All's Fair In Crime And Disgorgement: Supreme Court Upholds SEC's Authority To Disgorge Ill-Gotten Gains With Limitations

• Published date: 01 July 2020
• Subject Matter: Corporate/Commercial Law, Corporate and Company Law, Securities
• Law Firm: Duane Morris LLP
• Author: Ms Mary P. Hansen and Nicolette J. Zulli

On June 22, 2020, the Supreme Court, in an 8 to 1 decision, held in Liu v. SEC that the U.S. Securities and Exchange Commission ("SEC" or "Commission") may seek "disgorgement" in federal court actions in amounts which do not exceed a wrongdoers' net profits and are, if possible, ultimately returned to victims pursuant 15 U.S.C. ' 78u(d)(5), which authorizes the SEC to seek "equitable" relief.¹

What is Disgorgement?

Disgorgement is generally defined as "the act of giving up something on demand or by legal compulsion."² Functionally, disgorgement is a remedy or penalty that has been used by the SEC as an enforcement tool for violations of the federal securities laws. More specifically, the SEC has sought to disgorge "ill-gotten gains" from violators of federal securities laws as an equitable remedy in federal civil actions since the 1970's.³ The SEC has consistently argued that disgorgement is an equitable remedy because it seeks to deprive the violators of illicit profits and prevents violators from unjustly enriching themselves as a result of their unlawful misconduct.

The SEC has employed this tool in a broad range of cases, including, but not limited to, insider-trading, Ponzi schemes, and investment adviser cases. For example, disgorgement would include, any profits made as a result of trading on material non-public information, any amounts raised from investors in a Ponzi scheme, and undisclosed fees charged or monies earned without proper disclosure by an investment adviser.

Background

The SEC has always maintained the statutory authority to obtain civil monetary penalties, injunctions, and equitable relief in enforcement matters.⁴ The SEC administers four statutes that provide for civil monetary penalties: the Securities Act of 1933; the Securities Exchange Act of 1934; the Investment Company Act of 1940; and the Investment Advisers Act of 1940.⁵ A civil monetary penalty is defined in relevant part as any penalty, fine, or other sanction that: (1) is for a specific amount, or has a maximum amount, as provided by federal law; and (2) is assessed or enforced by an agency in an administrative proceeding or by a federal court pursuant to federal law.⁶ This definition covers the monetary penalty provisions contained in the statutes administered by the SEC.⁷

Despite its authority to obtain penalties, no statute expressly authorizes the SEC to seek disgorgement in federal court actions. Nevertheless, the SEC has continuously utilized a disgorgement remedy in enforcement cases filed in federal court.⁸

In 2016, Charles Liu and Xin Wang were charged in an SEC enforcement action in the Central District of California for defrauding investors in an EB-5 Immigrant Investor Program scheme. Under the EB-5 Program, foreign citizens can obtain lawful permanent residence if they make a significant investment in a U.S. commercial enterprise.⁹ The SEC alleged that Liu and Wang raised more than $27 million from investors for a purported new cancer center development that never materialized.¹⁰ Instead, they diverted investor money to their personal and certain other overseas accounts.¹¹ In April 2017, the Court granted the SEC summary judgment and ordered disgorgement of more than $26 million.

The Supreme Court's decision in Kokesh v. SEC came down shortly before Liu and Wang's appeal to the Ninth Circuit. In Kokesh, the Supreme Court addressed whether the SEC's ability to seek disgorgement was subject to a five-year statute of limitations. There, the Court held that the SEC's disgorgement remedy constitutes a "penalty" under 28 U.S.C. ' 2642 and is therefore subject to the five-year statute of limitations.¹² The immediate impact of the 2017 Kokesh decision was to limit the SEC's ability to seek disgorgement of ill-gotten gains older than five years. While the...