Liu v. S.E.C.: Supreme Court's Narrowing Of SEC Disgorgement Raises Questions For Insider Trading Cases

Published date08 July 2020
Subject MatterCorporate/Commercial Law, Litigation, Mediation & Arbitration, Criminal Law, Trials & Appeals & Compensation, Securities, White Collar Crime, Anti-Corruption & Fraud
Law FirmKramer Levin Naftalis & Frankel LLP
AuthorMr Alan Friedman, Dani R. James, Gary P Naftalis, Paul H. Schoeman and Chase Henry Mechanick

Three years ago, in a footnote to its unanimous opinion in Kokesh v. S.E.C., the Supreme Court left open two questions: "whether courts possess authority to order disgorgement in SEC enforcement proceedings" and "whether courts have properly applied disgorgement principles in this context."1On June 22, the Court in Liu v. S.E.C.2answered the first question with a simple "yes," but, as to the second, significantly limited the authority of a court to grant the remedy.

In extended commentary, the Supreme Court stated that courts generally may not grant disgorgement:

(1) when the proceeds are not remitted to investors, though it left open for the future any possible exception when it would not be feasible to identify the investors who had been harmed;

(2) when one defendant is made to disgorge profits that were received by someone else, with possible exceptions for certain relationships such as business partners or married couples; or

(3) when the amount of disgorgement fails to deduct legitimate business expenses, except where the business as a whole constitutes a fraudulent scheme.

Statutory Background

There is no provision in the federal securities laws explicitly authorizing courts to order "disgorgement" in SEC enforcement proceedings. Initially, the securities laws did not contain provisions for any kind of monetary remedies; the only statutory remedies available to the SEC were injunctions barring future violations. In the 1960s and '70s, however, the SEC's Enforcement Division began to argue that courts could order defendants to give back their illicit profits under their inherent equitable powers. This theory was accepted for the first time in SEC v. Texas Gulf Sulphur Co.3(a case well known for recognizing that insider trading constitutes a violation of the federal securities laws). After Texas Gulf, courts widely embraced disgorgement as a remedy.

As one former assistant director of the Enforcement Division has written, "the temptation for the SEC to request and the courts to grant disgorgement" during this period of time "was understandable, lest securities law violators appear to avoid punishment by suffering a mere injunction against future wrongdoing without any accompanying monetary sanctions."4 However, Congress later amended the securities laws to explicitly permit civil penalties for insider trading in 1984 and for other securities violations in 1990. Congress also explicitly authorized the SEC to seek "disgorgement" in administrative and cease-and-desist proceedings.

More recently, as part of the Sarbanes-Oxley Act, Congress authorized courts in 11 U.S.C. ' 78u(d)(5) to award "equitable relief" in civil enforcement actions, but Congress did not clarify whether disgorgement, as sought by the SEC, was a form of "equitable relief." This question has arguably been complicated by the lack of a clear historical practice of describing any form of equitable relief as "disgorgement." The term was not widely used prior to its application in the SEC enforcement context. As one court noted in 1974, "The word 'disgorgement' appears to be a term of modern vintage utilized in connection with [SEC] suits seeking to deprive the defendants of the gains from their wrongful conduct . . . ."5

The Facts in Liu

Petitioner Charles C. Liu operated a regional center under the EB-5 Immigrant Investor Program, the stated purpose of which was to develop and operate a cancer treatment center. The project raised $27 million from at least 50 investors, consisting of $24.7 million in capital contributions and $2.3 million in administrative fees. The project's offering documents stated that all capital contributions would be used...

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