Following the recent Court’s ruling in Liu v. Securities and Exchange Commission[1] one thing is certain: the SEC can continue to seek disgorgement[2] as an equitable remedy.[3] However, the Liu ruling has created several limitations to SEC disgorgement which could . Fomenting more uncertainty for the industry and regulators alike, the majority opinion leaves to the lower courts the task of defining the specifics of these new limitations. As such, we can expect cases regarding the following three SEC disgorgement issues to appear before the high court again very shortly.
1- “Legitimate Expenses” must be deducted from any disgorgement award
Courts may not enter disgorgement awards that exceed the gains “made upon any business or investment, when the receipts and payments are taken into account”.[4] As such, any ruling that makes no allowance for the cost and expense of conducting a business would be inconsistent with disgorgement’s status as an equitable remedy.[5] The Court reasoned that even entirely fraudulent enterprises must deduct an expense if it has “value independent of fueling a fraudulent scheme.”[6] The Court mentioned lease payments as one potentially independent expense, but left the lower courts to determine whether including those expenses in a profit-based remedy is consistent with the equitable principles underlying § 78u(d)(5).
2- Disgorgement funds must be “for the benefit of investors”
In many cases, the SEC is unable to locate or contact all victims of securities fraud.[7] The Dodd-Frank Wall Street Reform and Consumer Protection Act established a U.S. Treasury fund for the disgorgement awards not distributed to victims. Funds deposited in the Treasury are used to pay whistleblowers for reporting securities fraud and to fund the activities of the Inspector General. In the Liu ruling, the Court punted on whether this practice was “for the benefit of investors” as required by § 78u(d)(5), stating only that disgorgement “must do more than simply benefit the public at large by virtue of depriving a wrongdoer of ill-gotten gains.” It has been left to the lower courts to tee up arguments on whether whistleblower awards and Inspector General’s activities amount to uses which are “for the benefit of investors”.
3- SEC must show concerted wrongdoing for joint-and-several liability
The SEC sought joint-and-several liability against Petitioners Liu and Wang, husband and wife. At common law, defendants are only liable to account for such profits only as have accrued to themselves. However, common law also permits liability for partners engaged in concerted action. It is alleged that Liu formed business entities and solicited investments which he misappropriated. Evidence was also presented that Wang held herself out as the president and a member of the management team of an entity to which Liu directed misappropriated funds. The Supreme Court left the Ninth Circuit to determine on remand whether Petitioners’ actions constituted “concerted wrongdoing”, but noted potential factors such as comingling of funds and enjoyment of the fruits of the scheme, which would suggest that either spouse was a passive recipient of profits.
While disgorgement remains an available tool for the SEC to wield against securities fraudsters, the Liu ruling has raised several potential avenues for the Court to declaw the remedy in the future. With the metes and bounds of SEC enforcement remedies in flux, it is more important than ever that businesses monitor the regulatory landscape and maintain strict compliance with SEC rules. If the SEC has opened an investigation or brought a civil or administrative action against you, contact the experienced counsel at Cosgrove Law Group, LLC.
Authors: Max Simpson and Sydney Schack
[1] Liu v. Securities and Exchange Commission, --- S.Ct. ---- (2020).
[2] 15 U.S.C. § 77h-1(g) authorizes the SEC to seek limited civil penalties and disgorgement in administrative proceedings. However, § 78u(d)(5) allows the SEC to seek civil penalties and “equitable relief” in civil proceedings to punish securities fraud. Congress did not define what falls under the umbrella of “equitable remedies”, leaving it to the courts to define the available remedies. Beginning in 1971, the SEC has requested “profits” that “merely depriv[e]” a defendant of “the gains … of wrongful conduct”. SEC v. Texas Gulf Sulfur Co., 446 F.2d 1301 (CA2 1971). This relief has, through the years, come to be known as “disgorgement”.
[3] This was previously called into question by Kokesh v. SEC, 581 U. S. ––––, 137 S.Ct. 1635, 198 L.Ed.2d 86 (holding that disgorgement constituted a penalty for statute of limitations purposes).
[4] Rubber Co. v. Goodyear, 9 Wall. 788, 804, 19 L.Ed. 566 (1870).
[5] See Liu.
[6] Id.
[7]In Liu, the SEC had not returned the bulk of the funds to victims because the Government has been unable to collect them. Petitioners transferred the bulk of their misappropriated funds to China, defied the district court’s Order to repatriate those funds, and fled the United States, according to the SEC’s brief.