Earlier this week, the Supreme Court handed down its ruling in Liu v. Securities and Exchange Commission, No. 18-1501. This ruling is significant for two reasons. First, it resolves the previously unsettled question as to whether the SEC is empowered to seek a disgorgement award. The SEC is. Second, it explains limits upon disgorgement awards necessary to ensure it is not an improper penalty.
As you may know, disgorgement is an equitable remedy intended to deprive wrongdoers of the net profits of unlawful conduct. The SEC often seeks a disgorgement award in connection with securities fraud claims. In the 2017 case of Kokesh v. SEC, the Supreme Court found disgorgement to be a penalty for statute of limitations purposes, but did not go so far as to decide whether disgorgement could still be imposed as a form of equitable relief. Equitable relief has generally not permitted recovery that would be punitive. This left a big question for the SEC and defendants alike. Can the SEC keep seeking disgorgement in these cases?
In this case, appellants challenged a $27 million award of disgorgement stemming from a visa scheme as an improper penalty. While the Supreme Court vacated the disgorgement award and remanded for further proceedings, it reaffirmed that the SEC had authority to seek disgorgement and explained certain restrictions on that recovery to ensure it is correctly calculated and used to reimburse victims of the fraud found in the lawsuit. More specifically, the Supreme Court clarified that courts must consider factors including what the actual profits from the fraud net of “legitimate expenses” are as well as ensuring that the money awarded is actually returned to defrauded investors and not the SEC.
This is a partial win for both the SEC and defendants against whom the SEC seeks disgorgement. For the SEC, it can still seek disgorgement, which has been a vital tool in its tool belt for enforcement in recent years. For defendants, they are now armed with significant arguments to limit the amount of disgorgement awarded. It remains to be seen exactly how or to what extent this will impact securities litigation, but for now we expect the SEC to continue pursuing and receiving disgorgement awards, but the size of those awards to shrink under the Supreme Court’s new guidance of what is necessary to avoid constituting an improper penalty.