SCOTUS weighs in on SEC power to recover ill-gotten gains
The U.S. Senate recently passed a resolution recognizing July 30, 2020 as National Whistleblower Appreciation Day, commemorating the signing of the nation’s first whistleblower law in 1778. You can read more on the history of the day in my previous blog post, “Whistleblower Appreciation Day reinforces nation’s commitment to justice, accountability.”
While Whistleblower Appreciation Day is a time to reflect on the countless individuals who selflessly come forward with valuable information for the good of us all, it is also a time to examine the ever-changing landscape as our country continues to craft new laws and establish precedent that hopefully will make it easier for whistleblowers to come forward, and for the SEC and other agencies and whistleblower programs to hold wrongdoers accountable.
One such area that is currently being explored is the extent of the SEC’s power as it relates to disgorgement – a legal term for returning ill-gotten gains to wronged parties.
On June 22, 2020, the U.S. Supreme Court issued its decision in Liu v. SEC, 591 U.S. __, 12 (2020). At issue in the case was whether the SEC has the statutory authority to pursue disgorgement as equitable relief in a federal court action under 15 U.S.C. § 78u(d)(5). The law states, in pertinent part, that “in any action or proceeding brought or instituted by the Commission under any provision of the securities laws … any Federal court may grant ... any equitable relief that may be appropriate or necessary for the benefit of investors.” The specific question presented in Liu was whether the SEC may seek and obtain disgorgement from a court as “equitable relief” for a securities law violation.
In the Liu litigation, the SEC sued business partners Charles Liu and Lisa Wang, alleging they had misappropriated funds and defrauded foreign investors in their EB-5 visa business, which was purportedly to build a cancer treatment center in California. After finding that Liu and Wang’s scheme violated federal securities laws, the court ordered them to disgorge more than $26 million, which was the total amount of funds they had raised from investors. Liu and Wang argued that this disgorgement award failed to account for their “legitimate” business expenses in setting up the cancer center. The district court ruled in favor of the SEC, finding that Liu and Wang violated the Securities Act of 1933, and imposed civil penalties in addition to a disgorgement order requiring Liu and Wang to surrender to the SEC the millions of dollars they raised from investors. Liu and Wang appealed and argued that the SEC lacked the legal authority to ask the district court to impose a disgorgement order because disgorgement was a penalty and, thus, not a form of “equitable relief” that is permissible under the law. The Ninth Circuit Court of Appeals affirmed the district court’s decision and the Supreme Court granted certiorari.
The Supreme Court in Liu upheld disgorgement as an available remedy for the SEC, stating that it is an equitable remedy under the law because this type of relief falls within a long line of “equity jurisprudence,” which allowed courts to “strip wrongdoers of their ill-gotten gains.” As such, it is relief that the SEC may properly seek as “appropriate or necessary for the benefit of investors” pursuant to the statute. The Supreme Court also held, however, that disgorgement awards must be limited to a wrongdoers’ net profits as opposed to their gross illicit gains, and that “courts must deduct legitimate expenses before ordering disgorgement under 78u(d)(5).” What constitutes a legitimate business expense will likely involve a fact-heavy inquiry as Liu does not clearly address how this would work with a wholly fraudulent operation as compared to a legitimate company found to have violated the securities laws.
Importantly, the Liu decision deals specifically with the question of the SEC's remedies in federal court actions, but the SEC, however, can also bring actions administratively. Before Liu, it was clear that the SEC is specifically authorized to seek disgorgement in administrative proceedings. Indeed, Congress granted the SEC this authority in the Remedies Act of 1990, which expanded the SEC’s administrative enforcement powers to include “an order requiring accounting and disgorgement, including reasonable interest.” As the Remedies Act was not before the Court in Liu, the SEC may still retain its ability to obtain large disgorgement awards. This is significant as approximately 90%–100% of SEC Foreign Corrupt Practices Act (FCPA) enforcement actions against issuers are administrative actions.
In contrast, the federal securities laws do not explicitly grant the SEC authority to seek disgorgement in federal court. Rather, the securities statutes generally provide that the SEC may ask courts for “any equitable relief that may be appropriate or necessary for the benefit of investors.” The SEC has traditionally sought, and courts have awarded, disgorgement as an equitable remedy.
Notably, the Supreme Court's opinion does not address whether the limits that it applies to disgorgement as an equitable remedy will apply to disgorgement as a remedy in an SEC administrative proceeding. Thus, it might seem that Liu has no effect on the extent to which the SEC can seek disgorgement in administrative proceedings as the word “equitable” does not appear in the administrative provision. Given this, the Liu decision may compel the SEC toward bringing more actions as administrative proceedings as opposed to bringing judicial actions. Regardless of the forum, disgorgement does play a large role in the SEC’s enforcement priorities. In the last three years, the SEC obtained disgorgement awards totaling $2.9 billion (2017), $2.5 billion (2018), and $3.2 billion (2019).
Also significant in the Liu decision in the Supreme Court’s recognition that disgorgement only be invoked as “appropriate or necessary for the benefit of investors.” The Court, however, refused to address whether the SEC’s ongoing policy of remitting disgorged funds to the Treasury, as opposed to disbursement to specific investors or victims, can continue under certain circumstances. The Court stated that the remedy “generally requires the SEC to return a defendant’s gains to wronged investors for their benefit,” but expressly left open the fact that this might be infeasible in certain circumstances and did not address all SEC violations, such as insider trading, for which there may not be specific “wronged investors” to remit funds to. Consequently, Liu will certainly increase the burden on the SEC in attempting to locate and return funds to investors.
Another option the SEC may pursue is seeking higher civil monetary penalties in judicial actions. The SEC has broad flexibility under the federal securities laws to determine the amount of the civil penalty in each case. As demonstrated in Liu, the SEC can seek civil penalties in the amount of a defendant’s illicit gain, and some securities violations (such as insider trading) provide for treble damages.
In conclusion, we will have to wait and see how the SEC will address the Liu decision and the district courts’ application of the rulings in Liu before we can ascertain the decisions’ impact on the SEC’s Whistleblower Program.
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