has successfully obtained disgorgement orders, to the tune of billions of dollars, in federal court since the early 1970s. Even after Congress gave the SEC the statutory authorization to obtain civil monetary penalties in 1990, the SEC continued to seek disgorgement as an equitable remedy, and in 2018 alone, collected over $2.5 billion in disgorgement awards. See SEC, Annual Report Division of Enforcement (2018) at 11. Available at https://www.sec.gov/files/enforcement-annual-report-2018.pdf (last accessed on Nov. 4. 2019).
Petitioners contend, however, that disgorgement can no longer be characterized as an equitable remedy in light of the Supreme Court’s clear holding in Kokesh that disgorgement is a penalty. The problem for the SEC is that, stripping disgorgement from its long-enjoyed equitable remedy status deprives the Commission from relying on the one statutory provision that empowers the agency to pursue “any equitable relief that may be appropriate or necessary” in civil cases initiated in federal court. 15 U.S.C. § 78u(d)(5).
In opposing certiorari, the Commission contended that its continued pursuit of disgorgement on equitable grounds remains compatible with Kokesh, arguing that remedies can qualify as a form of equitable relief even though they might also be construed as “penal” for some other purposes. So the SEC asserts, “[t]he understanding that disgorgement constitutes an equitable remedy therefore is not inconsistent with the Kokesh Court’s holding that disgorgement constitutes a ‘penalty’” for statute of limitations purposes. Brief in Opposition at 8, Liu v. SEC, No. 18-1501.
The future viability of disgorgement in SEC enforcement proceedings is at stake in Liu v. SEC. Based on questioning during the oral argument in Kokesh, multiple Justices seem skeptical that SEC disgorgement awards have a statutory basis. See Oral Argument Transcript 7-9, 13, 31, 52, Kokesh v. SEC, No. 16-529 (Apr. 18, 2017). Further, as the SEC noted in its opposition to certiorari, unlike other situations where the Supreme Court agrees to hear a case, there is no clear “circuit split” on the issue of whether the SEC has the authority to obtain a disgorgement, which suggests that the Justices have a strong appetite to clarify the law surrounding disgorgement. Brief in Opposition at 8-12, Liu v. SEC, No. 18-1501.
A ruling that a federal court may not order disgorgement under the current statutory scheme could have a dramatic impact on how the SEC prosecutes violations of the federal securities laws. To be sure, regardless of the outcome in Liu, the SEC will still have statutory authority to obtain civil monetary penalties. But the amount the SEC obtains via disgorgement dwarfs the amount the SEC obtains pursuant to that statutory authority. See SEC, Annual Report Division of Enforcement (2018) at 11 (noting the SEC obtained $2.5 billion in disgorgement in 2018 but only about half that amount, $1.4 billion, in penalties) (hyperlink supra).
A possible end run around on the unavailability of disgorgement in federal court is for the Commission to seek disgorgement administratively. In contrast to the relief authorized by statute in federal court, Congress specifically permits the SEC to “enter an order requiring accounting and disgorgement” in administrative proceedings. 15 U.S.C. § 78u-2(e). Administrative proceedings, however, may not be appropriate in every case, particularly in those cases where the Commission desires injunctive relief—relief that only a federal court can impose. See 15 U.S.C. § 78u(d)(1).
Further, as the petitioners note in their certiorari brief, numerous other agencies, including the Federal Trade Commission, the Food and Drug Administration, and the Commodities Futures Trading Commission, like the SEC, seek disgorgement under implied equitable powers. The decision in Liu thus has the potential to have repercussions far beyond the SEC.
After Kokesh, the Commission warned that its ability to collect disgorgement has been stymied by the Supreme Court’s 2017 ruling, prompting Commission Chair Jay Clayton to appear before a U.S. House of Representatives committee in early 2018 to request that Congress give the SEC statutory authority to seek both disgorgement and restitution for investors’ losses.1 If the Supreme Court rules that court-ordered disgorgement has no existing statutory basis, that would probably prompt intense lobbying before Congress to address what the Commission will undoubtedly characterize as a legislative deficiency harmful to investors and the public.
We will continue to closely monitor the proceedings in Liu v. SEC, and the impact of the Supreme Court’s decision in this important case.
1 Dave Michaels, SEC Wants More Power to Get Funds Back for Bilked Investors, WSJ.com (June 21, 2018), https://www.wsj.com/articles/sec-wants-more-power-to-get-funds-back-for-bilked-investors-1529622404 (last accessed Nov. 4, 2019).