The Supreme Court allowed the SEC to seek “disgorgement” as a form of “equitable relief” in civil-actions, but limited the remedy to net profits for benefit of harmed investors.  Answering part of a question reserved in 2017’s Kokesh opinion, this week’s Liu opinion raised more questions than it answered.

The Liu’s raised investor funds for an EB-5 visa program under a private offering, but pocketed most of them.  In a civil enforcement action, the SEC obtained the Liu’s disgorgement of full amount raised from investors (not net), jointly and severally.  The Supreme Court vacated and remanded the disgorgement award for revision.

In. Kokesh v. SEC, 581 U. S. ___ (2017), the Court held that a disgorgement in an SEC enforcement action is a “penalty,” thus subject to five-year limitations under 28 U. S. C. §2462.  But Kokesh didn’t address:

• whether, and to what extent, the SEC may seek “disgorgement” in the first instance through its power to award “equitable relief ” under 15 U. S. C. §78u(d)(5), a power that historically excludes punitive sanctions. The Court holds today 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).

Liu, Slip Op. at 1.

The ’34 Act provides:

• “In any action or proceeding brought or instituted by the Commission under any provision of the securities laws, . . . any Federal court may grant . . . any equitable relief that may be appropriate or necessary for the benefit of investors”

15 U.S.C. § 78u(d)(5).  Since the early 1970s, Courts recognized the SEC’s ability to recover ill-gotten gains as a form of restitution;  the remedy only later became widely known as “disgorgement.”

The Court observed:

• First, equity practice long authorized courts to strip wrongdoers of their ill-gotten gains, with scholars and courts using various labels for the remedy [e.g., restitution, unjust enrichment, accounting, constructive trust]. Second, to avoid transforming an equitable remedy into a punitive sanction, courts restricted the remedy to an individual wrongdoer’s net profits to be awarded for victims.

Slip Op. at 6.  From these principals, it follows that “disgorgement” awards may not be (a) “deposited in Treasury funds instead of disbursing them to victims,” (b) joint and several, (c) gross, without deducting “even legitimate expenses.”  Slip Op. at 12.

Justice Thomas was the lone dissenter, regarding disgorgement as “not a traditional equitable remedy” and thus would hold that it “can never be award under 15 U.S.C. § 78u(d)(5).”  Dissent at 1.  Justice Thomas also predicted:

• The majority’s decision to tame, rather than reject, disgorgement will also cause confusion in administrative practice. As the majority explains, the SEC is expressly authorized to impose “‘disgorgement’” in its in-house tribunals. Ante, at 13 (quoting 15 U. S. C. §77h–1(e)). It is unclear whether the majority’s new restrictions on disgorgement will apply to these proceedings as well. If they do not, the result will be that disgorgement has one meaning when the SEC goes to district court and another when it proceeds inhouse.

Dissent at 7-8.

Liu leaves lots of questions:

• Whether any part of a “disgorgement” award may be deposited to the Treasury, as when ill-gotten profits exceed amounts disbursable to identifiable victims or to fund a whistleblower fund. Slip Op. at 14-17.
• Under what circumstances might joint-and-several disgorgement awards be permissible along “the wide spectrum of relationships between participants and beneficiaries of unlawful schemes – from equally culpable codefendants to more remote, unrelated tipper-tippee arrangements.” Slip Op. at 1.
• What expenses may be deducted from profits to be disgorged or instead “are merely wrongful gains ‘under another name.’” Slip Op. at 19.
• The effect of the opinion upon SEC administrative proceedings. Dissent at 7-8.
• Is disgorgement for insider-trading dead? The Opinion twice implicitly criticizes the long-standing “disgorgement” by tippers of their tippees’ trading gains and the lack of identifiable victims may doom it altogether.
• Is “equitable relief” disgorgement within Liu’s guidelines, no longer “punitive” under Kokesh, hence no longer subject to five-year limitations?

Liu v. SEC, No. 18-1501 (U.S., June 22, 2020), is here.

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