June 24, 2020
has authorized the SEC to enforce the securities laws against those committing
fraud both in SEC enforcement actions and in SEC administrative proceedings. In
SEC administrative proceedings, the agency can seek both (a) civil monetary
penalties and (b) “accounting and disgorgement.” 15 U.S.C. §§
77h-1(e) & 77h-1(g). No statutory
language grants “disgorgement” authority for SEC enforcement actions.
Liu v. SEC,
discussed in this Alert,
an SEC enforcement action.
actions, the SEC is authorized to request and obtain statutory (1) limited civil
monetary penalties and (2) “equitable relief that may be appropriate or
necessary for the benefit of investors.” 15 U.S.C. § 78u(d)(5) &
78u(d)(3). Since 1971, even prior to receiving authority for penalties and
equitable relief, the agency obtained from federal courts what would later be
called “disgorgement.” That remedy often required a defendant to disgorge to
the SEC all ill-gotten gains from a fraudulent scheme without deduction for
legitimate business expenses, and the disgorged funds were for the most part deposited
in U.S. Treasury accounts to support SEC and other government operations, with
about 25% collected in 2019 sent to investors. While the courts of appeals were
unanimous in granting such unlimited disgorgement awards, the practice was not
challenged and was never therefore approved by the Supreme Court.
SCOTUS Reformulates Disgorgement
On June 22, 2020, the Court in
decided whether “courts possess
authority to order disgorgement in SEC enforcement.” The Court held 8-to-1 that
“a disgorgement award that does not exceed a wrongdoer’s net profit and is
awarded for victims is equitable relief permissible under § 78u(d)(5).” It stipulated the criteria to render
disgorgement equitable, vacated the $27 million judgement affirmed by the Ninth
Circuit, and remanded for consideration of a disgorgement award under its new
criteria. Justice Thomas, in dissent, concluded that disgorgement was not an
“equitable remedy” and would have reversed the judgment. In the past, as the
Court had noted in
Kokesh v. SEC, 137
S. Ct. 1635 (2017), SEC disgorgement awards had the hallmarks of a non-equitable
punitive sanction: disgorgement was “imposed as a consequence of violating
public law, it is assessed in part for punitive purpose, and in many cases, the
award is not compensatory.”
federal EB-5 program to raise about $27 million capital in China to build a cancer-therapy
center in California. Granting summary judgment for the SEC, the district court
found that substantially all of the capital raised had been misappropriated and
not used to build the center, as the investors were promised. The district
court entered final judgment awarding the SEC about $27 million in disgorgement
and an additional $8 million in civil monetary penalties. The court denied
defendants’ request to deduct from the gross capital raised legitimate business
expenses (e.g., purchase of cancer-treatment
equipment and acquisition of land to build the center and lease payments for
Criteria for Disgorgement as Equitable Remedy
Liu, the Court stipulates at least three
criteria a disgorgement judgment must meet to conform to the “equitable remedy”
standard. Relying on its “longstanding equitable principles,” which the Court
found Congress had incorporated into section 78u(d)(5), the Court concludes:
- disgorgement must be limited by the “net
profits” of the defendant from the fraud scheme,
- disgorged funds must generally be distributed to
victims of the fraud, and
- joint-and-several liability of defendants is not
appropriate for judgments of disgorgement. Each defendant is liable for
disgorgement of the net profits received from his or her individual wrongdoing.
The Court ruled that the “SEC’s disgorgement remedy … is in considerable tension with equity practices.”
Future Litigation Issues
The Court remanded
with precious little guidance on
the limits imposed on SEC disgorgement by its equity precedents. The Court has
left it to the lower courts to ensure that disgorgement awards are “so
limited.” These courts will now have to grapple with these issues, among others.
- How should “net profits” be defined and
determined? An income statement definition? A more restricted legal definition?
- What are “legitimate business expenses?” Do they
include taxes? Putting aside reasonable salaries of officers and owners of the
business, salaries of operating personnel? Outside professionals such as
lawyers and accountants employed to advise regarding business operations?
- How much of disgorged funds can be turned over
to the Treasury and not distributed to victims and still have a disgorgement
award be equitable? The Court rejects the SEC position that merely bringing an
enforcement action and depriving a wrongdoer of ill-gotten profits is for the
benefit of investors, as required by statute. It leaves for lower court
consideration the issue of whether infeasibility of identifying and
distributing funds to investors meets the SEC’s obligation to benefit investors
by returning funds to them.
- If a defendant settles with and compensates a
victim, is the amount of that compensation a credit against the disgorgement
- If a defendant paid the full disgorgement
judgment to the SEC, will that defendant get credited for that payment in any
private action brought by the victims?
One important issue not presented in Liu
(but raised in amicus briefing) is the extent to which the Court’s standard
will apply retroactively. Presumably, the ruling applies to all judgments not
yet made final or on appeal. Whether the Court’s decision is applicable to
prior cases where disgorgements were granted “in considerable tension with
equity practices” (i.e.
, in excess of
“net profits” without distribution of the funds to defrauded investors) is an
issue that awaits further litigation.
Sills Cummis & Gross lawyers are available to assist in addressing any questions you may have regarding developments in SEC disgorgement, including any possible remedies available for prior disgorgement payments to the SEC that do not comply with the equitable criteria stipulated by the Court in Liu
Sills Cummis & Gross P.C. was counsel to Mr. Charles Liu and his wife, Ms.
Xin Wang, in the district court and court of appeals, and was co-counsel with
Kellogg, Hansen, Todd, Figel and Frederick, P.L.L.C. in the Supreme Court.
This Client Alert has been prepared by Sills Cummis & Gross P.C. for informational purposes only and does not constitute advertising or solicitation and should not be used or taken as legal advice. Those seeking legal advice should contact a member of the Firm or legal counsel licensed in their state. Transmission of this information is not intended to create, and receipt does not constitute, an attorney-client relationship. Confidential information should not be sent to Sills Cummis & Gross without first communicating directly with a member of the Firm about establishing an attorney-client relationship.