In Liu v. SEC, Supreme Court Upholds – But Limits – SEC’s Ability to Obtain Disgorgement, Leaving Many Questions for Lower Courts to Decide
Can the SEC obtain disgorgement in civil enforcement actions? Yes.
What, exactly, is disgorgement? Well, it’s complicated.
In an 8-1 opinion, the Supreme Court held that the SEC can seek and obtain disgorgement in federal civil actions, as long as that disgorgement meets the definition of an equitable remedy. The Court then provided guidance to lower courts on what does and does not qualify as an equitable remedy. Rather than simplifying the questions around disgorgement, the Court may have given just enough ammunition to both sides so that the issue will resonate in legal battles for years to come.
How We Got Here: The Decisions Below
Petitioners Charles Liu and Xin (Lisa) Wang defrauded foreign investors of nearly $27 million through use of the EB-5 Program, which incentivizes investment in “approved [U.S.] commercial enterprises” by permitting noncitizen investors in such enterprises to apply for permanent residence in the U.S. Rather than channeling the nearly $27 million into a cancer-treatment center as they represented would occur, Liu and Wang redirected nearly $20 million into “ostensible marketing expenses and salaries,” and deposited “additional funds to personal accounts and to a company under Wang’s control.” In sum, a slim margin of investments went to the intended cancer-treatment center, and the SEC brought a civil action for violation of securities laws.
The District Court ordered, and the Ninth Circuit affirmed, a civil penalty and “disgorgement equal to the full amount petitioners had raised from investors, less the $234,899 that remained in the corporate accounts for the project.” The lower court held Liu and Wang jointly and severally liable for the to-be-disgorged amounts; did not reduce the amount to be disgorged based on Liu and Wang’s “legitimate” expenses; and did not clearly order return of the disgorged funds to investors. Liu and Wang appealed.
The Kokesh Decision Left Open the Disgorgement Question
The Liu opinion follows just over three years after the Court’s 2017 opinion in Kokesh v. SEC, in which the Court held disgorgement awards in SEC enforcement actions are “penalties” for purposes of the relevant statute of limitations. Anticipating the arguments that might stem from such a designation, the Court narrowly limited its holding in Kokesh and, in a footnote, explicitly refused to address the underlying question whether courts have authority to order disgorgement as a form of equitable relief in SEC enforcement proceedings, given that equity traditionally excludes penalties. Despite its limited application, Kokesh led many to believe the Court might reign in or eliminate the SEC’s disgorgement powers on direct challenge. Liu v. SEC presented such a direct challenge.
The Supreme Court Decision in Liu v. SEC: Disgorgement Survives, with Limitations
On June 22, 2020, the United States Supreme Court issued a decision in Liu v. SEC upholding the SEC’s ability to seek, and federal courts’ power to award, disgorgement of profits in civil actions as a form of equitable relief under 15 U.S.C. §78u(d)(5), albeit with limitations. In civil actions to enforce securities laws, the SEC can seek, and a “Federal court may grant [,] . . . any equitable relief that may be appropriate or necessary for the benefit of investors.” 15 U.S.C. § 78u(d)(5). Since at least 1971, courts have granted the SEC relief under Section 78u(d)(5) in the form of “restitution,” or awards in amounts sufficient to “deprive a defendant of the gains of . . . wrongful conduct.” This form of relief has come to be known commonly as “disgorgement.”
Justice Sotomayor, writing for the majority, characterizes the Court’s task as determining whether disgorgement under §78u(d)(5) “falls into ‘those categories of relief that were typically available in equity’” and may thus be rightfully awarded as “equitable relief.”
The key distinction between the majority and dissenting opinions, inherent in Justice Sotomayor’s characterization of the question itself, stems from their respective views on how to cabin the reach of “equitable” remedies. Justice Thomas, in his dissent, adheres to what he characterizes as the Court’s “usual interpretive convention,” which includes as “equitable relief” only those “forms of equitable relief available in the English Court of Chancery at the time of the founding. Because disgorgement is a creation of the 20th century, it is not properly characterized as ‘equitable relief,’ and, hence, the District Court was not authorized to award it under § 78u(d)(5).” Easy enough, right?
