Liu, et al. v. Securities and Exchange Commission, S.Ct. case no. 18-01, decided June 22, 2020
In a highly anticipated decision last week, the Supreme Court upheld the SEC’s authority to use the “disgorgement” of ill-obtained funds as a remedy in securities fraud cases. However, while the Court confirmed the SEC’s authority to exercise this remedy, the Court also further limited the SEC’s use of this powerful tool.
What is disgorgement?
As we’ve previously discussed (see Alert, January 31, 2020), one of the SEC’s strongest instruments in its enforcement of the securities laws is to seek the “disgorgement” of money that was obtained through allegedly improper conduct. Pursuant to the securities anti-fraud statute, 15 USC 78u(d)(5), the SEC has the power to seek, among other things, “equitable relief” to punish those that engage in fraud in the sale of securities. For many years, the SEC has used this “equitable” authority granted by Congress under the securities laws to argue that it can seek from defendants the return of ill-gotten gains through disgorgement. Disgorgement is a different remedy than penalties: penalties are specific fines set by Congress by statute for certain violations. But while Congress also gave the SEC the power to seek “equitable relief,” disgorgement is not expressly authorized as a type of relief available, and unlike penalties, it is not restricted to certain amounts. While the authority to seek disgorgement has often raised questions, its use has been critical to the SEC’s enforcement priorities. Indeed, the SEC typically obtains more money from disgorgement than in fines; in 2019 it obtained $1.1 billion in fines, versus $3.2 billion in disgorgement from defendants.
Disgorgement called into question
Three years ago, a Supreme Court decision in Kokesh v. SEC limited in part the SEC’s use of disgorgement as a remedy, holding that a five-year statute of limitations applies to the disgorgement of money, meaning that the SEC can no longer seek the return of funds from beyond five years. Moreover, the Court in Kokesh left an open question whether disgorgement was lawful altogether, as the power is not expressly granted to the SEC by Congress, and could be viewed as an unauthorized additional penalty. When Charles Liu and Xin Wang were granted certiorari on their challenge to the SEC’s use of disgorgement, some commentators speculated that the Court was sending signals that it would terminate the SEC’s use of disgorgement as a remedy.
The Court sustains the SEC’s authority to use disgorgement as a remedy
Charles Liu and his wife Xin Wang solicited $27 million from investors pursuant to the EB-5 Immigrant Investment Program pursuant to a private offering memorandum. According to the SEC, Liu and Wang diverted a substantial portion of those invested funds toward personal expenses or marketing, contradicting the statements in the offering memorandum. In a civil action brought by the SEC, the district court found for the SEC, and issued civil penalties as well as a disgorgement order in the full amount that Liu and Wang raised from investors. Liu and Wang appealed the court’s entry of the disgorgement order on several grounds, including that the SEC failed to take into account their legitimate business expenses. The Ninth Circuit affirmed the lower court’s order, and the Supreme Court granted certiorari to close the loop on the question left open in Kokesh.
Last week, in an 8–1 opinion authored by Justice Sotomayor, the Court held that the SEC has the authority to seek disgorgement of monies obtained through improper conduct, because Congress gave the SEC the power to seek equitable relief, and disgorgement falls within the Court’s historical view of available equitable remedies—namely that it is inequitable to allow a wrongdoer to profit from their own bad acts.
Limits on the SEC’s authority
While the Court in Liu maintained the SEC’s authority to utilize the agency’s disgorgement powers, the Court limited use of the remedy beyond the limitations articulated in Kokesh, holding that it is also a fundamental principle of equitable relief that a wrongdoer should not be unfairly punished by paying the victim more than fair compensation. For that reason, the Court held last week in Liu that the SEC must subtract from its calculation of any disgorgement amount the legitimate business expenses expended by the defendant in the securities sales process.
Additionally, because of the purely equitable nature of the remedy, the Court offered guidance to lower courts that disgorged funds should in most instances be returned to the harmed investors, and not utilized by the SEC for the general treasury fund. On this point, the Court did not decide in Liu whether the SEC ran afoul of this issue in this particular matter, because no order was entered to direct any funds to the Treasury. Given that ambiguity, the Court advised that the lower court on remand should ensure that the order concerning how the funds are directed must be consistent with equitable principles.
We will continue to follow SEC enforcement priorities closely and the courts’ views of the actions taken.