Posted: March 1st, 2020
By: Hannah Weiss
The Supreme Court recently granted certiorari to determine whether US courts, under their equitable powers, can require people convicted of securities law violations to disgorge their ill-gotten profits. The answer to this question could have a significant effect on the Security and Exchange Commission’s (SEC’s) mechanisms for enforcing securities laws. The question is the central issue in Liu v. SEC and has remained unanswered since the Court’s 2017 ruling in Kokesh v. SEC.
In Kokesh, the Court determined that disgorgement is a penalty and that it should, therefore, be subject to a five-year statute of limitations. But the Court specifically declined to “interpret . . . whether courts possess authority to order disgorgement in SEC enforcement proceedings.”
Black’s Law Dictionary defines “disgorgement” as “[t]he act of giving up something (such as profits illegally obtained) on demand or by legal compulsion.” It is arguably the most important tool the SEC has to enforce securities law, and eliminating or severely restricting it could be detrimental to the effectiveness of the agency’s enforcement activities.
The SEC’s enforcement office has used disgorgement as a remedy since 1971 when the Second Circuit Court of Appeals decided SEC v. Texas Gulf Sulphur Company. The court determined that it was able to order disgorgement (and did so in the case), as long as its purpose was as an equitable remedy, rather than as a penalty. When courts order disgorgement, is it is through their own authority to issue equitable remedies. Because, as a general rule, there are no penalties in equity, the Supreme Court’s Kokesh decision called into question the validity of judicial orders of disgorgement by classifying them as “penalties.”
In addition to seeking court-ordered disgorgement, the SEC is authorized by law to seek disgorgement through administrative proceedings. In a 2016 opinion, however, the Tenth Circuit Court of Appeals called into question the Constitutional validity of the SEC’s administrative law judges. It is not the first circuit court to address this question, and there is some split of opinions, so the Supreme Court may soon hear a case on this issue. If the SEC’s judges are found unconstitutional, all of their administrative decisions would be similarly invalid. So, preserving court-ordered disgorgement is likely critical to the SEC’s continued ability to carry out its enforcement duties.
Preserving disgorgement also appeals to most people’s (and the law’s) general sense that victims should be returned to the state they were in before whatever harm they suffered. The SEC is often able to return money obtained through disgorgement to victims of illegal financial schemes. While the SEC is also able to levy fines on those found guilty of securities violations, it still resonates with most people as both reasonable and inherently fair that people should not be allowed to profit from their own wrong-doings.
The SEC is also particularly effective at returning lost funds to investors. Investors can attempt to recover their losses through other means, such as class action litigation. But these avenues are difficult to pursue and generally not fruitful for investors, so SEC “fair fund distribution is often the only source of compensation for defrauded investors.” The commission is able to assist far more investors than would be compensated by other restitution-seeking efforts, and disgorgement is a key tool in its ability to provide that relief.
Disgorgement is a significant tool in enforcing securities law and assisting harmed investors and needs to be preserved. We cannot say for sure how this issue will be resolved, but one way or another, the decision in Liu v. SEC will be significant. Oral arguments in the case are scheduled for March 3, 2020.
Hannah Weiss is a second-year law student at Wake Forest University. She completed her Bachelor’s degree at the University of Florida and a Master’s degree at the University of Virginia and spent several years in public service before law school. After graduation, she intends to practice international trade law.