The majority thinks not. The contours of equity, the Court observes, are “well known” and mapped against two primary principles: (1) equity practice has “long authorized courts to strip wrongdoers of their ill-gotten gains, with scholars and courts using various labels for the remedy;” and (2) equity practice historically has required “restrict[ion of] the remedy to an individual wrongdoer’s net profits . . . awarded for victims,” so as to “avoid transforming an equitable remedy into a punitive sanction.” For the majority, the determination whether a remedy truly is equitable turns not on the name given it, in past or present, but on its function. True, courts might not have referred to “disgorgement” earlier than the 20th century, but disgorgement acts similarly to the traditional remedies of restitution or accounting, and its function, to “take back” profits earned by the wrongdoer, makes it yet another incarnation of the “protean” profits-recovery remedy. In other words, done correctly, disgorgement qualifies as equitable relief.
Nonetheless, the Court in Liu acknowledges courts’ disgorgement awards have gone too far. Specifically, the SEC’s requests and courts’ awards have exceeded the bounds of equitable relief by (1) “ordering the proceeds of fraud to be deposited in treasury funds instead of disbursing them to victims;” (2) “imposing joint-and-several disgorgement liability;” and (3) “declining to deduct even legitimate expenses from the receipts of fraud.” Disgorgement in practice therefore stands in tension with traditional notions of equity, which restrict equitable remedies to recovery of the wrongdoer’s ill-gotten gains and require return of those gains to victims. And contrary to the SEC’s argument otherwise, Congress cannot expand the well-established notions and reach of equity by inserting references to “disgorgement” into relevant statutes, to be interpreted in alignment with the SEC’s prior, overreaching application of the term.
Regarding the award at issue, the Court finds the parties “did not fully brief” whether the award overstepped in any of the three ways outlined above. Accordingly, the Court does not decide these narrower issues as applied to the underlying facts but does “discuss principles that may guide the lower courts’ assessment” on remand.
The Takeaway: Disgorgement Is Alive and Well, but Don’t Expect It to Be Easy
The generalized takeaway from this discussion, and from the Court’s analysis overall, is that disgorgement awards in SEC enforcement actions may continue, but will be more heavily scrutinized to ensure:
- …proceeds go to victims (except when they don’t). Section 78u(d)(5) restricts equitable relief to that which “may be appropriate or necessary for the benefit of investors.” The SEC often deposits at least a portion of fees recovered under Section 78u(d)(5) with the Treasury, however, and return of the funds to investors may not always be feasible. The disgorgement remedy “must do more than simply benefit the public at large by virtue of depriving a wrongdoer of ill-gotten gains,” but whether deposit of amounts with the Treasury satisfies the SEC’s obligations and aligns with the equitable nature of the remedy remains “an open question.”
- …defendants are not held jointly and severally liable (except when they are). Joint and several awards risk transforming “any equitable profits-focused remedy into a penalty.” However, common law exceptions equally apply to the disgorgement remedy and allow courts to impose collective liability for “partners engaged in concerted wrongdoing.” “Given the wide spectrum of relationships between participants and beneficiaries of unlawful schemes,” the boundaries of the exception to this rule necessarily also remain open to interpretation.
- …legitimate expenses are deducted from net gains (except when they aren’t). Courts must limit disgorgement awards to a wrongdoer’s gains minus “legitimate expenses” under Section 78u(d)(5). Yet in certain circumstances, the “entire profit of a business or undertaking” may stem from the wrongdoing, thereby justifying the court’s refusal to discount any expenses. Determination of whether deductions should be made “requires ascertaining whether expenses are legitimate or whether they are merely wrongful gains ‘under another name,’” but the Court finds it “not necessary” to provide guidance on how to so ascertain. Offering at least a hint regarding appropriate application, the Court suggests expenses that “went toward lease payments and cancer-treatment equipment” in the underlying matter “arguably have value independent of fueling a fraudulent scheme.” One can presume this independence might, in the Court’s eyes, bring such payments within the realm of legitimacy.
The Court answered the easy question easily: Yes, the SEC can seek disgorgement in federal civil action. The Court’s guidance on when disgorgement is an equitable remedy and when it is not may end up creating just enough uncertainty to increase litigation on the issue rather than minimize it.
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