Seyfarth Synopsis: On Monday, June 22, 2020, the Supreme Court issued its decision in Liu et al v. Securities and Exchange Commission ("SEC").1 In an 8-1 decision, written by Justice Sotomayor, the Court held that a disgorgement award that does not exceed a wrongdoer's net profits, and is awarded for compensation of victims, is permissible under the SEC's power to seek "equitable relief"-upholding the SEC's disgorgement power but leaving open important questions, including the propriety of the SEC's practice of depositing disgorgement funds with the Treasury when distribution to victims is not feasible. The Court's decision indicates that SEC disgorgement is here to stay, but for now parties still have viable arguments that any disgorgement should be limited to actual distributions to victims.
In our previous article on the Supreme Court's Liu oral argument, we noted that the Justices appeared disinclined to eliminate SEC disgorgement outright, but asked a number of questions as to whether that remedy should be limited to the return of net profits to the victims of securities fraud. In its written decision, issued on Monday, June 22, the Supreme Court indeed held that a disgorgement award is permissible equitable relief for the SEC where it does not exceed a wrongdoer's net profits and is awarded for victims' compensation. But the Court left open several important questions, including the propriety of the SEC's practice of depositing funds with the Treasury in certain circumstances and when it is appropriate to apply joint and several liability to disgorgement awards. In the sole dissent, Justice Thomas rejected the idea of disgorgement as an "equitable remedy" but stated that, even if disgorgement was permissible, lower courts should answer the Court's open questions by limiting that power.
As we previously discussed, since the 1970s federal courts hearing SEC enforcement proceedings have routinely ordered defendants to disgorge their profits. In Liu, the Supreme Court considered whether, and to what extent, such disgorgement was actually permitted under 15 U. S. C. §78u(d)(5), which does not specifically grant a disgorgement power, but rather provides that "the Commission may seek, and any Federal court may grant, any equitable relief that may be appropriate or necessary for the benefit of investors."2 Congress did not define "equitable relief" in this statute, and thus, the Liu decision addressed the question of whether disgorgement by the SEC was, in fact, permitted as "equitable relief."3
The Court's 8-1 Decision Found that SEC Disgorgement Was Permissible as Equitable Relief
The Court, with Justice Sotomayor writing for an 8-1 majority, held 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)."4 The opinion explains that equity courts have routinely deprived wrongdoers of net profits from wrongful activity, using powers of "restitution," "accounting," or, "disgorgement." 5 The Court found that "[n]o matter the label, this 'profit-based measure of unjust enrichment' . . . reflected a foundational principle" of equity that a wrongdoer should not make a profit out of his own wrong.6
The Court then identified three "narrower" questions, and discussed "principles that may guide the lower courts' assessment" of these questions, but declined to decide them in this case as they were not fully briefed by the parties:
- First, whether SEC's practice of placing funds in the Treasury that cannot be returned to victims was lawful. The Court noted that the SEC's equitable remedy must do more than simply benefit the public at large by virtue of depriving a wrongdoer of ill-gotten gains and flagged as an "open question" whether the SEC's practice of depositing disgorgement funds when it is infeasible to distribute these funds to investors satisfies the SEC's obligation to award relief for the benefit of investors.7
- Second, whether the SEC's imposition of joint-and-several liability when disgorging funds is lawful. The Court noted that there is a "wide spectrum of relationships" in unlawful schemes and it "need not wade into all the circumstances where an equitable profits remedy might be punitive when applied to multiple individuals," noting that in the case at hand petitioners were married and no evidence suggests that one spouse was a mere passive recipient of profits or that finances were not comingled.8
- Third, as to the deduction of petitioners' business expenses, the Court noted that while courts must deduct legitimate expenses before ordering disgorgement, this requires ascertaining the legitimacy of such expenses, which the lower court must assess.9
In his dissent, Justice Thomas began by stating unequivocally that disgorgement is not a traditional equitable remedy and as such it can never be awarded under 15 U. S. C. §78u(d)(5) which authorizes the SEC to seek only equitable relief.10 Justice Thomas's opinion rests on his view that "equitable relief" only applies, within the Court's usual interpretation, to forms that were recognized by the English Court of Chancery at the time of the founding.11 The concept of "disgorgement," Justice Thomas noted, is a 20th century invention, which does not have an easily recognizable or clearly defined meaning.12 Disgorgement also does not have a foundation as a method for equitable relief in either historical practice, discussions in legal publications, or case law pre-dating the 20th century.13 Justice Thomas agreed with the majority that the lower courts should be able to limit the disgorgement award, but disagreed that disgorgement should be classified as "equitable relief" for the purposes of validating the SEC's disgorgement power under the statute.14 In particular, Justice Thomas advised that courts should, at the very least, limit disgorgement orders to the profits of each petitioner, not impose the orders jointly and severally, and use the money recovered to compensate the victims rather than the government.15
The SEC's disgorgement power has survived the Supreme Court's Liu decision narrowly. The Court found that an award cannot exceed a wrongdoer's net profits, and has to be awarded "for victims." Importantly, businesses and individuals can continue to argue that profits which cannot be returned to an identified victim should not be disgorged.
1 Liu et al v. SEC, No. 18-1501 (June 22, 2020), https://www.supremecourt.gov/opinions/19pdf/18-1501_8n5a.pdf.
2 See id. at 1.
3 Id. at 2.
4 Id. at 1.
5 Id. at 6.
6 Id. (quoting Restatement (Third) of Restitution and Unjust Enrichment §51, Comment a, p. 204 (2010)). The Court also rejected the argument that the Supreme Court's 2017 Kokesh decision necessitated a finding that disgorgement was a "penalty," noting that the Kokesh Court explicitly declined to answer that question. Id. at 12 (citing Kokesh v. S.E.C., 137 S. Ct. 1635, 1640 (2017), https://www.supremecourt.gov/opinions/16pdf/16-529_i426.pdf).
7 Id. at 16-17.
8 Id. at 18.
9 Id. at 18-19.
10 Id., Thomas, J., dissenting at 1.
12 See id. at 1-2.
13 See id. at 1-4.
14 See id. at 1.
15 See id. at 8-10.
Originally published June 23, 2020.
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