On June 22, 2020, the U.S. Supreme Court issued its highly anticipated decision in Liu v. Securities and Exchange Commission,[1] which found that disgorgement awards that do not exceed a wrongdoer’s net profits (gross profits reduced by legitimate expenses) are considered equitable relief under 15 U.S.C. §78u(d)(f). This ruling comes after the Court signaled its desire to rein in the Securities and Exchange Commission’s (“SEC”) disgorgement powers without eliminating them entirely. Notably, the Court also ruled that the equitable remedy of disgorgement requires that funds be collected for the “benefit of investors” rather than merely deposited into the U.S. Treasury in the ordinary course. The Court likewise observed that the law of equity placed some limitations on the SEC’s ability to seek joint and several liability under an equitable profits recovery theory.
Challenges to the SEC’s Disgorgement Power
Liu began in 2016 when the SEC sued Charles Liu and Xin “Lisa” Wang for defrauding investors by misusing funds solicited under the EB-5 program authorized by U.S. Citizenship and Immigration Services for an alleged private placement offering in a cancer treatment center.[2] In 2017, the district court ruled against Liu and Wang, and ordered penalties in the form of $27 million in disgorgement and $8.2 million in civil monetary penalties.[3] The Ninth Circuit affirmed the disgorgement award,[4] and Liu and Wang petitioned the Supreme Court to review whether the SEC may seek disgorgement in federal court as a penalty for violating the securities laws.
As detailed in our prior alert, disgorgement is a remedy that the SEC uses to recover wrongdoers’ ill-gotten gains and, in many cases, to return those gains to the victims.[5] The federal securities laws authorize the SEC to seek injunctive relief in federal district courts as well as “any equitable relief that may be appropriate or necessary for the benefit of investors.”[6] The Securities Exchange Act of 1934 (“Exchange Act”) specifically authorizes the SEC to obtain disgorgement as a civil remedy in administrative proceedings but is silent as to whether the remedy is available in federal court actions.[7] The SEC has historically sought and been successful in obtaining disgorgement beyond administrative proceedings under the “equitable relief” provision of the Exchange Act.
In 2017, however, the Supreme Court held in Kokesh v. SEC that disgorgement is a punitive remedy rather than a restorative remedy for the purposes of statute of limitations.[8] Specifically, the Court found that disgorgement is a penalty and therefore subject to the five-year statute of limitations under 28 U.S.C. § 2462.[9] The Court did not reach the question of whether courts have the authority to order disgorgement in the first instance.
The Liu petitioners relied heavily on Kokesh and argued that it foreclosed the SEC’s argument that its authority to seek equitable relief and injunctions justifies a disgorgement remedy.[10] Moreover, the petitioners reasoned that disgorgement is punitive in nature because money obtained from defendants is not always returned to victims but, instead, given to the U.S. Treasury.[11] This would not, in petitioners’ view, be viewed as an equitable remedy because it fails to restore the status quo that existed prior to the alleged wrongdoing.
Finally, the petitioners argued that, assuming disgorgement is allowable, it should be limited to a defendant’s net profits rather than the net loss to aggrieved investors. In other words, disgorgement, according to petitioners, seeks payments without consideration of expenses that reduced the amount of the illegal profit. For example, the district court found that petitioners gained more than $8 million from their alleged scheme, but the court nevertheless ordered them to disgorge – jointly and severally – nearly $27 million.[12] Petitioners averred that, in this sense, disgorgement is a true penalty that leaves defendants worse off.[13]
