On June 22, 2020, the Supreme Court issued its decision in Liu v. Securities and Exchange Commission, 591 U.S. ___ (2020)—a case concerning whether, and under what circumstances, the SEC may obtain disgorgement awards in judicial enforcement actions. In an 8–1 opinion by Justice Sotomayor, the Court rejected the petitioners' frontal assault on such disgorgement awards. Nevertheless, the Court imposed limits upon the scope of disgorgement remedies—in particular, requiring that awards be limited to a wrongdoer's net profits and that they be "awarded for victims." The Court's ruling will likely require the SEC to engage in increased litigation regarding the calculation of disgorgement awards. It may similarly impact efforts by other agencies, such as the Federal Trade Commission, to obtain disgorgement awards.
As we noted following the oral argument in Liu, the central question was whether the SEC may obtain disgorgement 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, 15 U.S.C. § 78u(d)(5), 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." Unlike statutory provisions pertaining to administrative proceedings, this provision does not explicitly authorize disgorgement.
In, the SEC sued husband and wife 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 "the bulk" of the money raised would go toward building a cancer treatment center. Liu, 591 U.S. at ___ (slip op., at 4). In reality, only "a fraction" of investors' money was "put toward a lease, property improvements, and a proton-therapy machine for cancer treatment," while nearly $20 million was spent on "ostensible marketing expenses and salaries," and Liu diverted a "sizeable" amount to personal accounts and to a company controlled by Wang. Id. The district court imposed civil penalties equivalent to the amount that Liu and Wang had "personally received" from their activity ($8.2 million). SEC v. Liu, 754 Fed. App'x. 505, 507 (9th Cir. 2018), vacated and remanded, Liu v. SEC, 591 U.S. ___ (2020). The district court also ordered disgorgement of the entire amount that had been raised—as is typically the case in SEC enforcement proceedings—minus the amount that remained in the corporate accounts for the project. See Liu, 591 U.S. at ___ (slip op., at 5). The Ninth Circuit affirmed.
The Supreme Court granted certiorari "to determine whether §78u(d)(5) authorizes the SEC to seek disgorgement beyond a defendant's net profits from wrongdoing." Id. The Liu petitioners went further though and argued that the SEC cannot obtain disgorgement under section 21(d)(5) because disgorgement is necessarily a "penalty" with a primarily punitive purpose, and thus outside the bounds of permissible "equitable relief" under the statute. The Supreme Court disagreed, holding that "a disgorgement award that does not exceed a wrongdoer's net profits and is awarded for victims is equitable relief permissible under § 78u(d)(5)." Id. (slip op., at 1). In so doing, the Court rejected the petitioners' invitation to extend its ruling in Kokesh v. SEC, 581 U.S. ___ (2017), in which it had held that disgorgement constituted a "penalty" for purposes of a statute of limitations provision, but had expressly declined to rule upon the permissibility of disgorgement in SEC enforcement proceedings. See Liu, 591 U.S. at ___ (slip op., at 3).
However, the Liu Court did impose greater restrictions upon SEC disgorgement awards under section 78u(d)(5). In particular, it held that awards may not "exceed the gains 'made upon any business or investment, when both the receipts and payments are taken into account.'" Id. (slip op., at 18–19) (citation omitted). This is significant, as, in the past, the SEC has obtained disgorgement awards calculated based upon the net loss to investors, which typically exceeds defendants' net gain or profits. The Court also made clear that "courts must deduct legitimate expenses before ordering disgorgement under §78u(d)(5)." Id. (slip op., at 19). Yet a great deal may hinge upon the word "legitimate." The Court noted that, "when the 'entire profit of a business or undertaking' results from the wrongdoing, a defendant may be denied 'inequitable deductions' such as for personal services." Id. (citation omitted).
In addition, the Court emphasized that disgorgement funds must be "awarded for victims." Id. (slip op., at 1) (emphasis added). It raised doubts as to whether depositing defendants' disgorged gains in a fund in the Treasury—as the SEC does in many cases—can satisfy section 78u(d)(5)'s requirement that any remedy be "appropriate or necessary for the benefit of investors." See id. (slip op., at 15–17) (emphasis added). As the Court noted, "the SEC's equitable, profit-based remedy must do more than simply benefit the public at large by virtue of depriving a wrongdoer of ill-gotten gains." Id. (slip op., at 16). Still, the Court left as an "open question whether, and to what extent," the SEC may permissibly deposit disgorged funds in the Treasury—a practice that the government contends is appropriate where, for instance, "the wrongdoer's profits cannot practically be disbursed to the victims." Id. (slip op., at 16–17).
Similarly, the Court expressed concern regarding the SEC's practice of seeking to "impose disgorgement liability on a wrongdoer for benefits that accrue to his affiliates, sometimes through joint-and-several liability . . . ." Id. (slip op., at 17). The Court suggested that this practice "could transform any equitable profits-focused remedy into a penalty" and run afoul of the rule that defendants should be held liable only for profits that have accrued to them. Id. Once again, however, the Court stopped short of forbidding the practice. Acknowledging that "the common law did . . . permit liability for partners engaged in concerted wrongdoing," the Court ultimately found it unnecessary to resolve the circumstances under which "an equitable profits remedy might be punitive when applied to multiple individuals." Id. (slip op., at 18).
Thus, while the Court's decision in Liu affirmed the SEC's ability to obtain disgorgement awards under section 78u(d)(5), it also placed greater limitations upon such awards and left the door open to further challenges to existing SEC practices regarding disgorgement. Increased litigation regarding the deduction of business expenses may be one impact of the ruling. Defendants in SEC, FTC, or CFPB actions, for example, attempting to have "expenses" deducted from disgorgement awards, will take heart from the Court's command that legitimate expenses be deducted from disgorgement awards.