Bloomberg Law Analysis

ANALYSIS: SEC Disgorgement Survives SCOTUS Challenge With Limits

June 23, 2020, 8:53 AM

The U.S. Supreme Court upheld the authority of the Securities and Exchange Commission to order disgorgement in civil enforcement actions brought in federal district courts.

The high court answered a question left unresolved in its 2017 decision in SEC v. Kokesh. In the earlier decision, Justice Sonia Sotomayor included a rather interesting footnote in which she stated that "[n]othing 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.” The Liu v. SECdecision says that courts may do so, with some significant restrictions.

The Ninth Circuit had found for the SEC and affirmed a trial court finding that Charles Liu and his wife misappropriated most of the $26 million they raised from international investors. The couple raised the funds through the EB-5 Immigrant Investor Program to construct a cancer treatment facility that was never built. The appeals panel also affirmed the disgorgement order, which covered almost all the funds raised from investors, along with prejudgment interest.

The Supreme Court reversed the Ninth Circuit’s decision and remanded the case for further consideration. The Court found in its 8-1 decision that federal courts may order disgorgement in SEC enforcement actions. They must, however, deduct “legitimate expenses” in calculating the final disgorgement amount, resulting in an award approximating net profits from the scheme.

In this case, the Court noted that some moneys paid out by Liu actually went toward lease payments and cancer-treatment equipment. “Such items arguably have value independent of fueling a fraudulent scheme,” stated the Court. Justice Sotomayor continued that “we leave it to the lower court to examine whether including those expenses in a profits-based remedy is consistent with the equitable principles underlying [Exchange Act §21].” The Court also stated that if lower courts ordered any disgorged funds to be deposited with the Treasury rather than returned to investors, “the lower courts may evaluate in the first instance whether that order would indeed be for the benefit of investors as required by [Exchange Act §21] and consistent with equitable principles.”

The Liu decision will make enforcement cases brought by the SEC in district courts more complicated for the agency to prosecute and to seek disgorgement. The process of separating out legitimate expenses from the proceeds of fraud will be a challenging exercise in forensic accounting. In these cases, the SEC will have to contend with actually showing net gains by fraudsters, rather than producing a reasonable estimate of the funds acquired through the scheme.

Justice Thomas cast the sole dissenting vote. He argued, after a historical analysis of disgorgement practice, that the Exchange Act “authorizes the [SEC] to seek only ‘equitable relief that may be appropriate or necessary for the benefit of investors,’ and disgorgement is not a traditional equitable remedy.”

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