On June 22, 2020, in a much anticipated decision, the Supreme Court held that the Securities and Exchange Commission (SEC or the Commission) can continue its longstanding practice of seeking disgorgement as an equitable remedy in judicial proceedings under section 21(d) of the Securities Exchange Act of 1934. In Liu, the court held that a disgorgement award that (1) does not exceed a wrongdoer’s net profits, and (2) is awarded for victims constitutes an equitable remedy within the scope of the SEC’s statutory authority. In so holding, the Court made clear that legitimate business expenses must be accounted for in determining how much the SEC can seek in disgorgement. Although the Court indicated its skepticism toward the SEC’s longstanding practice of sending disgorged funds to the Treasury, it did not specifically address whether disgorged funds must be returned to victims of the misconduct being prosecuted, leaving that determination to the lower courts. The Court also left unanswered whether the SEC is authorized to impose joint and several liability on violators. Following Kokesh and other recent decisions, this is the Supreme Court’s latest effort to rein in the SEC’s enforcement authority. Although Liu stopped short of eliminating the power of the SEC to seek disgorgement for securities law violations, it provided companies facing SEC enforcement scrutiny with the necessary tools for challenging and circumscribing the amount sought by the Commission. This decision provides some clarity on the parameters of the SEC’s authority, but it leaves open many questions that will be resolved in future settlement negotiations and court battles.
The Court’s Holding
The Liu decision was eagerly anticipated by SEC defense counsel and regulated entities. The potential impact on SEC enforcement actions if disgorgement were eliminated as an equitable remedy would have been game-changing, but instead of providing absolute clarity in either direction, the Supreme Court stopped short. In doing so, it raised more questions that may give rise to potential future challenges. Writing for an 8-1 majority, Justice Sotomayor rejected an all-or-nothing approach to the question of whether disgorgement constitutes a permissible equitable remedy. The Court held that a disgorgement award that (1) does not exceed a wrongdoer’s net profits, and (2) is awarded for victims constitutes equitable relief the SEC is permitted to seek in enforcement actions. To arrive at this holding, the Court examined whether the disgorgement sought in Liu—which required the defendants, a married couple, to disgorge the full amount they raised from defrauded investors, without any reduction for their claimed business expenses, and which imposed joint-and-several liability on the two spouses—falls into “those categories of relief that were typically available in equity.” The Court examined cases in which courts imposed “profits-based remedies” while placing limitations on those remedies that ensured they did not constitute penalties beyond the scope of a court’s equitable powers.