Supreme Court Affirms And Narrows SEC’s Use of Disgorgement as Remedy

In a closely-watched case that could have significantly upended the status quo of disgorgement in regulatory enforcement proceedings, the Supreme Court issued an 8-1 decision in Liu v. SEC holding that disgorgement was considered “equitable relief” and was thus authorized as a remedy in enforcement actions brought by the Commission. Although the result is undoubtedly a win for the Commission, which obtained over $3 billion in disgorgement in 2019 alone[1], the decision also introduces new questions about how disgorgement is calculated and implemented going forward and suggests that simply disgorging the gross amount raised by the wrongdoers and depositing those funds into the U.S. Treasury may no longer suffice.

Background
Disgorgement has long been sought as a remedy by the Commission in enforcement actions and, until recently, was rarely questioned. In 2017, the Court issued its decision in SEC v. Kokesh holding that disgorgement constituted a “penalty” pursuant to 28 U.S.C. §2462 and thus was subject to a five-year statute of limitation.[2] The Court also included a cautionary reminder that its decision was not to be accepted as “an opinion on whether courts possess authority to order disgorgement in SEC enforcement proceedings.” Kokesh, 581 U.S. at __ n. 3 (slip op., at 5, n. 3).[3]

The Kokesh decision came shortly after the Commission filed an enforcement action against Charles C. Liu and Xin “Lisa” Wang (collectively, “Petitioners”) on allegations the pair raised $27 million in an alleged fraudulent EB-5 immigrant investor program.[4] The District Court later granted the Commission’s requested relief which included a disgorgement award of $27 million equaling the full amount raised from investors. In doing so, the District Court rejected Petitioners’ contentions that the disgorgement award improperly failed to account for their business expenses, concluded the award was a “reasonable approximation of [Petitioners’] profits,” and ordered that Petitioners were jointly and severally liable for the full amount. On appeal, the Ninth Circuit affirmed the District Court while also acknowledging that Kokesh had “expressly refused to reach” the lower court’s ability to order disgorgement. The Court later granted certiorari.

The Court’s Ruling
In its 8-1 decision authored by Justice Sotomayor and joined by all Justices except Justice Thomas, the Court sought to harmonize the competing yet complementary principles that a wrongdoer should not be allowed to profit from his own wrong but should also not be forced to pay more than fair compensation for his wrongs.; In recognizing that “a remedy tethered to a wrongdoer’s net unlawful profits…has long been a mainstay of equity courts,” the Court concluded that a disgorgement award was an appropriate equitable remedy when it did not exceed a wrongdoer’s net profits and was awarded for the benefit of victims. The Court did not stop there, also addressing the three main case types in which courts occasionally awarded disgorgement and observing that the Commission’s pursuit of disgorgement in those situations was “in considerable tension with equity practices.”

The first case involved whether or not disgorgement was necessary only when the disgorged funds were to be returned to victims, with the Court noting the apparent contrast between the statutory language restricting equitable relief to instances where appropriate or necessary for the benefit of investors and the fact that the Commission did not always return all of the disgorged proceeds to investors.[5] Although the Court questioned whether simply depriving the wrongdoer of ill-gotten gains would meet this statutory threshold, it noted that the issue was not before it given that there was no order directing Petitioners to pay disgorgement to the U.S. Treasury.

Next, the Court analyzed the situation where the Commission imposed disgorgement on multiple wrongdoers on a joint-and-several liability basis. The Court theorized that the imposition of disgorgement on a wrongdoer that was not specifically attributable to that wrongdoer could theoretically transform the remedy into a penalty. Again, the Court abstained from issuing a bright-line rule in this situation, instead suggesting that the Ninth Circuit could analyze whether the underlying facts warranted holding Petitioners liable “as partners in wrongdoing or whether individual liability is required.”

Finally, the Court addressed the calculation of a disgorgement award and held that “courts must deduct legitimate expenses before ordering disgorgement under §78u(d)(5).” Although it acknowledged certain situations where it might be inequitable to permit deduction of such expenses, the Court held that any analysis should be guided by a factual analysis of the nature of the expenses. The Court relegated the analysis as to Petitioners’ expenses back to the lower court, but it did observe that expenses such as lease payments and equipment purchases “arguably have value independent of fueling a fraudulent scheme.”

Takeaways and Implications
There is no question that the Liu decision is a clear win for the Commission and a vindication of a powerful tool in its arsenal of remedies to remedy violations of the federal securities laws. Indeed, a contrary outcome would have arguably had a much more significant effect on the Commission’s enforcement strategy. The ruling provides a clear path forward for a pure form of disgorgement in which the Commission seeks to disgorge a wrongdoer’s profits and return those profits to defrauded investors. In a practical sense, any burden to demonstrate “legitimate” expenses to be deducted from a proposed disgorgement award continues to rest with the wrongdoer.

However, the decision raises several new considerations for disgorgement awards going forward. First, the Court declined to speculate how it would treat an award of disgorgement that would be paid to the U.S. Treasury rather than returned to victims. This distinction may not be as pronounced for investment fraud cases brought by the Commission in which disgorgement is routinely (where justified by the size of the award) returned to victims whether through fair funds or court-appointed receivers. But in other actions, such as Foreign Corrupt Practices Act and insider trading cases brought by the Commission and enforcement efforts brought by other regulators seeking disgorgement such as the Federal Trade Commission, the identification of victims or establishment of a framework to return funds to victims is often not as simple. The decision will also likely spur an increased focus (and wave of litigation) concerning the identification and calculation of a wrongdoer’s “net profits,” which will likely be further complicated by the Court’s seeming reluctance to endorse joint and several liability. Above all, the decision will present new challenges for lower courts in interpreting and implementing the Court’s analysis.

For more information on the disgorgement case and the Supreme Court's decision, please contact:

• Jonathan Hackbarth / (414) 277-5603 / jon.hackbarth@quarles.com