SCOTUS: SEC Disgorgement Permissible Under Equitable Relief Doctrine; Supreme Court of the United States No. 18–1501, Charles C. Liu et al. v. Securities and Exchange Commission


In an 8-1 decision, the Supreme Court held that disgorgement is a permissible remedy under the doctrine of equitable relief, provided the award does not exceed a wrongdoer’s net profits and is awarded for the victims of fraud. Nonetheless, the court vacated and remanded a Ninth Circuit decision affirming a district court order of disgorgement, directing the lower courts to assess whether the order as written satisfied the general outlines of equitable relief, including whether any of the funds obtained from investors were used for legitimate purposes. The court also rejected the government’s assertion that Congress’ use of the term “disgorgement” in enacting various statutes had expanded the scope of SEC’s statutory authority to obtain relief, even if it exceeds the scope of equity practice. The court held that later unrelated statutes had not revised the limitations on SEC’s authority.

In Kokesh v. SEC, the Supreme Court held that a disgorgement order in a Securities and Exchange Commission enforcement action imposes a “penalty” for the purposes of 28 U. S. C. §2462. In reaching this decision, the court reserved an antecedent question: whether, and to what extent, the SEC may seek “disgorgement” in the first instance through its power to award “equitable relief ” under 15 U. S. C. §78u(d)(5), a power that historically excludes punitive sanctions.

In these proceedings, the court held that a disgorgement award that does not exceed a wrongdoer’s net profits and is awarded for victims is equitable relief permissible under §78u(d)(5).

The court noted that Congress authorized the SEC to punish securities fraud through administrative and civil proceedings, in which the commission can seek limited civil penalties, disgorgement, and equitable relief. However, Congress did not define what falls under the umbrella of equitable relief, leaving the courts to consider which remedies the SEC may impose.

Earlier rulings have concluded that the SEC has authority to obtain restitution, which in substance amounted to the recovery of profits a defendant gained through wrongful conduct. In Kokesh, the Supreme Court determined that disgorgement constituted a “penalty” for the purposes of 28 U. S. C. §2462, which also established a 5-year statute of limitations for an action for the enforcement of any civil fine, penalty, or forfeiture. However, at that time, the court did not address whether this penalty qualified as equitable relief, given that equity is not used to enforce a forfeiture or penalty. The court also cautioned that its decision should not be interpreted as an opinion on whether courts have the authority to order disgorgement in SEC enforcement proceedings. That very topic was the question before the court in Liu.

In this action, the SEC alleged that defendants Charles Liu and his wife, Xin (Lisa) Wang, solicited nearly $27 million from foreign investors under the EB–5 Immigrant Investor Program. Despite Liu’s pledge to investors that the bulk of any contributions would be used to construct a cancer treatment center, an SEC investigation revealed that Liu spent nearly $20 million of investor money on ostensible marketing expenses and salaries, an amount far more than what the offering memorandum permitted and far in excess of the administrative fees collected. SEC also discovered that Liu diverted a substantial portion of the funds to personal accounts and to a company under his wife’s control, while only a fraction was used for the cancer treatment center.

SEC brought a civil action against the petitioners, alleging that they violated the terms of the offering documents by misappropriating millions of dollars. SEC prevailed in the district court, which imposed a civil penalty at the highest tier authorized and ordered disgorgement equal to the full amount petitioners had raised from investors, less the $234,899 that remained in the corporate accounts for the project.

The petitioners argued that the disgorgement award failed to account for their business expenses, but the district court disagreed, concluding that the sum was a reasonable approximation of the profits causally connected to their violation. The Ninth Circuit later affirmed, while also acknowledging that Kokesh expressly refused to reach the issue of whether the district court had the authority to order disgorgement. The circuit court relied on its own precedent to conclude that the proper amount of engorgement in cases such as this is the amount of money raised less the money paid back to investors.

The petitioners went to the Supreme Court, which granted certiorari to determine whether §78u(d)(5) authorizes the SEC to seek disgorgement beyond a defendant’s net profits from wrongdoing.

The court analyzed whether the remedy fell into a category of relief typically available in equity. Generally, equity practice authorizes courts to strip wrongdoers of their ill-gotten gains and restricts this remedy to net profits to be awarded to victims. The Supreme Court has held to this basic concept of equitable relief.

The petitioners argued that equity courts limited this remedy to cases involving a breach of trust or of fiduciary duty, but the Supreme Court disagreed, noting, for example, that courts have  authorized profits-based relief in patent-infringement actions where no such trust or special relationship existed.

The petitioners attempted to distinguish these patent cases by suggesting that an “accounting” was appropriate only because Congress explicitly conferred that remedy by statute in 1870, but the court concluded that patent law had not previously deviated from the general principles outlined above. Rather, the court had previously held that a plaintiff may recover the amount of profits the defendants may have made by improper use of an invention through a series of decisions under the Patent Act, which simply conferred general equity jurisdiction upon the courts. Thus, equity courts habitually awarded profits-based remedies in patent cases well before Congress explicitly authorized that form of relief.

The court acknowledged that equity courts avoided transforming awards into a penalty outside their equitable powers. However, the court carved out an exception when the entire profit of a business or undertaking resulted from wrongful activity. In such cases, the court explained that a defendant would not be allowed to diminish the calculation of profits by putting in claims for personal services or other inequitable deductions. When defendants are allowed to deduct legitimate expenses, these remedies fall comfortably within the category of relief typically available in equity, the court held.

