On March 3, 2020, the Supreme Court appeared unified during oral argument in Liu v. SEC to preserve one of the Securities and Exchange Commission’s most valuable enforcement tools: disgorgement. Disgorgement requires violators of securities laws to forfeit their ill-gotten gains, and the SEC has used this equitable remedy for nearly 50 years. The co-director of the SEC’s Division of Enforcement, Steven Peikin, emphasized in 2019 that “disgorgement is a central component of meaningful relief and often the surest way to restore at least a portion of investors’ losses.”
The Securities Exchange Act of 1934 (the “Act”) gives the SEC broad authority to enforce federal securities laws and to prescribe rules and regulations in the public interest or for the protection of investors. While the statute specifically permits the SEC to seek injunctions, it is silent on disgorgement. The source of the SEC’s authority to seek disgorgement comes from a 1971 Second Circuit case entitled SEC v. Texas Gulf Sulphur (446 F.2d 1301, 1308 (1971)), which found that district courts have general equitable power under Section 27 of the Act and that “the SEC may seek other than injunctive relief in order to effectuate the purposes of the Act, so long as such relief is remedial relief and is not a penalty assessment.” Since then, district courts have consistently upheld the SEC’s authority to recover ill-gotten gains obtained through fraud or insider trading. And the practice has been impactful: in 2016, the SEC obtained $3 billion in court-ordered disgorgement, more than double what it had collected in other types of monetary penalties.
This long-standing form of equitable relief was called into question in a mighty footnote in the Supreme Court’s 2017 Kokesh v. SEC opinion (137 S.Ct. 1635, 1642 at n.3). There, the Court held that disgorgement constitutes a penalty and is therefore subject to a five-year statute of limitations. A footnote in that decision stated that “[n]othing 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.” Many securities law scholars and practitioners predicted that this footnote would lead to a defendant challenging the SEC’s ability to seek disgorgement.
Sure enough, that defendant took the form of a California couple, Charles Liu and Xin “Lisa” Wang. Before the Kokesh decision was issued in June 2017, the SEC filed suit against the couple in May 2016 in the Central District of California alleging that Mr. Liu and Ms. Wang defrauded 50 Chinese investors in an EB-5 Immigrant Investor Program. (The EB-5 Program grants permanent residence – and a path to citizenship – to foreign investors who invest at least $500,000 toward job-creating real estate projects.) The case alleged that the couple raised $26 million from investors who had been told that the money would be used to build a cancer research center. But the center was never built. Instead, the couple allegedly misappropriated the money for their personal use and funneled it into Chinese marketing firms. The SEC charged them with making misstatements or omissions of material information when soliciting those investments. In April 2017, the District Court granted summary judgment for the SEC, ordering the couple to pay $8.2 million in monetary penalties and to disgorge the $26 million of ill-gotten gains they took from the investors (they were also banned from participating in the EB-5 Program).
In June 2017, less than two months after summary judgment had been granted against the couple requiring disgorgement of $26 million, the Supreme Court issued its decision in Kokesh, which contained its now-infamous footnote. Mr. Liu and Ms. Wang appealed the disgorgement decision against them to the Ninth Circuit, which upheld the judgment.
The couple then appealed to the Supreme Court to confront the footnote and decide “[w]hether the [SEC] may seek and obtain disgorgement from a court as equitable relief for a securities law violation even though this Court has determined that such disgorgement is a penalty.” During oral argument, the Justices seemed united around fairness. Justice Ginsburg asked, “Is it not an equitable principle that no one should be allowed to profit from his own wrong?” Rather than doing away with the remedy altogether, Justice Gorsuch appeared to want assurance that the proceeds from disgorgement were returned to the harmed investors: “Would the government have any difficulty with a rule that the money should be returned to investors where feasible?”
These questions from both ends of the Supreme Court spectrum suggest that Justices both liberal and conservative seem to be supportive of the role that disgorgement may play in the SEC’s arsenal of available penalties and tools. While time will tell, that time appears to be fast approaching in the form of an opinion in this consequential case.