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U.S. Supreme Court Considers Limiting SEC’s Ability to Recover Disgorgement

Oral arguments held in Liu v. SEC

Back in November, we blogged about the United States Supreme Court’s willingness to consider whether the Securities and Exchange Commission (SEC) could continue to seek the remedy of disgorgement of illegally obtained funds. On March 3, 2020, the Supreme Court held oral arguments on the case, which is styled as Liu v. SEC.

The appellants in this case make the simple argument that disgorgement of illegally obtained funds, a remedy commonly sought by the SEC, should not be permitted because it is not authorized anywhere in the SEC statutory scheme.

The SEC counters that disgorgement need not be explicitly authorized by statute because it is an “equitable” remedy that has been traditionally available for courts to award.

The current definition of disgorgement includes all funds received by a defendant as a result of illegal activity, even if that defendant no longer possesses those funds. For example, if a defendant subsequently paid out the funds to a third party, the SEC would require those funds to be paid back by the Defendant, not the third party. This definition of disgorgement leads to very harsh results in cases where defendants retained only a modest profit but the SEC obtains an order requiring the defendants to disgorge much greater sums of money than they currently possess or ever earned.

At oral arguments, the Supreme Court Justices appeared to be considering a middle ground rather than the all-or-nothing stakes laid out in the parties’ briefs. Justice Samuel Alito asked the appellants’ attorney the following question: “Suppose [disgorgement] were limited to net profits and suppose every effort was made to return the money to the victims of the fraud. Would that not fall within a traditional form of equitable relief?”

The Appellants responded that, “the better course would be to say this remedy that the SEC has sought here, SEC disgorgement, which does not have a historical parallel, does not exist… [I]n the case where Congress has not [mentioned] disgorgement, and they did not say so here, I think the Court should hesitate to read it into a general provision for equitable relief.”

Justices Ruth Bader Ginsburg and Brett Kavanaugh both followed up with related questions implying a preference towards limiting disgorgement to profits, and requiring the profits to be returned to the victims (instead of them flowing into government coffers).

When the SEC’s attorney got his chance at the lectern, he was repeatedly asked similar questions, i.e., whether it would be appropriate to make disgorgement available to the SEC on the condition that the funds must then be returned to the investors. In other words, the Justices were asking why the SEC should be allowed to retain for itself funds illegally obtained from investors. The SEC attorney stammered, but eventually conceded the point: “I --I --I wouldn't have a problem with that. I mean, I don't know that it is kind of in accordance with usual principles for the Court to announce that sort of instruction[.]”   

While the Supreme Court has no timetable for issuing a decision, a ruling is expected prior to the end of June. The ruling will be of great importance to cases brought by the Federal Trade Commission, which also regularly claims the right to obtain disgorgement despite no explicit authorization to do so.

TAKEAWAY: While one should never assume too much based on questions asked by judges during oral arguments, it appears there is a very real chance that the Supreme Court will drastically reduce the SEC’s powers of judicial recovery. If the recent oral arguments were an accurate indication of the Justices’ reasoning, a ruling could be forthcoming that limits disgorgement to profits only, and requires such profits to be returned to the investors rather than remaining with the government.

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