Disgorgement has long been one of the most powerful tools in the SEC’s enforcement arsenal. Generally speaking, disgorgement requires that individuals or entities who violate SEC regulations pay back, with interest, any ill-gotten gains, which may then be distributed to the victims of the misconduct. In recent years, disgorgement has come to dwarf all other civil monetary penalties obtained by the SEC in terms of monetary value. In fiscal year 2018, 64% of all monetary relief obtained in SEC enforcement proceedings derived from disgorgement alone, and in fiscal year 2019, that percentage jumped to 74% (roughly $3.25 billion). A pending appeal before the United States Supreme Court, however, threatens to significantly limit—if not eliminate—the SEC’s authority to seek disgorgement in federal district court.
The Liu case stems from an alleged fraud carried out by a California couple, Charles Liu and Xin Wang (“Appellants”), in connection with the United States’ EB-5 Immigrant Investor Program, which enables foreign citizens to obtain immigration visas in exchange for investments in job-creating projects in the U.S. On May 26, 2016, the SEC brought an enforcement action against Appellants in the U.S. District Court for the Central District of California (the “District Court”) for violations of Section 17(a)(2) of the Securities Act of 1953, alleging that Appellants misappropriated approximately $27 million raised from Chinese investors to construct and operate a cancer treatment center in California. In granting the SEC summary judgment on their claims, the District Court ordered injunctive relief, civil monetary penalties, and disgorgement of the entire amount that had been collected from Appellants’ investors.
Shortly after the District Court’s decision, the Supreme Court issued an opinion in Kokesh v. SEC, 137 S. Ct. 1635 (2017), which teed-up the issue now being addressed in the Liu appeal. In Kokesh, the Supreme Court examined whether, for statute of limitations purposes, disgorgement constitutes a “penalty” subject to a five-year statute of limitations or a form of equitable relief subject to no limitations period. Although the Supreme Court unanimously found that disgorgement constitutes a penalty, it declined to address whether federal district courts possess the authority to order disgorgement in SEC enforcement proceedings.
On the heels of Kokesh, Appellants appealed the District Court’s decision to the Ninth Circuit Court of Appeals, arguing that the District Court “lacked statutory authority to award disgorgement.” The Ninth Circuit rejected this argument, concluding that it was still bound by pre-Kokesh circuit law that had upheld similar disgorgement awards obtained by the SEC.
In their appeal to the Supreme Court, Appellants argue that the Ninth Circuit erred in ordering disgorgement because the SEC is not permitted to seek and obtain disgorgement in federal district court as a penalty for securities laws violations. Specifically, Appellants argue that Congress has identified three types of relief that may be awarded to the SEC: (1) injunctive relief, (2) equitable relief, and (3) civil monetary penalties. Appellants contend that, based on the Supreme Court’s finding in Kokesh that disgorgement is not a form of “equitable relief,” it then follows that the SEC is no longer authorized to obtain disgorgement in federal district courts.
The SEC is opposing the appeal on several grounds, including that (i) the Securities Act of 1933 and the Securities Exchange Act of 1934 permit courts to order the disgorgement of profits obtained in violation of statutory provisions; (ii) Congress has enacted numerous statutes that presuppose the availability of disgorgement; and (iii) the holding in Kokesh was limited to whether disgorgement is considered a penalty for statute of limitations purposes only.
Thoughts:
Given the prevalence of disgorgement in SEC enforcement actions over recent years, a Supreme Court decision that eliminates or even significantly curtails the SEC’s ability to seek disgorgement in federal district courts would have far reaching implications. As both a deterrent of federal security law violations and a point of leverage for the SEC during settlement negotiations, the threat of disgorgement often shapes the entire enforcement proceeding. Indeed, the Co-Director of the SEC’s Division of Enforcement, Steven Peiken, has written that the SEC decided to forgo seeking approximately $800 million in potential disgorgement in the wake of Kokesh. Steven Peiken, Remedies and Relief in SEC Enforcement Actions, SEC (Oct. 3, 2018), www.sec.gov. Moreover, the end of disgorgement would mean the denial of billions of dollars in distributions to harmed investors (e.g., $1.197 billion in fiscal year 2019).
If the Supreme Court concludes that disgorgement is not within the SEC’s statutory authority, it is likely that the SEC will respond by urging Congress to give it the power to obtain disgorgement in federal district court going forward. In the meantime, there is likely to be a corresponding increase in administrative proceedings, where disgorgement is expressly permitted by statute, see 15 U.S.C. § 78u-2(e), and the actions are decided by administrative law judges employed by the SEC. In fact, enforcement actions have already been trending in this direction for several years. See Stephen J. Choi and A.C. Pritchard, The SEC’s Shift to Administrative Proceedings: An Empirical Assessment, 34 YALE L.J. 1, 19 (2017) (showing that the number of administrative proceedings initiated by the SEC outpaced the number of civil enforcement actions in 2014 and 2015 by a more-than 2:1 margin, after seven years of the opposite trend). This, in turn, is likely to prompt a constitutional challenge over the SEC’s ability to obtain the remedy of disgorgement in administrative proceedings but not in federal district court, where defendants enjoy greater protections, such as the right to a jury, broader discovery, and judges who are entirely independent of the agency.
Client Alert 2019-279
