Six months after Liu: The SEC and disgorgement
Just over six months ago, the US Supreme Court concluded that an SEC disgorgement award may be considered equitable relief permissible under Section 21(d)(5) of the Securities Exchange Act of 1934 (Exchange Act) if the award does not exceed a wrongdoer’s net profits and is awarded for the benefit of victims. Reaching this decision, however, the Court specified limitations on equitable disgorgement that could curb overly ambitious claims by the SEC. This, in turn, left a number of open questions which are only now starting to work their way through the courts.
The Liu case
As discussed in this alert, the SEC initially sued the defendants alleging that they had misappropriated at least $20 million of almost $27 million raised from investors through the EB-5 Immigrant Investor Program. The district court ordered disgorgement of the entire $27 million (less amounts still available to be returned to investors).
The Supreme Court granted certiorari to determine whether the SEC could seek disgorgement beyond a defendant’s net profits under Exchange Act Section 21(d)(5). The Liu petitioners argued the SEC could not do so based on an interpretation of the Supreme Court’s prior decision in Kokesh v. Securities and Exchange Commission which found that disgorgement was a penalty within the five-year statute of limitations under 28 U.S.C. §2462, but expressly left open the question of whether disgorgement could qualify as equitable relief under Exchange Act §21(d)(5). The Liu petitioners contended that since Kokesh held that disgorgement is a penalty, the remedy was not available to the SEC as equitable relief under Section 21(d)(5)
The Supreme Court rejected the petitioners’ arguments, holding that Kokesh has “no bearing on the SEC’s ability to conform future requests for a defendant’s profits to the limits outlined in common-law cases awarding a wrongdoer’s net gains.” Those limits on disgorgement included ensuring that the remedy (i) compensates victims of the wrongdoing; (ii) is imposed against individuals or partners in concerted wrongdoing and not through joint and severable liability; and (iii) is limited to the net profits from the wrongdoing after deduction of legitimate expenses. The Court found that while equity principles did not limit a court’s ability to deprive a wrongdoer of ill-gotten gains, Section 21(d)(5) of the Exchange Act restricted equitable relief to that which “may be appropriate or necessary of the benefit of investors.” Consequently, the Supreme Court concluded, a court may only enter disgorgement in favor of the SEC for the victim’s benefit and only after legitimate expenses incurred by the defendant are deducted.
Recent interpretations of Liu
Since Liu was decided, several courts have considered its scope and limitations.
- First, courts have rejected efforts to extend the rationale of Liu to limit government claims under different statutes, including Canadian government claims for disgorgement under Canadian law (Lathigee v. British Columbia Securities Commission, Nev.) and claims by the Federal Trade Commission for restitution, the imposition of asset freezes, the appointment of a receiver and disgorgement under the FTC Act. See FTC v. Cardiff (C.D. Cal.); In re Sanctuary Belize Litig. (D. Md.); FTC v. Noland (D. Ariz.). In each of these cases, the courts have concluded that Liu “is cabined to disgorgement in SEC actions under a distinct provision of the [Exchange] Act. . .” (Cardiff)
- Second, courts have identified certain circumstances in which the SEC may obtain disgorgement on a joint and several basis against partners engaged in concerted wrongdoing. For instance, in SEC v. Blockvest, et al., the District Court for the Southern District of California entered a final judgment against Blockvest LLC and its founder, Reginald Buddy Ringgold, and ordered disgorgement of $332,370.99 jointly and severally, in addition to a civil monetary penalty. Reaching its decision, the court noted that the Liu court recognized the imposition of joint and several liability “for partners engaged in concerted wrongdoing.”
- Third, courts have considered the scope of disgorgement against relief defendants. In SEC v. Erwin, et al., the District Court for the District of Colorado concluded that Liu’s holding that disgorgement should not “exceed the wrongdoer’s net profits” and must exclude legitimate expenses has no bearing on the propriety of judgments against relief defendants not accused of wrongdoing. Similarly, in dicta, the District Court for the Southern District of New York stated in SEC v. Yin that the Second Circuit had historically required an insider trader to disgorge not only his profit, but also the profits of those s/he had tipped. The court noted, however, that Liu explicitly overruled that notion as “at odds with the common-law rule requiring individual liability for wrongful profits,” but left the issue open for resolution at a later point in the proceeding.
- Fourth, courts have considered Liu’s requirement that disgorgement be awarded for victims, requiring the SEC to demonstrate that the disgorgement is for the benefit of the investors. Prior to granting disgorgement, the District Court for the Southern District of New York in SEC v. Rinfret, et al. considered evidence regarding how disgorgement would be used, among other things, to ensure it was being used to compensate investors. And in SEC v. Bevil, the District Court for the District of Nevada actually denied the SEC’s request for disgorgement, citing Liu, finding the SEC had failed to present sufficient proof that the award was for the benefit of the investors.
- Finally, courts have started to consider what constitutes net profits and legitimate expenses post Liu. In SEC v. Slowinski, the District Court for the Northern District of Illinois rejected attempts to use Liu to justify the exclusion of certain business expenses, namely payments to a company that was complicit in the fraud. As the Slowinski court reasoned, while Liu excluded the “gains made upon any business or investment, when both the receipts and payments are taken into account,” the credits for expenses in the instant case were not valid.
Congress takes action
On January 1, 2021, the US Congress passed the National Defense Authorization Act (the “Act”), which includes a set of securities law amendments that strengthen the SEC’s enforcement powers, in partial response to the decision in Liu. As explained in greater detail in this recent alert, Congress eliminated the SEC’s need to rely on its implied authority to seek disgorgement under Section 21(d)(5) of the Exchange Act by expressly authorizing the SEC to seek “disgorgement . . . of any unjust enrichment by the person who received such unjust enrichment as a result of such [a securities law] violation.” The Act also established, among other things, a 10-year statute of limitations for “any equitable remedy,” including injunctions, bars, suspensions, and cease-and-desist orders, regardless of the wrongdoer’s knowledge or intent.
What might 2021 hold?
It is unlikely that the recent amendments to the Exchange Act will end all debate about disgorgement. In 2021, disputes will continue on such topics as:
- What constitutes net profits? Which expenses may be deducted?
- Even with express authority to seek disgorgement, must any disgorgement award still benefit only those who are harmed, consistent with the general equitable principles outline by the Supreme Court in Liu?
- What are the boundaries for disgorgement from relief defendants against whom no wrongdoing is asserted?
- How will tolling of the statute of limitations for time spent outside the US apply to businesses and individuals located outside of the US?
Liu was a reminder that equitable remedies must remain within the confines of equitable principles. The Act’s amendments to the securities laws did not change the nature of the remedy. Rather, those amendments clarified the SEC’s ability to seek disgorgement and gave the agency more time to pursue that remedy in certain cases. The full impact of Liu remains in flux and will continue to evolve over time.
To learn more about the continuing ramifications of the Liu decision, or the impact of the National Defense Authorization Act on future actions for equitable relief, please contact any of the authors or your DLA Piper relationship partner.