Supreme Court Could Weaken SEC Enforcement as Justices Focus on Victim Compensation
Weighing the propriety of one of the Securities and Exchange Commission’s (“SEC”) most critical law enforcement tools, last week the U.S. Supreme Court entertained arguments that the SEC should not be able to disgorge profits from defendants and signaled that the SEC should be doing more to compensate victims in securities fraud cases. On March 3, 2020, the Supreme Court heard oral argument in Liu v. SEC to consider whether the SEC has the right to disgorge profits as “equitable relief” for a securities violation when the remedy is not specifically set forth in the Securities and Exchange Act of 1934 (“SEA”).1 Disgorgement has been one of the most powerful tools in the SEC’s law enforcement toolkit for many years, and during last week’s oral argument, certain Justices suggested that disgorgement may be more palatable when calculated to avoid inflicting a “penalty” and when disgorged funds are used to repay victims of securities laws violations.
In the Supreme Court case, Petitioners Charles Liu and Xin Wang are appealing a decision by the United States Circuit Court of Appeals for the Ninth Circuit affirming a district court judgment ordering them to disgorge approximately $27 million in alleged profits. Liu and Wang argue that Congress never authorized the SEC to disgorge profits under the SEA, rendering the SEC’s longstanding practice of doing so unlawful,2 and they seized upon helpful dicta from the Supreme Court’s landmark 2017 decision in Kokesh v. SEC, which held that disgorgement is a “penalty” subject to the five-year statute of limitations.3 Specifically, the Kokesh Court stated in an important footnote 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.”4
Last Week’s Oral Argument
During oral argument, a number of Justices made statements suggesting that the SEC could properly obtain disgorgement as an inherent “equitable” remedy, especially if disgorgement of profits was used to benefit those who were harmed by a defendant’s wrongdoing. Justice Ginsburg noted that labeling disgorgement as a penalty for the purpose of determining the proper statute of limitations did not necessarily mean that the Supreme Court would view disgorgement as a penalty in all contexts.5 Justice Ginsburg also signaled an openness to upholding the right to obtain disgorgement on fairness grounds, asking, “Is it not an equitable principle that no one should be allowed to profit from his own wrong? That’s not an equitable principle?”6 In response, petitioners’ counsel agreed, but added that “a court of equity will not inflict a penalty; it will make the person no worse off than they were had they not committed the wrong,” and the SEC’s employment of disgorgement often leaves defendants in a worse position than they would be if the wrong had never been committed by recouping more than just ill-gotten profits. For example, petitioners noted when applied to insider trading cases, the SEC’s exercise of disgorgement does far more than restore the status quo ante,7 rather those “who illegally provide confidential trading information have been forced to disgorge profits gained by individuals who received and traded based on that information—even though they never received any profits.”8
Justice Alito also asked whether disgorgement would be an appropriate equitable remedy in an SEC enforcement action if “it were limited to net profits [of the wrongdoer] and … every effort was made to return the money to the victims of the fraud.”9 Petitioners’ counsel contended that disgorgement would still be inappropriate because Congress never intended the SEC to be able to disgorge profits in the first place, arguing, “When Congress says disgorgement, then it is the Court’s task to figure out what does disgorgement mean. … But, in the case where Congress has not said disgorgement, and they did not say so here [then] the Court should hesitate to read it into a general provision for equitable relief.”10
For its part, the SEC explained that it attempts to return disgorged funds to investors “when it can.”11 Seeking more information on this point, Justices Gorsuch and Sotomayor asked under what circumstances disgorged funds were redistributed to victim investors versus being sent to the United States Treasury.12 The SEC explained that sometimes disgorged funds are not returned to investors because it is “deemed infeasible to go to the expense of locating the individuals given the small amount that each would receive.”13 With respect to FCPA cases in particular, the SEC frequently does not return disgorged funds because “there just is no obvious universe of investors.”14 Finally, the SEC explained that the applicable statute does not require that funds be returned to victims in any particular category of cases and that such payment is left to the court’s discretion.15
Justice Gorsuch pressed further, asking, “Would the government have any difficulty with a rule that the money should be returned to investors where feasible?” In response, the SEC took no issue with such a hypothetical rule, explaining that “there would be nothing wrong with a district judge in an individual case saying unless you can persuade me that it is infeasible to return this money to investors, I am going to order that that be done.”16
What This Means for You
It is always difficult to predict how the Supreme Court will decide a given case based on questioning at oral argument alone. However, the Supreme Court’s questions concerning the compensation of victims builds on another noteworthy judicial decision recently urging the government to do more to compensate victims in FCPA cases. At stake in this case is whether, or at least to what degree, the SEC will be able to pursue disgorgement in enforcement actions in the future. Disgorgement is a powerful tool for the SEC. In 2018 alone, the SEC obtained monetary judgments totaling $3.945 billion, $2.506 billion of which was in the form of disgorgement of ill-gotten gains.17 Similarly, the Justices have hinted that disgorgement, even if it is an appropriate remedy, must be calculated under the equitable principle that the return of ill-gotten gains should not leave the wrongdoer in a worse position than if the wrong had never been committed, and should be returned to the victim investors where feasible. Such restrictions could remove a powerful enforcement tool from the SEC, and many will be watching to see what the Supreme Court ultimately decides.
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1 See Sec. & Exch. Comm’n v. Liu, 754 F. App’x 505 (9th Cir. 2018) (summary order), cert. granted sub nom. Liu v. SEC, No. 18-1501, 2019 WL 5659111 (U.S. Nov. 1, 2019).
2 See Sec. & Exch. Comm’n v. Liu, 754 F. App’x at 509.
3 See 137 S. Ct. 1635 (2017).
4 Id. at 1642 n.3.
5 Transcript of Oral Argument at 5-6, Liu v. SEC, No. 18-1501 (Mar. 3, 2020).
6 Id. at 7.
7 Id. at 7-8
8 Kokesh, 137 S. Ct. at 1644.
9 Id. at 8.
10 Id. at 11.
11 Id. at 34.
12 Id. at 34-35.
13 Id. at 35-36.
14 Id. at 35.
15 Id. at 36; see 15 U.S.C. § 78u(d)(5).
17 U.S. SEC. & EXCH. COMM’N, DIV. ENF’T 2018 ANNUAL REPORT 11 (2018).
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