Supreme Court Upholds Disgorgement as SEC Remedy

Background of SEC Disgorgement Awards and Kokesh v. SEC

Federal district courts have long ordered disgorgement and other equitable remedies in SEC enforcement actions.  Initially, courts awarded such relief based on their inherent equitable powers. Then, as part of the Sarbanes-Oxley Act of 2002, Congress authorized the SEC, through Exchange Act Section 21(d)(5), to seek, and federal courts to grant, “any equitable relief that may be appropriate or necessary for the benefit of investors.” While Congress did not define “equitable relief” in the statute, courts have continued to grant disgorgement in SEC enforcement actions under Section 21(d)(5) and as an exercise of the court’s general equitable powers. The question of permissibility of a disgorgement remedy only applies to proceedings in federal court; Congress provided the SEC with express authority to seek disgorgement in administrative proceedings. See, e.g., 15 U.S.C. § 77h–1(e).

The issue in Liu arises from the Supreme Court’s 2017 decision in Kokesh v. SEC. In Kokesh, the Court determined that disgorgement constituted a “penalty” for the purposes of 28 U. S. C. § 2462, which establishes a 5-year statute of limitations for “an action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture.” The Court reached this conclusion based on, among other considerations, the imposition of disgorgement as a consequence of violating public laws, which is at least partially punitive. The Court expressly reserved for another day whether federal courts could impose disgorgement as an equitable remedy under Section 21(d)(5).

Liu Ruling

 In Liu, the petitioners solicited investments from foreign nationals for the construction of a cancer-treatment center but misappropriated a large amount of the funds. The SEC brought suit in federal court seeking disgorgement equal to the amount the petitioners had raised from investors. The district court permitted, and the Ninth Circuit affirmed, the SEC’s award of disgorgement, which the petitioners challenged.

The Supreme Court agreed that disgorgement qualifies as “equitable relief” pursuant to Section 21(d)(5). The Court made clear, however, that equity courts circumscribed such awards “to avoid transforming [them] into a penalty outside their equitable powers.” (Slip Op. at 9.) The Court identified three limitations courts should follow with respect to disgorgement awards to maintain consistency with the equitable principles underlying Section 21(d)(5). First, courts should confirm that the remedy returns the “wrongful gains” to the “wronged victims”. Second, courts should award remedies against “individuals or partners engaged in concerted wrongdoing,” not against multiple wrongdoers under a joint-and-several liability theory. Third, courts should limit disgorgement awards to the net profits from wrongdoing (after the deduction of legitimate expenses). (Slip Op. at 9-12.)

The Court observed that “courts have occasionally awarded disgorgement in three main ways that test the bounds of equity practice: by ordering the proceeds of fraud to be deposited in Treasury funds instead of disbursing them to victims, imposing joint-and several disgorgement liability, and declining to deduct even legitimate expenses from the receipts of fraud.” (Slip Op. at 12.) But, because the parties had not fully briefed the issues, the Court declined to consider whether the disgorgement award before it ran afoul of these three identified limitations, or whether there are situations in which there might be exceptions to these limitations. Instead, the Court concluded with a discussion of principles that may guide the lower court’s assessment of the disgorgement award.

Considerations

Liu raises many questions about the practical application of the SEC’s disgorgement remedy going forward. For example:

• Administrative Proceedings. Whether the decision will curtail when and how the SEC seeks disgorgement in administrative proceedings (even though the decision does not arise in this context).
• Deposits with Treasury. Whether the SEC’s practice of depositing disgorgement funds with the Treasury is justified when the wrongdoer’s profits cannot be practically disbursed to the victim.
• Collective Liability. Under what circumstances will defendants be found collectively liable for profits as partners in wrongdoing instead of individually liable?
• Deducting Expenses. The circumstances in which a defendant’s expenses are considered “legitimate” and can deducted when calculating net profits.
• Public Companies. How will the decision apply in the context of public companies, where net profits might differ from simply the proceeds the corporation received from the conduct in question, and where determining the “net profit” might be extremely difficult?
• FCPA. How will courts assess disgorgement in FCPA cases where the ill-gotten gains are not from harmed investors?
• Insider Trading. How will the SEC’s historic practice of requiring tippers to disgorge trading profits earned by tippees square with the decision’s limits on joint and several liability for disgorgement?

Given that disgorgement has been, for years, one of the SEC’s most common remedies, tribunals and the SEC itself may well be taking up these issues sooner rather than later.