Last week, the U.S. Securities and Exchange Commission (SEC) filed its brief in Liu v. SEC,1 claiming that disgorgement in federal courts is within its statutory authority and that the U.S. Supreme Court should not disrupt this important enforcement and remedial mechanism. As of the time of this writing, the petitioners and the SEC have both filed briefs in the Supreme Court, along with fifteen amici curiae briefs weighing in. Given that the lynchpin of the petitioners' argument hinges on disgorgement being a penalty instead of equitable relief, the SEC recites numerous cases in which the Court referred to disgorgement as equitable relief within a statutory scheme that intends to give the SEC broad authorization. Among other things, the SEC avers that "[f]orbidding courts to order disgorgement in SEC suits would make it easier for wrongdoers to keep their ill-gotten gains, thereby reducing the deterrent effect of the current remedial scheme."2
For decades, disgorgement of ill-gotten gains has been one of the SEC's often-used enforcement powers and has been broadly accepted by the circuit courts that have considered the issue. The grant of certiorari in Liu v. SEC, absent a circuit split, could signal that the Supreme Court is questioning this settled understanding.
I. Background
Disgorgement is a remedy that the SEC uses to recover wrongdoers' ill-gotten gains and, in many cases, to return these gains to the victims.3 The federal securities laws authorize the SEC to seek injunctive relief in the federal district courts, which in turn have equitable powers to order appropriate remedies for wrongdoing. The Securities Exchange Act of 1934 specifically authorizes the SEC to obtain disgorgement as a civil remedy in administrative proceedings.4 The SEC has successfully obtained disgorgement beyond the context of administrative proceedings in a wide variety of matters, including offering frauds, Foreign Corrupt Practices Act resolutions, and settlements with regulated entities.5 In Fiscal Year 2019 alone, the SEC obtained a total of $3.248 billion in disgorgement of ill-gotten gains.6
Although disgorgement has historically been viewed as an equitable remedy designed to prevent wrongdoers' unjust enrichment, a recent Supreme Court decision cast doubt on the SEC's authority to obtain disgorgement. In Kokesh v. SEC,7 the Court held that disgorgement is a punitive remedy, rather than a restorative remedy. 28 U.S.C. § 2462 imposes a five-year statute of limitations on any suit or proceeding for the enforcement of any "civil fine, penalty, or forfeiture." Two factors determine whether a monetary sanction qualifies as a penalty: (1) whether the wrong sought to be addressed is a wrong against the public or a wrong against an individual; and (2) whether the purpose is to punish and deter others, as opposed to compensating victims for a loss.8
The Kokesh Court found that disgorgement satisfies this two-factor penalty test; disgorgement addresses a wrong committed against the public, and its primary purpose is to deter violations of federal securities laws by depriving wrongdoers of their ill-gotten gains. The Court further explained that disgorgement is not compensatory because there is no statutory mandate to pay the disgorgement to the victims. Finally, the Court rejected the SEC's argument that disgorgement simply returns wrongdoers to their original state had they not violated the securities laws, noting that insider-trading defendants can end up worse off by disgorging both their personal profits and the profits made by third parties. The Court concluded that disgorgement qualifies as a penalty and is therefore subject to the five-year statute of limitations under Section 2462.9 Accordingly, ill-gotten gains obtained by a wrongdoer outside the five-year statute of limitations are insulated from disgorgement. Significantly, in a footnote to its decision, the Court explicitly declined to address whether courts have the authority to order disgorgement in the first place, effectively flagging this as an open question.10
II. Liu v. SEC
