Supreme Court affirms SEC’s authority to use disgorgement remedy, with limits
In an 8-1 decision affirming the U.S. Securities and Exchange Commission’s (“SEC”) authority to continue using disgorgement as a remedy in federal court enforcement actions, the U.S. Supreme Court recently held that a disgorgement award that does not exceed a wrongdoer’s net profits and is awarded for victims is permitted as a form of equitable relief.
The SEC is authorized to seek “equitable relief” in civil proceedings under 15 U.S.C. §78u(d)(5). For decades, the SEC has relied on disgorgement as a form of equitable relief in its enforcement actions, under the theory that disgorgement serves a remedial purpose by requiring wrongdoers to give up their ill-gotten gains. That view has been a source of contention for the last few years, particularly following the 2017 Kokesh v. SEC decision, in which the Supreme Court held that the SEC disgorgement order in the case constituted a “penalty” and was thus subject to a five-year statute of limitations under 28 U.S.C. §2462. In Kokesh, however, the court did not address the broader question of whether disgorgement in general can qualify as equitable relief under Section 78u(d)(5).
In Liu v. SEC, the SEC charged Charles Liu and Xin Wang (the “petitioners”) with misappropriating much of the funds they had solicited in a private offering for investment in the construction of a cancer-treatment center. The SEC brought a civil action against the petitioners, seeking disgorgement equal to the full amount that the petitioners had raised from investors. The district court’s order made the petitioners jointly and severally liable for the full amount, and the U.S. Court of Appeals for the Ninth Circuit affirmed the district court’s order.
The Supreme Court concluded that, as a general principle, disgorgement is permitted as equitable relief under 15 U.S.C. §78u(d)(5), as long as the award does not exceed a wrongdoer’s net profits and is awarded for victims. To ensure that the disgorgement award meets these requirements, the court vacated the Ninth Circuit’s decision and remanded the case to the lower courts.
Petitioners had argued that the disgorgement award exceeded the bounds of equitable relief by failing to return funds to victims, imposing joint-and-several liability, and declining to deduct business expenses from the award. The court declined to rule on those issues because the petitioners had not adequately briefed them, but did offer some general principles that could guide the lower courts’ assessment of the issues on remand, including that:
- Section 78u(d)(5) provides limited guidance as to whether the practice of depositing a defendant’s gains with the U.S. Department of Treasury (“Treasury”) satisfies the statute’s command that any remedy be “appropriate or necessary for the benefit of investors,” and the equitable nature of the profits remedy generally requires the SEC to return a defendant’s gains to wronged investors. Since the parties did not identify a specific order directing proceeds to Treasury, the lower courts should evaluate whether any such order, if provided upon remand, would be for the benefit of investors and consistent with equitable principles.
- Imposing disgorgement liability on a wrongdoer for benefits that accrue to his or her affiliates through joint-and-several liability generally runs against the rule in favor of holding defendants individually liable, but common law does permit liability for partners engaged in concerted wrongdoing. The decision states that on remand, the Ninth Circuit may determine whether the facts are such that petitioners can, consistent with equitable principles, be found liable for profits as partners in wrongdoing or whether individual liability is required.
- Courts must deduct legitimate expenses before awarding disgorgement under Section 78u(d)(5). Because the district court did not determine whether any of petitioners’ expenses were legitimate, the Supreme Court has directed the lower courts to examine whether including such expenses in a profits-based remedy is consistent with the equitable principles underlying §78u(d)(5). Doing so will requiring ascertaining whether expenses are legitimate or whether they are merely wrongful gains “under another name.” The court noted that some expenses from the scheme went toward lease payments and cancer-treatment equipment and arguably have value independent of fueling a fraudulent scheme.
Although the Supreme Court has put some limits on disgorgement awards, the decision in general is a significant win for the SEC. Disgorgement is the SEC’s most important enforcement remedy, with disgorgement accounting for US$3.248bn of the total monetary remedies ordered in fiscal year 2019, while penalties only accounted for US$1.101bn. In fact, disgorgement awards have significantly exceeded penalties in the SEC’s last five fiscal years, according to the SEC Enforcement Division’s annual report for 2019.
We will continue to monitor developments in this area and welcome any queries you may have.