The U.S. Supreme Court limited the power of the Securities and Exchange Commission to recoup illegal profits from wrongdoers, putting new curbs on one of the agency’s most potent legal weapons.
The 8-1
The SEC typically wins more than $1 billion a year in disgorgement orders in federal court. Disgorgement is a traditional tool used by judges to return wrongful gains to the victims. It’s distinct from SEC fines, which the agency is allowed to use as punishment.
Writing for the court, Justice Sonia Sotomayor said Congress had prohibited the SEC from seeking disgorgement “in excess of a defendant’s net profits from wrongdoing.” She said courts must subtract “legitimate expenses” before ordering disgorgement.
The ruling is a partial victory for a California couple ordered to pay $27 million after being found to have defrauded investors.
Distribute to investors
Sotomayor also said disgorgement awards must be geared toward compensating investors, rather than simply stripping wrongdoers of their profits. She said it was an “open question” whether the SEC can deposit recouped money in the Treasury when it’s not feasible to distribute it to investors.
Disgorgement “must do more than simply benefit the public at large by virtue of depriving a wrongdoer of ill-gotten gains,” she wrote.
In addition, Sotomayor suggested that awards generally must track individual wrongdoing and not try to make one wrongdoer give back benefits an associate received.
Although federal law doesn’t explicitly say the SEC can seek disgorgement, the 2002 Sarbanes-Oxley Act says judges hearing SEC enforcement actions can award “any equitable relief” they deem appropriate to protect investors. Courts have traditionally viewed disgorgement as an “equitable” measure, which means judges make awards based on fairness rather than strict legal rules.
The ruling “will provide defendants strong ammunition for battling back against the SEC’s tendency to seek aggressive disgorgement remedies,” said Howard Fischer, a former SEC trial lawyer and now a partner at Moses & Singer in New York.
‘Existential threat’
But even with the limits, some agency veterans said they see the decision as a victory for the SEC because it formally preserves the enforcement program’s ability to obtain disgorgement. Banning the remedy would have been a major setback for its policing efforts.
“That was the existential threat” that the commission feared, said Stephen Crimmins, a former agency enforcement attorney who is now a partner at Murphy & McGonigle. “This is a big win for the SEC.”
The ruling didn’t directly affect the SEC’s separate authority to seek disgorgement through administrative proceedings.
The couple, Charles Liu and Xin Wang, had asked the justices to go further and bar the SEC from seeking court-ordered disgorgement at all. Liu and Wang said that tool isn’t one of the remedies Congress has authorized the SEC to seek against people who violate the nation’s securities fraud laws.
Sotomayor rejected that contention, saying Congress incorporated the traditional courtroom rule that judges may “strip wrongdoers of their ill-gotten gains.”
Justice Clarence Thomas was the court’s only member who said he would have barred the SEC from seeking disgorgement at all in federal court.
Returning funds
President Donald Trump’s administration and the SEC defended the disgorgement power, saying Congress authorized it three times, including in the Sarbanes-Oxley Act.
SEC spokeswoman Chandler Costello said the decision “allows us to continue to strip wrongdoers of their ill-gotten gains and return money to its rightful owners, following the court’s direction to ensure that our efforts embody principles of equity and fairness.”
The SEC says it tries to return disgorged funds to injured investors when possible. The agency says it collected $1.5 billion in disgorgements and penalties in 2019 and paid out $1.2 billion to investors that year.
Liu and Wang were found to have defrauded people seeking to take advantage of a visa program for foreigners who make large U.S. investments. The SEC said Liu and Wang falsely told investors their money would be used for a cancer treatment center.
Liu and Wang said the order in their case went well beyond the $8 million the trial judge found they had gained from their scheme.
The case is Liu v. Securities and Exchange Commission, 18-1501.
— With assistance from Ben Bain, Robert Schmidt and Andrew Ramonas