In the case that is now before the Supreme Court, the petitioners argue that since disgorgement is a penalty under Kokesh, it is not an equitable remedy and therefore falls outside the scope of the SEC's authority.11 The petitioners note that Congress authorized the SEC to seek enumerated remedies that do not include disgorgement, while explicitly providing for disgorgement only in administrative proceedings. According to the petitioners, this demonstrates that Congress did not intend to grant disgorgement authority.12 The petitioners further argue that the remedies available to the SEC leave it "more than amply equipped" to enforce the securities laws without disgorgement power.13
In opposition, the SEC argues that Congress has authorized the courts to order any equitable relief that may be appropriate or necessary for the benefit of investors, which includes disgorgement.14 The SEC claims that the petitioners' reliance on Kokesh is misplaced, insisting that the Supreme Court determined disgorgement was a penalty within the meaning of the statute of limitations, which can be squared with other precedent describing disgorgement as equitable relief for other purposes. The SEC also attacks the petitioners' practical arguments, contending that eliminating court-ordered disgorgement would enable wrongdoers to keep their ill-gotten gains and reduce the deterrent effect of the current remedial scheme.15 Moreover, the SEC argues that victims left without recourse to the SEC's disgorgement funds would be forced to bring their own private actions, which are "narrow" in scope under the Supreme Court's jurisprudence.16
III. Key Takeaways
For decades, disgorgement of ill-gotten gains has been a powerful tool of the SEC. Through its enforcement proceedings, the SEC successfully obtains billions of dollars per year in disgorgement and similarly pays billions of dollars to injured investors.
The forthcoming opinion in Liu, which is anticipated in mid-2020, could dramatically limit the SEC's disgorgement power, which is averred to be both an enforcement tool to deter bad actors and a remedy to make defrauded investors whole. If the Supreme Court decides that the SEC lacks the authority to seek, and courts lack the authority to order, disgorgement as a remedy in actions to enforce the federal securities laws, the SEC may have to reconsider its enforcement approach. For instance, if the Court eliminates the availability of disgorgement in enforcement actions initiated in federal court, the SEC may instead have to seek disgorgement through administrative proceedings—the avenue in which Congress has unequivocally authorized disgorgement.17
Meanwhile, Congress is weighing in by introducing federal legislation that would effectively overturn Kokesh and expand the SEC's disgorgement powers. In September 2019, the U.S. House Committee on Financial Services passed a bipartisan bill that would amend the Securities Exchange Act of 1934 to explicitly authorize the SEC to seek, and federal courts to order, disgorgement of ill-gotten gains.18 The bill explicitly instructs that disgorgement "may not be construed to be a civil fine, penalty, or forfeiture" subject to Section 2462, and expands the statute of limitations to 14 years.19 Similar legislation to codify SEC disgorgement was recently introduced in the Senate.20 If passed, such legislation would effectively overturn Kokesh, potentially before the Supreme Court has the chance to address the question in Liu.
Footnotes
1 Br. for Resp't, Liu v. SEC, No. 18-1501 (Sup. Ct. filed January 15, 2020).
3 Fair Funds were created by the Sarbanes-Oxley Act of 2002, and hold money recovered from an SEC case, which is distributed to injured investors. See 15 U.S. Code § 7246.
4 Securities Exchange Act of 1934, 15 U.S.C. § 78u-2(e).
5 Steven Peikin, Remedies and Relief in SEC Enforcement Actions (October 3, 2018).
6 U.S. Securities and Exchange Commission, Division of Enforcement, 2019 Annual Report, at 16.
7 Kokesh v. SEC, 137 S. Ct. 1635 (2017).
8 John J. Carney and Lauren P. Berglin, Limiting SEC Disgorgement – Unanimous Supreme Court Draws a Bright Line Five-Year Rule, BakerHostetler (June 12, 2017).
10 Kokesh, 137 S. Ct. at 1642 n.3.
11 Br. for Pet'rs at 19-20, Liu v. SEC, No. 18-1501 (Sup. Ct. filed December 16, 2019).
14 Br. for Resp't at 7, Liu v. SEC, No. 18-1501 (Sup. Ct. filed January 15, 2020).
17 Securities Exchange Act of 1934, 15 U.S.C. § 78u-2(e).
18 H.R. 4344, 116th Cong. (2019).
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