There were few surprises awaiting readers of the U.S. Supreme Court’s June 22 opinion in Liu v. Securities and Exchange Commission, which addressed the SEC’s authority to seek disgorgement of ill-gotten gains in its enforcement cases, but the few were unpleasant.
In Liu, the third Supreme Court decision in recent years concerning the reach of the SEC’s statutory penalty authority, the court held that “a disgorgement award that does not exceed a wrongdoer’s net profits and is awarded for victims is equitable relief permissible under” the Securities Exchange Act—and not a whit more. But since no reasonable securities lawyer believed that the court would abolish the SEC’s ability to collect disgorgement of ill-gotten gains, the biggest surprise is surely that the court agreed to hear the appeal at all.
In two prior decisions, Kokesh v. SEC and Gabelli v. SEC, the court scaled back the SEC’s penalty power when it held that the statute of limitations applicable to SEC enforcement cases foreclosed claims for monetary penalties and disgorgement brought more than five years after the occurrence of the underlying misconduct. The big question remaining after Kokesh was: Does the statute of limitations also apply to injunctive relief, the third pillar of the trifecta of remedies sought in nearly every SEC enforcement case?
So it was with bated breath that the securities bar waited for the court to answer this question in Liu, or any number of other pressing questions related to the scope of the SEC’s penalty authority, which, alas, it did not.
Instead, the court answered a question no one seemed to be asking—“whether, and to what extent, the SEC may seek ‘disgorgement’ in the first instance through its power to award ‘equitable relief’” under Section 21(d)(5) of the Exchange Act.”
The answer to why the court thought this question was worth taking up now is likely to be found in the notorious “footnote 3” of the Kokesh opinion, in which Justice Sonia Sotomayor remarked—apropos of nothing—that “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.”
A careful reading of Liu leaves one with the distinct impression that the primary reason for the decision was to close the Pandora’s box that Sotomayor opened with this off-hand observation; Before Kokesh, the SEC’s right to seek disgorgement in the district court was fairly well-settled.
Important Issues Left Unresolved
Another unhappy surprise in Liu was that, even within the narrow scope of decision that the court set for itself, it didn’t resolve important issues that naturally presented themselves given Liu’s facts. The court instead left them to be resolved in the district and appellate courts, which, as Justice Clarence Thomas predicted in his dissent in Liu, “is sure to create opportunities for the SEC to continue exercising unlawful power.”
Among other issues, the court declined to decide whether the petitioners’ “disgorgement award [was] unlawful because it fail[ed] to return funds to victims” of the petitioners’ fraud, and because it did not “deduct business expenses from the award.”
These questions, the court said, were “not fully brief[ed]” by the parties, and so the court would not decide them. This is unfortunate because a concrete pronouncement form the court about, for example, the specific circumstances in which an SEC disgorgement award does “exceed a wrongdoer’s net profits” and become an impermissible penalty would have made Liu a useful decision.
Was SEC Given Wiggle Room?
The final surprise Liu had in store, and the one that may wind up eclipsing any good the decision might otherwise have done, is that it may have given the SEC enough wiggle room to argue that some types of disgorgement aren’t subject to the statute of limitations.
In Kokesh, the court held that SEC disgorgement claims are subject to a five-year statute of limitations in part because disgorgement is not always “compensatory,” in which case it is a “penalty.” In Liu, the court suggested—without deciding—that disgorgement collected by the SEC but not returned to investors (because they can’t be located or because there’s no discernable victim of the defendant’s fraud) may not qualify as legitimate equitable disgorgement at all.
The point the court was trying to make was that such wayward disgorgement payments may not satisfy Section 21(d)(5) of the Exchange Act because they are not “appropriate or necessary for the benefit of investors,” as that section requires.
But, probably unwittingly, the court’s musings also suggest that any disgorged money that is returned to investors is “compensatory” within the meaning of Kokesh, and therefore not a “penalty” to which the five-year statute of limitations applies.
Liu may therefore have the unfortunate (and unintended) effect of helping upend the statute of limitations rule that Kokesh promulgated. If so, Liu would contain a surprise not only for those of us trying to make sense of that decision, but for anyone who has been relying on Kokesh since it was issued three years ago.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.