Liu v. SEC: Disgorgement in Danger

6 min

The Supreme Court heard oral argument yesterday in Liu v. Securities and Exchange Commission and should issue a decision by midsummer.  The immediate impact of the Court's decision, assuming that the Court rules against the SEC, will be upon the SEC's ability to obtain disgorgement in federal court cases.  In addition, the decision may have significant implications relating to equitable remedies for other agencies, such as the Federal Trade Commission.

In Liu, the SEC sued two individuals, Charles Liu and Xin Wang, who operated an investment fund that solicited investments from foreign nationals seeking to qualify for immigrant visas by investing in American businesses.  Liu and Wang told investors that they would use the money that they raised to build a cancer treatment center, but a significant portion of the money was not in fact used for this purpose.  The district court imposed civil penalties equivalent to all of the "personal gain" that Liu and Wang had received from their activity ($8.2 million).  And, as is typically the case in SEC enforcement proceedings, the district court ordered disgorgement of the entire amount that had been raised.  The district court calculated this amount based on the net loss to investors versus the net gain or profits to defendants stemming from the unlawful conduct.

The main question in Liu is whether disgorgement is permissible in judicial—as opposed to administrative—enforcement actions under Section 21 of the Securities and Exchange Act of 1934, 15 U.S.C. § 78u.  Section 21(d)(5) of the Act provides that, in an action brought by the SEC under the securities laws, "the Commission may seek, and any Federal court may grant, any equitable relief that may be appropriate or necessary for the benefit of investors."  This statutory provision does not explicitly authorize disgorgement.  In contrast, as the petitioners in Liu note, other statutory provisions do expressly enable the SEC to obtain disgorgement in the context of administrative proceedings.

At the heart of the debate in Liu is whether disgorgement is a penalty rather than a proper equitable remedy that may be awarded under Section 21.  The SEC—represented at oral argument by the DOJ's Office of the Solicitor General—pointed to the long history of viewing disgorgement as an "equitable" remedy available to the Commission.  However, Petitioners contended that this traditional understanding should be abandoned, considering the Supreme Court's recent decision in Kokesh v. SEC, 137 S. Ct. 1635 (2017).  In Kokesh, the Court held that disgorgement by the SEC was a "penalty" for purposes of the statute of limitations, 28 U.S.C. § 2462.  See Kokesh, 137 S. Ct. at 1639.  As the Liu petitioners emphasized, the Kokesh Court found that disgorgement by the SEC has a primarily punitive purpose.  According to the Liu petitioners, this should be the death knell for disgorgement, since a penalty imposed primarily for punitive purposes does not fit within the purpose of equitable relief—namely, restoring the status quo that existed prior to the commission of the wrongdoing.  The Kokesh Court expressly declined to resolve the issue presented in Liu, stating that "[n]othing in this opinion should be interpreted as an opinion on whether courts possess authority to order disgorgement in SEC enforcement proceedings."  Kokesh, 137 S. Ct. at 1642 n.3.  The petitioners and respondents in Liu disputed whether the reasoning of Kokesh should be applied in deciding whether disgorgement is a penalty for purposes of Section 21.

In keeping with their contention that the purpose of disgorgement is primarily punitive, the petitioners in Liu noted that money disgorged from defendants is not necessarily returned to individual victims, but rather may be paid to the Treasury.  The SEC countered that disgorgement awards can be necessary as a deterrent, rather than as a punishment, in cases where compensatory damages may be insufficient to deter future wrongdoing.  Moreover, while acknowledging that disgorged money is not always returned to victims, the SEC stated that it is the agency's "general practice" to return such money to individual victims when it can locate them, and when it makes sense to distribute the money, that is, when the cost of distribution is not greater than the amount to be distributed to victims.

While Petitioners' primary argument is that the SEC should not be able to obtain disgorgement through Section 21 at all, they also argue that, to the extent any disgorgement awards are permitted, such awards should be limited to the defendants' net gain or profits.  Of course, the net gain to defendants, generally, will be smaller than the net loss to investors.  Furthermore, Petitioners argued that defendants should be allowed to deduct legitimate business expenses from the net gain or profit calculation.  They faulted the district court in Liu for not permitting any such deductions.  In response, the SEC noted that, in this case, the lower courts had found that the defendants had engaged in a pervasively fraudulent scheme in which essentially all of their business expenses were incurred in furtherance of an outright fraud with no legitimate business components.  The SEC also argued that where the defendant's expenses were made for the purpose of engaging in the fraudulent activity itself, courts have calculated disgorgement based on a defendant's net profits without any deductions for business expenses.

Justice Alito asked counsel for Petitioners whether disgorgement would be permissible if awards were limited to net profits and if every effort were made to return money to victims.  However, counsel for Petitioners maintained that disgorgement would still not be an equitable remedy, and that where Congress has not provided for disgorgement, courts should hesitate to read such a remedy into a statute authorizing equitable relief.  Meanwhile, counsel for the SEC stated, in response to a question from Justice Kavanaugh, that he would have no problem with the Court directing district courts to return disgorged money to investors where feasible.  However, counsel for the SEC argued that, even if the Court finds that certain disgorgement awards have been excessive, the appropriate response is not to take disgorgement under Section 21 off the table entirely, but rather to provide instructions to lower courts to ensure that they properly apply traditional equitable principles. 

Needless to say, the Supreme Court's eventual decision in Liu could significantly reshape the landscape with respect to disgorgement in the SEC context—either by preventing the SEC from obtaining disgorgement under Section 21 at all in federal court actions or by placing limitations upon disgorgement awards that may be imposed.  Moreover, the Liu decision could have significant implications for other federal agencies, including the FTC.  The latter agency currently faces a circuit split regarding whether it can obtain equitable monetary relief under Section 13(b) of the Federal Trade Commission Act ("FTC Act"), 15 U.S.C. § 13(b)—a provision which, on its face, only authorizes injunctive relief.  Compare FTC v. Credit Bureau Ctr., LLC, 937 F.3d 764, 767 (7th Cir. 2019) (holding that "section 13(b) does not authorize restitutionary relief") with FTC v. AMG Capital Management, LLC, et al., 910 F.3d 417, 426–27 (9th Cir. 2018), petition for cert. docketed, AMG Capital Management, LLC, et al. v. FTC (U.S. Oct. 21, 2019) (No. 19-508) (holding that FTC can obtain equitable monetary relief pursuant to section 13(b)).  A ruling in favor of the petitioners in Liu would bolster the argument that courts should follow the Seventh Circuit in Credit Bureau and decline to recognize an implied right to obtain equitable monetary relief under section 13(b) of the FTC Act.

A copy of the oral argument audio should be here by the end of the week: