Supreme Court Adds Limits To SEC’s Disgorgement Power

In the Supreme Court’s 8-1 June 22, 2020 Liu v. Securities and Exchange Commission decision, the Court held that the Securities and Exchange Commission’s (the “SEC”) practice of obtaining disgorgement is considered equitable relief and is therefore authorized under 15 U.S.C. § 78u(d)(5). However, the Supreme Court placed certain limits on the SEC’s disgorgement power regarding how much the SEC is able to collect and what the SEC must do with the money.

In 2017, the Supreme Court ruled in Kokesh v. SEC that the SEC’s use of disgorgement is a penalty and is therefore subject to the five-year statute of limitations found in 28 U.S.C. § 2462. Nevertheless, the Court declined to address whether courts have the power to order disgorgement at all. The Liu case sought clarity to this issue and the Liu defendants argued that under Kokesh, the SEC is not authorized to seek or obtain disgorgement as a form of equitable relief.

The majority opinion, as authored by Justice Sotomayor, upholds the SEC’s ability to seek and obtain disgorgement, but identified three troublesome aspects of the SEC’s prior application of disgorgement as equitable relief. First, the Court noted that the SEC frequently deposits some amount of the recovered funds with the Treasury. The Court did not find that depositing funds into the Treasury violated 15 U.S.C. § 78u(d)(5)’s requirement that the equitable relief be for the benefit of investors, but the Court emphasized that depriving defendants of their illicit gains without returning proceeds to harmed investors does not meet the statutory requirement.

Second, the Court highlighted the SEC’s practice of pursing disgorgement against defendants and holding them jointly and severally liable. The Court found that when defendants are tried under a joint and several liability theory, the equitable relief sought could be transformed into a penalty. The Court declined to rule on when holding defendants jointly and severally liable would be acceptable.

Third, the Court explained that the SEC has not allowed the deduction of legitimate business expenses. The Court held that disgorgement is limited to only the net profits of the scheme but acknowledged that there are certain situations where the entire profit came from the wrongdoing. In those situations, a defendant might not be able to deduct certain expenses and a court would be required to determine if the expenses were legitimate.

The Court’s decision in Liu did not touch the Kokesh decision and therefore SEC disgorgement actions are still bound by a five-year statute of limitations. However, the opinion leaves many other open issues that will surely be litigated in the near future.