On Monday, June 22, 2020 the United States Supreme Court issued its opinion in Liu v. SEC,1 upholding the Securities and Exchange Commission’s ability to obtain disgorgement from defendants in federal district court proceedings but indicating there are limits to this power. Specifically, the Court held that disgorgement awards may not exceed “a wrongdoer’s net profit” and must be “awarded for victims.” The Supreme Court remanded the case for further consideration on whether the disgorgement order entered in Liu complied with the limitations set forth in its opinion.
Below, we provide more detail on the Liu decision, but here are three key take-aways:
- Disgorgement is here to stay. Despite predictions that Liu would be the death-knell for disgorgement, the Supreme Court seemingly found it unremarkable that the equitable remedies available to the SEC include requiring wrongdoers to disgorge ill-gotten gains.
- Nonetheless, the Supreme Court’s decision places some limits on the SEC’s disgorgement power and, in future cases, courts will have to hue more closely to traditional equitable principles when imposing disgorgement. Specifically, the Court questioned the practice of requiring disgorged funds to be deposited in the U.S. Treasury (instead of being returned to identifiable victims), indicated that there are significant limits to requiring a defendant to disgorge profits that accrued not just by the wrongdoer himself, but by his affiliates, and indicated that legitimate expenses should generally be deducted before ordering disgorgement.
- The Liu decision does not affect the Supreme Court’s 2017 holding in Kokesh v. SEC that disgorgement is subject to a five year-statute of limitations.
The SEC’s Disgorgement Authority and Kokesh
For the first 55 years of its existence, the SEC lacked statutory authorization to obtain monetary relief in an enforcement action in federal district court. To fill this gap, and at the Commission’s urging, courts began ordering disgorgement in early 1970s, citing the SEC’s undisputed statutory power to obtain “equitable relief,” and courts’ “inherent equity power to grant relief ancillary to an injunction.” See, e.g., SEC v. Texas Gulf Sulphur Co., 312 F. Supp. 77, 91 (S.D.N.Y. 1970). Using this theory, the Commission successfully obtained disgorgement orders, to the tune of billions of dollars, over the last 40-plus years.
In 2017, in Kokesh v. SEC, 137 S. Ct. 1635, 1642 (2017), the Supreme Court held that disgorgement was a “penalty” and, as such, was subject to a five-year statute of limitations. In a footnote, the Supreme Court stated that “nothing in this 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.” See id. at n.3. Many observers took this oblique statement, and the Court’s subsequent grant of certiorari in Liu, as signs that the Supreme Court was ready to eliminate the SEC’s disgorgement authority altogether.
Prior Proceedings in Liu
In May 2016, the SEC brought an enforcement action in federal district court against petitioners Charles Liu and Xin Wang. The Commission alleged that the petitioners had misappropriated millions of dollars of funds they solicited from investors. After the district court granted the SEC summary judgment, the SEC sought—and the district court imposed—an order requiring 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.” SEC v. Liu, 262 F. Supp. 3d 957, 976 (C.D. Cal. 2017).
The United States 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). On November 1, 2019, the Supreme Court granted certiorari to determine to whether, and to what extent, the SEC could obtain disgorgement as “equitable relief” in federal district court proceedings.
Supreme Court Opinion
In Liu, an 8-1 Supreme Court held that the SEC can obtain disgorgement as an equitable remedy, noting that “equity practice long authorized courts to strip wrongdoers of their ill-gotten gains . . . .” Slip op. at 6. However, the Court noted this power is subject to certain limitations. “[T]o avoid transforming an equitable remedy into a punitive sanction,” the Court concluded that lower courts must tether orders of disgorgement to a “wrongdoer’s net unlawful profits” and award such unlawful profits to victims. Id. at 6-7. The Court observed that, contrary to these principles, over time, the SEC has used disgorgement in three primary ways that have stretched the concept of a truly “equitable” remedy and indicated that such uses were impermissible.
- Depositing Money in Treasury Fund
First, the Supreme Court noted that the statute giving the SEC the ability to obtain equitable relief restricts such relief “to that which ‘may be appropriate or necessary for the benefit of investors.’” Id. at 14 (quoting 15 U.S.C. § 78u(d)(5)). However, disgorged funds are sometimes deposited in the Treasury fund instead of returned to wronged investors. The Court noted that although this practice does deprive wrongdoers of their ill-gotten gains, an equitable, profits-based remedy generally must do more than just benefit the public at large. Id. at 16. Because there was no specific order in Liu directing proceeds to the Treasury, the Court declined to address whether doing so “satisfies the SEC’s obligation to award relief ‘for the benefit of investors’ and is consistent with the limitations of § 78u(d)(5).” Id. at 16-17. Therefore, it remains an “open question” as to whether depositing the funds into the Treasury is appropriate in instances where it is impractical or infeasible to distribute funds to investors.
- Joint-and-Several Disgorgement Liability
Second, the Supreme Court noted that the SEC occasionally seeks to disgorge profits accrued not just by the wrongdoer himself, but by his affiliates through joint-and-several liability. Id. at 17. Although common law required individual liability for wrongful profits, it allowed joint liability for “partners engaged in concerted wrongdoing.” Id. at 18. However, where the relationship between the wrongdoers is more remote, joint-and-several disgorgement liability could easily transform from equitable to punitive. Id.
The Liu Court ultimately left it up to the Ninth Circuit to decide on remand whether petitioners in this case, Liu and Wang, can be held jointly and severally liable for the profits they accrued as partners. However, the Court noted that Liu and Wang were married, were both active participants of the entity that misappropriated funds, enjoyed the fruits of the scheme, and did not otherwise present evidence that would support a finding that joint-and-several disgorgement liability would be unfair, suggesting that joint and several liability might be appropriate, at least in this case. Id. at 18. At the same time though, the Court’s opinion also suggests that it would not be appropriate for courts to continue to impose disgorgement on a defendant for benefits received by friends or associates. See id. at 17 (citing, among others, SEC v. Contorinis, 743 F.3d 296, 302 (2d Cir. 2014)).
- Deducting Legitimate Business Expenses from the Award
Finally, citing common-law principles, the Supreme Court explained “courts must deduct legitimate expenses before ordering disgorgement . . .” The Court noted that an exception to this rule could occur where the “entire profit of a business or undertaking” results from fraud, but noted that this exception “requires ascertaining whether expenses are legitimate or whether they are merely wrongful gains under another name.” Id. at 19 (quotation omitted). As an example, the Court noted that, in Liu, “some expenses from petitioners’ scheme went toward lease payments and cancer-treatment equipment,” which may “arguably have value independent of fueling a fraudulent scheme.” Id. The Supreme Court directed the lower court on remand “to examine whether including those expenses in a profits-based remedy is consistent with equitable principles underlying §78u(d)(5).” Id. at 19-20.
In short, this week’s Supreme Court holding in Liu means disgorgement is here to stay. However, limiting disgorgement to a wrongdoer’s net profits, Liu provides defendants with significant ammunition in both settlement negotiations and litigated actions to reduce the amount of disgorgement a court ultimately orders. If you have any questions about the Court’s holding in Liu, please do not hesitate to contact a member of our team so that we may further assist you.
1 Liu v. SEC, 591 U.S. __ (2020), No. 18-1501.
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