On June 22, 2020, in an 8-1 decision authored by Justice Sotomayor, the United States Supreme Court upheld the ability of the Securities and Exchange Commission to seek disgorgement in civil actions brought in district court as a form of “equitable relief ” under 15 U. S. C. §78u(d), at least to the extent the disgorgement is of a defendant’s “net profits” and the disgorged funds are returned to defendant’s victims. Liu v. SEC, No. 18–1501, __ S.Ct. __ (June 22, 2020). Though it was generally expected that the Supreme Court would uphold the SEC’s ability to seek disgorgement in some form, the precise contours of any such decision have been much anticipated since the Supreme Court held in Kokesh v. SEC, 581 U. S. ___ (2017), that at least certain forms of disgorgement sought by the SEC enforcement action impose a “penalty” for purposes of calculating the appropriate statute of limitations under 28 U. S. C. §2462, calling into question whether it could be considered “equitable relief.” The Liu decision is ostensibly a win for the SEC, in that it upheld the SEC’s ability to obtain disgorgement. But by focusing on ensuring that a given disgorgement order constitutes “equitable relief,” the Supreme Court has placed important limits on the manner in which the SEC may obtain disgorgement that could have significant impacts on the way the SEC pursues enforcement actions.
Liu originated with an enforcement action brought by the SEC in U.S. District Court for the District of Central District of California against a husband and wife pair who solicited nearly $27 million from foreign investors under the EB–5 Immigrant Investor Program, allegedly based on fraudulent misrepresentations. The District Court ruled for the SEC and awarded disgorgement equal to the full amount petitioners had raised from investors, less the $234,899 that remained in the corporate accounts for the project, but there was no clear indication that such funds would be returned to investors. On appeal, the petitioners argued that the SEC lacked the power to seek such disgorgement, claiming that it was effectively a “penalty” and not “equitable relief,” and thus not authorized. The Ninth Circuit affirmed, and the Supreme Court granted certiorari.
Before the Supreme Court, the parties focused their briefing on the broad question of whether any form of disgorgement could be ordered. The Court held that it could be so ordered, but remanded for the lower courts to determine whether the specific disgorgement award should be upheld or modified. In doing so, the Court set forth certain key principles to guide both the lower courts in Liu and also district courts more broadly.
The Supreme Court emphasized that disgorgement must be “equitable relief” within the meaning historical precedent, and went on to address three areas in which SEC disgorgement awards may be in tension with that principle—where the SEC fails to return funds to victims, where it imposes joint-and-several liability, and where it declines to deduct business expenses from the award such that the amount disgorged is greater than a defendant’s “net profits” from the crime.
First, the Supreme Court held that an SEC disgorgement award must be “for the benefit of investors” to be consistent with 15 U. S. C. §78u(d). Thus, while the Supreme Court did not absolutely bar the practice of the SEC causing disgorged funds to be deposited with the U.S. Treasury (a standard practice employed by the SEC where victims are not easily identifiable), this decision will almost certainly raise the bar for what the SEC must demonstrate before it may obtain disgorgement that is not being returned to identified investors. That could have a particular impact on cases when the SEC’s theory is one of broad-based market harm, as in such cases there is often no attempt to show how individual investors were harmed, let alone which ones.
Second, the Supreme Court raised serious questions about the SEC’s ability to seek disgorgement on a joint and several theory of disgorgement, except in rare cases. While acknowledging that it may be appropriate in a case such as the one before it, where defendants were husband and wife, the Court noted that, in general, specificity will be required to ensure that a given defendant is being disgorged of its own ill-gotten gains. That will require the SEC to focus more specifically on the actual entities or individuals involved in any wrongdoing and the profits earned by each; it should preclude, for example, the SEC from seeking to disgorge from individual defendants trading profits earned by their employers.
Third, the Supreme Court made clear that only “net profits” may be disgorged, as that is the true measure of ill-gotten gains. The Court noted that expenses may not be deductible where the entire profit of enterprise results from the wrongdoing, but held that generally legitimate business expenses must be deducted from any amount to be disgorged. As this has often been a sticking point in negotiations with SEC enforcement staff, the decision will allow defendants concrete ways to argue that any revenues the SEC seeks to disgorge should be offset by legitimate expenses incurred in connection with such revenues.
It will take some time to see how this decision plays out in practice (particularly as to when “legitimate expenses” may be deducted such that a disgorgement amount can be reduced). However, the Court has now set out clear guidance in terms of what it believes the SEC should be seeking to do when pursuing disgorgement, and the focus on equitable principles—namely, that the SEC can seek only net profits from wrongdoing from culpable actors and for victims—is welcome.