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November 11, 2019

Supreme Court to Decide Whether the SEC Has the Authority to Seek Disgorgement in Enforcement Proceedings


On November 1, 2019, the Supreme Court granted certiorari in Liu v. Securities and Exchange Commission (18-1501). Liu seeks review of the US Securities and Exchange Commission's (SEC) authority to pursue disgorgement as a form of equitable relief for federal securities law violations in district court proceedings, an issue cast into doubt by the Supreme Court's 2017 opinion in Kokesh v. SEC, which held that disgorgement constitutes a "penalty."1 The Court's consideration of whether federal district courts have the authority to order disgorgement in SEC enforcement actions could result in fundamental changes to the SEC's enforcement program, which relies heavily on disgorgement as an enforcement remedy.

Courts Have Historically Viewed Disgorgement as an Equitable Remedy Designed to Prevent Unjust Enrichment

The debate over whether a district court has the authority to order disgorgement in an SEC enforcement action dates back to at least the early 1970s when the Second Circuit awarded the SEC disgorgement in Texas Gulf Sulphur, an insider trading case.2 Since then, the SEC has sought and obtained disgorgement in all manner of enforcement actions. In those actions, courts viewed disgorgement as an equitable remedy designed to force a defendant to relinquish the amounts by which the defendant was unjustly enriched. Over the intervening decades, federal courts have found disgorgement to be neither punitive nor compensatory. Rather, by denying a wrongdoer ill-gotten gains, courts have recognized that disgorgement deprives the defendant the fruits of the illegal conduct and deters subsequent fraud.

Kokesh Opens the Door to Scrutiny of the SEC's Authority to Seek Disgorgement

In Kokesh, the Supreme Court examined the issue of whether disgorgement constitutes a "penalty"—which is subject to a five-year limitations period under 28 U.S.C. § 2462—or a form of equitable relief to which no limitations period applies. The Court unanimously held that disgorgement readily meets the hallmarks of a penalty because: (i) the wrong sought to be redressed is to the public rather than an individual; and (ii) the purpose of the remedy is punishment and deterrence.3

Although the issue was not before the Supreme Court, the threshold question of whether the SEC has the authority to seek disgorgement in civil enforcement proceedings troubled the Court. During oral argument, five Justices questioned the SEC's authority to seek such remedy, which is not expressly provided for in any federal statutes.4 The resulting opinion explicitly refused to reach the issue, however, stating in a footnote: "Nothing in this opinion should be interpreted as an opinion on whether courts possess authority to order disgorgement in SEC enforcement proceedings or on whether courts have properly applied disgorgement principles in this context."5

The Supreme Court Seizes the Opportunity to Clarify the SEC's Authority to Seek Disgorgement in Liu

The Liu case was brought against two individuals, Charles C. Liu and Xin Wang, who operated a fund that used marketing companies to recruit Chinese investors seeking US visas pursuant to the EB-5 Immigrant Investor Program, which offers EB-5 visas to aliens who make a significant investment in a US commercial enterprise.6 The SEC alleged that, despite informing investors their money would fund an enterprise that met the EB-5 program's requirements, petitioners misappropriated the money for personal use and funneled $12.9 million to overseas marketers.7

The district court granted the SEC's motion for summary judgment as well as, among other things, the equitable remedy of disgorgement of all funds received from petitioners' illegal conduct, which totaled approximately $27 million.8 The Ninth Circuit affirmed the lower court's determination, finding that the Supreme Court's refusal to reach the issue of whether courts possess the authority to order disgorgement in SEC enforcement proceedings was not "clearly irreconcilable" with longstanding precedent on that topic.9

On appeal to the Supreme Court, the petitioners argued that Congress has authorized the SEC to seek only injunctions, civil monetary penalties of a more limited nature than disgorgement, and specific equitable relief in court proceedings under 15 U.S.C. § 77t and § 78u(d). Since the Kokesh Court held that disgorgement is a type of "penalty," it falls outside the scope of permissible equitable relief.10

