On March 3, 2020, the Supreme Court heard oral arguments in Liu v. SEC, No. 18-1501, once again taking up the question of whether the Securities and Exchange Commission (“SEC”) may seek disgorgement as equitable relief in a civil enforcement action for violations of the Securities Act of 1933 and the Securities Exchange Act of 1934. While it is always difficult to predict the outcome of a given case from oral argument, the questioning suggested that the Justices are likely to preserve some form of the SEC’s ability to seek disgorgement, albeit in perhaps a narrowed form more closely aligned to its underpinnings as an equitable remedy.
On May 26, 2016, the SEC brought an enforcement action against the petitioners in the U.S. District Court for the Central District of California for violations of Section 17(a)(2) of the Securities Act of 1953, alleging that the petitioners misappropriated approximately $27 million raised from Chinese investors to construct and operate a cancer treatment center in California. In granting the SEC summary judgment on their claims, the District Court ordered injunctive relief, civil monetary penalties, and disgorgement of the entire amount that had been collected from defendants’ investors. Sec. & Exch. Comm'n v. Liu, 262 F. Supp. 3d 957 (C.D. Cal. 2017). Defendants had argued that the SEC was not entitled to receive disgorgement, as there is no specific statutory authorization for the SEC to recover disgorgement in District Court actions, but the SEC claimed (and the District Court agreed) that the District Court was empowered to order disgorgement of any investor losses under its inherent equitable powers.
Shortly after the District Court’s decision, the Supreme Court issued an opinion in Kokesh v. SEC, in which the Supreme Court addressed whether, for statute of limitations purposes, disgorgement is a “penalty”—and thus subject to the five-year statute of limitations under 28 U.S.C. § 2462—or “equitable relief” available based on a court’s inherent equity power—and thus not subject to any explicit statute of limitations. The Court unanimously held that the SEC’s disgorgement remedy constitutes a “penalty” for statute of limitations purposes, reasoning that disgorgement “bears all the hallmarks of a penalty.” 137 S. Ct. 1635 (2017). In the opinion, Justice Sotomayor noted that the SEC disgorgement “sometimes exceeds the profits gained as a result of the violation,” leaving the defendant worse off, demonstrating that the disgorgement is a “punitive, rather than a remedial, sanction.” See Shearman & Sterling LLP Need To Know Weekly, United States Supreme Court Holds SEC Disgorgement Orders Subject To Five-Year Statute Of Limitations (June 16, 2017), https://www.lit-wc.shearman.com/United-States-Supreme-Court-Holds-SEC-Disgorgemen.
At the same time, in Kokesh, the Supreme Court was expressly reserved on whether its holding implicated courts’ powers to order disgorgement in general. Specifically, Justice Sotomayor wrote: “Nothing in this opinion should be interpreted as an opinion on whether courts possess authority to order disgorgement in SEC enforcement proceedings or on whether courts have properly applied disgorgement principles in this context.” 137 S. Ct. 1635, 1642 n.3.
After Kokesh, defendants in Liu appealed the District Court’s decision to the Ninth Circuit Court of Appeals, arguing that the District Court lacked statutory authority to award disgorgement. The Ninth Circuit affirmed the District Court’s decision, stating that Kokesh expressly refused to reach this issue. Sec. & Exch. Comm'n v. Liu, 754 F. App'x 505, 509 (9th Cir. 2018). Petitioners petitioned to the United States Supreme Court and certiorari was granted on November 1, 2019.
The petitioners argue that, notwithstanding the Supreme Court’s express reservation in Kokesh on the question of whether the SEC has the power to order disgorgement, based on the Supreme Court’s reasoning in Kokesh, it follows that the SEC is no longer authorized to obtain disgorgement in federal district courts. Petitioners argue that Congress explicitly identified the types of relief that the SEC may be awarded from courts in an enforcement action—injunctive relief, equitable relief, and certain civil monetary penalties—and because disgorgement is neither listed nor equitable relief, the SEC is not authorized to obtain it.
The SEC argued that the Securities Act of 1933 and the Securities Exchange Act of 1934 permit courts to order the disgorgement of profits obtained in violation of statutory provisions through their inherent equitable powers; that Congress has enacted numerous statutes that presuppose the availability of disgorgement; and that the holding in Kokesh was limited to whether disgorgement is considered a penalty for statute of limitations purposes only.
At oral arguments, the Justices appeared not to believe their decision was constrained by Kokesh, and they appeared inclined to preserve some form of the SEC’s ability to seek disgorgement, albeit in a form that would be more closely tied to disgorgement’s historical underpinnings as an inherent equitable remedy.
For instance, Justice Ginsburg distinguished Kokesh as stating that disgorgement can be a punishment in one context and it can be an equitable remedy in another context. (Tr. 5:21-22). Justice Ginsburg then suggested disgorgement was an appropriate equitable remedy because “it’s an equitable principle, that no one should profit from his or her own wrong.” Justice Alito discussed limitations on disgorgement, asking whether it would not fall within a traditional form of equitable relief for a court to order disgorgement “limited to net profits and suppos[ing] every effort was made to return the money to the victims of the fraud.” (Tr. 8:3-11).
A substantial amount of the questioning was focused on the ultimate destination of the disgorgement and whether the money was being disbursed to the defrauded investors, the SEC, or the U.S. Treasury. When addressing counsel for the SEC, Justices Sotomayor, Kavanaugh, and Gorsuch probed the circumstances in which each potential recipient was entitled to receive the disgorgement, and Justice Kavanaugh pressed the SEC whether “it would be appropriate for this Court to say that’s the rule; namely, that it has to be returned to investors where feasible.” While this would be a potentially significant change for the SEC—essentially mandating that the SEC use a fair funds remedy in all cases absent a showing of futility—the government replied that it “wouldn’t have a problem with that.” (Tr. 39:19-40:5).
A ruling from the Court rejecting the SEC’s authority to seek disgorgement would deprive the SEC of one of its most important remedies for securities violations and compel the SEC to reconsider the way it prosecutes its enforcement actions going forward. However, it appears somewhat unlikely that the Court will issue a sweeping ruling. Indeed, while it remains uncertain, the more likely outcome appears to be that the SEC will retain the ability to seek disgorgement, but only when and to the extent that it aligns with traditional equitable principles. That still would mark a significant shift—for example, limiting the amount of disgorgement that could be obtained from insider traders who did not personally profit and placing substantially more burden on the SEC to trace funds to harmed investors—but likely would not require a fundamental rethinking of the SEC’s enforcement approach.
The Court’s decision is expected by June 2020.