U.S. Supreme Court Allows Profits-Based SEC Disgorgement Awards
The Court holds that the Securities and Exchange Commission ("SEC") can continue to seek disgorgement from wrongdoers, while narrowing the remedy to net profits that are returned to victims.
In Liu v. SEC, 591 U.S. ___ (June 23, 2020), the Supreme Court gives and takes, holding that the SEC can continue to seek disgorgement from wrongdoers, while narrowing the remedy to net profits that are returned to victims. The Court rejected a series of practices that had been commonplace: The SEC can no longer hold defendants jointly and severally liable for disgorgement, which had enabled it to hold a bad actor responsible for profits obtained by another. It may not refuse to offset disgorgement by deducting legitimate business expenses. And in at least some cases it may not simply deposit disgorged profits with the U.S. Treasury, rather than return the funds to victims.
This issue arose in an SEC action against defendants who defrauded investors of nearly $27 million. Although defendants claimed that the bulk of investments would go toward a cancer treatment facility, most of the money went to defendants' personal accounts, purported salaries, and marketing expenses. The district court ordered disgorgement, and the Ninth Circuit affirmed.
In the Supreme Court, defendants argued that disgorgement could not qualify as equitable relief under 15 U.S.C. § 78u(d)(5), given the Court's holding in Kokesh v. SEC, 581 U.S. ___ (2017), that disgorgement is a penalty for purposes of 28 U.S.C. § 2462's statute of limitations, and the principle that equity is not punitive. The Court disagreed and held that a disgorgement award could be an equitable remedy if the award comported with traditional equitable principles, including the principle that an award cannot exceed a defendant's net profits.
This decision potentially eviscerates the SEC's ability to seek disgorgement in cases where there is no obvious ill-gotten gain or no clear victim to whom funds should be returned. Examples include:
- FCPA. Although the SEC has collected hundreds of millions of dollars as disgorgement in individual cases, foreign bribery cases do not typically involve individual victims who could be compensated by a return of funds.
- Internal Controls and Books and Records. Although the SEC has recovered many millions in disgorgement based on these claims, errors in internal controls and books and records are frequently victimless violations of securities laws.
- Insider Trading. Where a defendant bought securities based on material nonpublic information, but has not yet sold the securities, in many cases there is arguably no victim to whom net profits should be returned.
While the Court's ruling makes clear that disgorgement qualifies as equitable relief under § 78u(d)(5), the standards the Court recognized will significantly impact the SEC's settlements and litigation. One looming question is whether the SEC will increase the amount of penalties it seeks from defendants in light of the new limits on disgorgement. Another is whether the SEC may seek to establish that the five year state of limitations period recognized under Kokesh does not apply to the disgorgement upheld in Liu.
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