In response, the Solicitor General and SEC argued that both the Securities Act of 1933 and the Securities Exchange Act of 1934 authorize a federal court to enjoin violations of the federal securities laws, and such authority has been interpreted by the Supreme Court to encompass the power to order a violator to disgorge profits.11 The government also argued that (i) Congress has enacted a number of statutes that presuppose the availability of disgorgement as an equitable remedy, and (ii) while disgorgement may be treated as a penalty for statute of limitations purposes, the Supreme Court has recognized that it constitutes a form of equitable relief.12

Potential Implications

The forthcoming opinion, which is anticipated in mid-2020, could fundamentally change the enforcement landscape. While the Justices could ultimately agree with the distinctions articulated by the government, their skepticism regarding the statutory basis for disgorgement (as reflected in Kokesh) and willingness to hear Liu in the absence of a circuit split might signal that they are prepared to further limit or even eliminate the availability of disgorgement in SEC enforcement actions brought in federal court.

Disgorgement is one of the most important tools in the SEC's enforcement arsenal. As petitioners point out, the SEC routinely seeks disgorgement in enforcement proceedings and collects billions of dollars per year through such remedy. In Fiscal Year 2019, the SEC obtained nearly $3.25 billion in disgorgement, which significantly outweighs the $1.10 billion it obtained in penalties.13 Even before an enforcement proceeding is commenced, the possibility of a large disgorgement award gives the SEC considerable leverage during settlement negotiations.

Accordingly, a Supreme Court decision that removes disgorgement from the SEC's toolkit for federal court actions would have a profound effect on the SEC's enforcement approach. One possible reaction would be for the SEC to initiate more administrative proceedings, where Congress left no doubt regarding its authority to seek disgorgement.14 Administrative proceedings, however, also have recently faced significant setbacks in the Supreme Court.15

Of course, in the event that the Supreme Court were to eliminate the availability of disgorgement in SEC enforcement actions brought in federal court, Congress could intervene and expressly provide the SEC with the authority to pursue such remedy through legislation.16

© Arnold & Porter Kaye Scholer LLP 2019 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.

  1. 137 S. Ct. 1635 (2017). For an in-depth analysis of Kokesh, see the following Arnold & Porter Advisory: Supreme Court Unanimously Holds That Five-Year Limitations Period Applies to SEC Civil Disgorgement Claims.

  2. SEC v. Texas Gulf Sulphur Co., 446 F.2d 1301 (2d Cir. 1971).

  3. 137 S. Ct. at 1643-44.

  4. See Kokesh Oral Argument Tr. at 7-9, 13, 15-16, 31, 52.

  5. 137 S. Ct. at 1642 n.3.

  6. See Liu Pet. Br. at 3-4.

  7. Id. at 5.

  8. Id. at 5-6; SEC v. Liu, 262 F. Supp. 3d 957 (C.D. Cal. 2017).

  9. SEC v. Liu, 754 F. App'x 505, 509 (9th Cir. 2018).

  10. Liu Pet. Br. at 8-13.

  11. Liu Resp. Br. at 5.

  12. Id. at 6-8.

  13. See Division of Enforcement 2019 Annual Report at 16.

  14. 15 U.S.C. § 78u-2(e).

  15. See Lucia v. SEC, 138 S. Ct. 2044 (2018) (holding that the SEC's former process for appointing administrative law judges was unconstitutional). In the aftermath of Lucia, the SEC issued ordersthat ratified the appointments of its ALJs, but remanded hundreds of pending administrative proceedings for rehearing before a different ALJ. For an in-depth discussion of Lucia, see the following Arnold & Porter Advisory: Supreme Court Holds That SEC Administrative Law Judges Are Officers of the United States Under the Appointments Clause of the Constitution.

  16. In fact, recent bills have been introduced in both the Senate and the House of Representatives that expressly authorize the SEC to seek and obtain disgorgement in federal court proceedings.