Supreme Court Upholds, With Limits, The SEC's Authority To Seek Disgorgement

• Published date: 29 June 2020
• Subject Matter: Corporate/Commercial Law, Litigation, Mediation & Arbitration, Trials & Appeals & Compensation, Securities
• Law Firm: Cleary Gottlieb Steen & Hamilton LLP
• Author: Mr Breon S. Peace, Alexander Janghorbani, Robin M. Bergen and Matthew C. Solomon

On June 22, 2020, the Supreme Court held in Liu v. SEC that the Securities and Exchange Commission ("SEC") may seek, and courts have the power to grant, disgorgement as an equitable remedy for violations of the securities laws. ¹

However, the Court also placed potentially important limitations on disgorgement, holding that'to qualify as an equitable remedy and thus be allowable'disgorgement awards must accord with certain traditional equitable principles. While the Court left it to the lower courts to determine whether SEC disgorgement requests are in fact equitable on a case-by-case basis, it articulated guideposts calling into question the SEC's ability to obtain disgorgement that (1) exceeds a wrongdoer's net profits, (2) is not distributed back to victims, and (3) is awarded against multiple defendants on a joint-and-several basis. ² Although the Liu decision preserves the SEC's ability to seek disgorgement'a central tenet of the SEC's enforcement program'it imposes a number of line-drawing questions on lower courts to consider. Depending on how the case law develops, these issues may serve both to increase the SEC's burden in making out disgorgement claims and to reduce the total dollar amounts of disgorgement awards the SEC is able to obtain, perhaps significantly.

Background

The SEC has for decades obtained disgorgement of so-called "ill-gotten gains" from defendants who violate the Securities Exchange Act of 1934 ("Exchange Act") and other federal securities laws. ³ The SEC's basis for seeking this relief is Section 21(d)(5) of the Exchange Act, which permits the SEC to seek "any equitable relief that may be appropriate or necessary for the benefit of investors" for violations of the federal securities laws. ⁴ In the past decade, however, the Supreme Court has begun to place more stringent limits on the SEC's authority to seek monetary relief, including disgorgement. First, in 2013, the Court unanimously held in Gabelli v. SEC that 28 U.S.C. ' 2462's five-year statute of limitations'which applies to the SEC's ability to impose penalties'runs from the date that the defendant's offending conduct occurs, not from the date that the SEC discovers it. ⁵ Then, in 2017, the Court unanimously held in Kokesh v. SEC that claims for disgorgement are likewise subject to ' 2462's statute of limitations because they bear "all the hallmarks of a penalty." ⁶ In reaching its conclusion, the Court pointed out that'unlike traditionally equitable remedies that are designed to restore victims to the position they were in prior to the unlawful activity'the SEC seeks disgorgement in its role as an enforcement agency on the general public's behalf, can often require defendants to disgorge more than they personally profited, and does not always remit collected funds back to harmed investors. ⁷ Presaging the dispute in the Liu case, the Kokesh Court explicitly refused to determine whether federal courts are even authorized to order disgorgement in SEC cases. ⁸

The Liu Case

The SEC charged Liu and his wife ("Petitioners") with making false and misleading statements to investors'in violation of Section 17(a) Securities Act of 1933 and Section 10(b) of the Exchange Act'in connection with soliciting investments in an EB-5 visa program. ⁹ In short, the SEC alleged that, in raising nearly $27 million from investors, Petitioners had disclosed that the bulk of their investments would be allocated to costs associated with building and equipping cancer treatment centers, when in fact Petitioners spent nearly $20 million on purported marketing expenses and salaries and otherwise transferred funds to accounts they controlled. ¹⁰ The SEC brought a civil enforcement action in the Central District of California, seeking, among other relief, disgorgement equal to the full amount that the Petitioners raised from investors. ¹¹ The District Court, on summary judgment, held the Petitioners jointly and severally liable for the entire amount. In doing so, the District Court rejected Petitioners' argument that the disgorgement award improperly failed to account for their legitimate business expenses, instead finding that the SEC's requested disgorgement award constituted a "reasonable approximation of the profit causally connected to [their] violation." ¹² The Ninth Circuit affirmed. ¹³ On November 1, 2019, the Supreme Court granted...