The court acknowledged that lower court awards of disgorgement have tested the bounds of equity practice by ordering the proceeds of fraud to be deposited in Treasury funds instead of disbursing them to victims, imposing joint-and-several disgorgement liability, and declining to deduct even legitimate expenses from the receipts of fraud.

The petitioners argued that Kokesh effectively stated that disgorgement is necessarily a penalty, and thus not the kind of relief available at equity. However, the Supreme Court disagreed, explaining that Kokesh expressly declined to decide the question. While the Kokesh Court evaluated a version of the SEC’s disgorgement remedy that seemed to exceed the bounds of traditional equitable principles, that decision had no bearing on the SEC’s ability to conform future requests for a defendant’s profits to the limits outlined in common-law cases awarding a wrongdoer’s net gains.

The government argued that SEC’s interpretation of the equitable disgorgement remedy has Congress’ tacit support, even if it exceeds the bounds of equity practice, as Congress has enacted a number of other statutes referring to disgorgement. However, the court held that argument attached undue significance to Congress’ use of the term, as it merely made sense for Congress to expressly name the equitable powers it grants to an agency for use in administrative proceedings.

The court explained that Congress did not enlarge the breadth of an equitable, profit-based remedy simply by using the term “disgorgement” in various statutes. While the government argued that Congress should be presumed to have been aware of the scope of disgorgement when it enacted subsequent law, the court noted that the scope of disgorgement was far from settled. Even if Congress employed the term to refer to the relief permitted by §78u(d)(5), the court held lawmakers did not expand the scope of what the SEC could recover in a way that would contravene limitations embedded in the statute.

The petitioners argued that their disgorgement award was unlawful because it crossed the bounds of traditional equity practice in three ways: It failed to return funds to victims, it imposed joint-and-several liability, and it declined to deduct business expenses from the award. However, because the parties focused on the broad question of whether any form of disgorgement may be ordered and did not fully address narrower questions, the court declined to decide them. However, the court offered some guiding principles.

The court noted that Section 78u(d)(5) restricts equitable relief to that which may be appropriate or necessary for the benefit of investors. However, SEC does not always return the entirety of disgorgement proceeds to investors, instead depositing a portion of its collections in a fund in the Treasury, from which funds may be used to pay whistleblowers or fund the activities of the inspector general. In this case, SEC asserted that it had not returned the bulk of the funds to the victims because the government has been unable to collect.

The court noted that statutes provide limited guidance as to whether the practice of depositing a defendant’s gains with the Treasury satisfies the statute’s command that any remedy be “appropriate or necessary for the benefit of investors.” The court also noted that the government pointed to no analogous common-law remedy permitting a wrongdoer’s profits to be withheld from a victim indefinitely without being disbursed to known victims.

The government maintained that the primary function of depriving wrongdoers of ill-gotten profits is to deny them the fruits of their wrongdoing, not to return the funds to victims as a kind of restitution. However, the court held that the SEC’s equitable, profits-based remedy must do more than simply benefit the public at large by virtue of depriving a wrongdoer of ill-gotten gains. To hold otherwise would render meaningless the latter part of §78u(d)(5).

The government also suggested that the SEC’s practice of depositing disgorgement funds with the Treasury may be justified where it is infeasible to distribute the collected funds to investors. The court found it an open question whether this practice satisfies SEC’s obligation to award relief for the benefit of investors, but concluded it need not reach the issue, as the order in this case does not direct any monies to the Treasury. If such an order is entered on remand, the lower courts may evaluate in the first instance whether that order would indeed be for the benefit of investors as required by §78u(d)(5) and consistent with equitable principles.

In considering the issue of joint-and-several liability, the court noted SEC had imposed disgorgement liability in a manner sometimes at odds with the common-law rule requiring individual liability for wrongful profits. However, in this case, the petitioners were married. The government provided evidence that Liu formed business entities and solicited investments, which he misappropriated, and that Wang held herself out as the president, and a member of the management team, of an entity to which Liu directed misappropriated funds. The petitioners did not introduce evidence suggesting that one spouse was a passive recipient of profits, that their finances were not commingled, or that only one spouse enjoyed the fruits of the scheme. The court left it to the Ninth Circuit on remand to determine whether the petitioners can, consistent with equitable principles, be found liable for profits as partners in wrongdoing or whether individual liability is required.

Next, the court considered the deduction of expenses and payments from the amount of the profits to be disgorged. The court held that courts must consider such deductions. Nonetheless, the district court declined to deduct expenses on the theory that they were incurred for the purposes of furthering an entirely fraudulent scheme. The Supreme Court noted that a defendant may be denied inequitable deductions, but that determination can be made only when a court ascertains the legitimacy of the deduction.

On an 8-1 ruling, the court then vacated the judgment and remanded the case back to the Ninth Circuit for further proceedings.

In his dissent, Justice Thomas agreed with the decision to decline to affirm the Ninth Circuit’s decision upholding the district court’s order, but disagreed with the decision to vacate and remand for the lower courts to limit the disgorgement award. According to Thomas, disgorgement can never be awarded under 15 U. S. C. §78u(d)(5), as it is not a traditional equitable remedy.