In an eight-to-one decision delivered by Justice Sonia Sotomayor, the U.S. Supreme Court  held that disgorgement can be considered "equitable relief" as long as it does "not exceed a wrongdoer's net profits and is awarded for victims." In Liu et al. v. SEC ("Liu"), the Supreme Court concluded that there are limits to when disgorgement can be considered equitable relief, and identified three situations where disgorgement may go beyond equitable relief: (1) where the funds are deposited into the Treasury instead of disbursing them to victims, (2) where joint-and-several liability is imposed in the absence of concerted wrongdoing, and (3) where a disgorgement award fails to deduct even "legitimate" expenses from the receipts of fraud.

In Liu, the SEC charged a husband and wife for defrauding Chinese investors by falsely claiming that their investments would support a project that met the requirements of the EB-5 Immigrant Investment Program (see previous  coverage). The SEC obtained an Order for Disgorgement of almost $27 million dollars. Liu argued that disgorgement is not equitable relief (under the Court's reasoning in  Kokesh v. SEC) and that the SEC did not have the authority to obtain disgorgement in judicial proceedings. While it rejected Liu's argument that the SEC lacked the authority to seek disgorgement, the Supreme Court remanded the case to the lower court to determine whether the disgorgement award complies with the limitations set out in its decision.

Commentary Kyle DeYoung

The SEC dodged a bullet in the Liu decision but did not get away unscathed. While the decision preserved the SEC's ability to obtain disgorgement, it will likely force the SEC to change its current disgorgement practices in significant ways.

First, the Supreme Court held that the SEC must deduct legitimate expenses when calculating the amount of disgorgement it seeks in federal courts, something it refused to do in Liu, consistent with the position it often takes in other cases. Second, the decision limits the SEC's ability to impose joint-and-several liability for disgorgement to situations where the parties were "partners in wrongdoing." This limitation may be of particular impact in insider trading cases where the SEC has traditionally held the tipper responsible for his or her tippee's profits, even where the relationship between them was remote. Finally, and most significantly, the decision casts serious doubt on whether the SEC can obtain disgorgement in situations where the money collected does not go to injured investors, but goes to the U.S. Treasury instead. The SEC has regularly obtained disgorgement and sent disgorgement to the U.S. Treasury in cases where returning money to investors was impossible or impractical. A limitation on its ability to do so would have a significant impact on its current practice, especially in cases such as market manipulation, Foreign Corrupt Practices Act investigations, insider trading cases, and other cases where it is difficult to identify and/or return money to injured investors.

Originally published June 22, 2020.

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