U.S. Supreme Court provides guidance on SEC disgorgement power

The Supreme Court of the United States recently provided guidance regarding the U.S. Securities and Exchange Commission’s (the “SEC’s”) authority to seek disgorgement from parties who violate U.S. securities laws. Sotomayor J., writing for the Court in Liu v SEC (“Liu”), stated that “a disgorgement award that does not exceed a wrongdoer’s net profits and is awarded for victims is equitable relief permissible under 15 U. S. C. §78u(d)(5).”

Disgorgement is a form of relief used by securities regulators in both the U.S. and Canada to force the repayment of “ill-gotten gains” received through non-compliant activity. Disgorgement is a powerful tool for the SEC as well as in Canada. In fiscal 2019 the SEC won disgorgement orders totalling $3.2 billion, compared with $1.1 billion from other types of sanctions. Though the figures are much lower in Canada, Canadian securities administrators won $13.8 million from disgorgement awards in fiscal 2019/20, and in fiscal 2018/19 Canadian securities administrators collected $110 million in restitution and disgorgement compared with $77.5 million from administrative penalties.

Outside of the securities context, courts have traditionally viewed disgorgement as an “equitable” measure, which means that judges make these awards based on fairness principles, rather than available through the application of specific articulated  legal rules. However, in most Canadian jurisdictions, disgorgement is provided for explicitly by statute. For example, in Ontario, both the Ontario Securities Commission and the courts are permitted to grant an order requiring a wrongdoer to disgorge any amounts obtained as a result of the non-compliance with Ontario securities law.[1] In contrast, the SEC’s authority to seek disgorgement is grounded in the court’s civil remedial authorities. As a result, its role in the American securities enforcement regime has been the subject of recent scrutiny.

In recent years the SEC’s authority to seek disgorgement has been hemmed in. As we have previously discussed, the U.S Supreme Court held in Kokesh v SEC that disgorgement is a “penalty” for the purposes of American legislation concerning limitation periods. As a result, the petitioner in Kokesh was ordered to disgorge only $5 million of ill-gotten gains, while $30 million resulting from violations outside the applicable five-year limitations period was excluded. However, the Court in Kokesh declined to consider whether the SEC had the power to seek disgorgement in the first place. This was the issue before the Court in Liu.

Liu v SEC

In 2016, the SEC brought an action against Charles Liu and Xin Wang, alleging that they had defrauded participants in a visa program for foreigners who make large investments in the U.S. The two were accused of falsely informing these investors that their investments would be used for a cancer treatment center, when in reality only a small fraction went toward lease payments and equipment. The lower courts found in favour of the SEC and ordered the petitioners to disgorge $27 million in investor funds and $8 million in civil penalties. The petitioners argued that the award included more than just the ill-gotten funds from their scheme and also included amounts that were legitimate business expenses.

Under U.S. securities law, the SEC can seek civil penalties and equitable relief. The petitioners in Liu argued that, because equity is not punitive in nature, and Kokesh categorized disgorgement as a penalty, disgorgement could not fall within the scope of the “equitable relief” that the SEC is empowered to seek.

The Court disagreed. Speaking for an 8-1 majority, Sotomayor J. held that disgorgement is equitable relief so long as, among other things:

1. The ill-gotten funds are returned to the wrongdoer’s victims, as disgorgement “must do more than simply benefit the public at large” by denying the wrongdoers of their ill-gotten gains.
2. The amounts disgorged do not exceed the net profits from the wrongdoing (i.e., excluding legitimate expenses).[2]

The Court imposed these limitations in an effort to bring disgorgement in line with longstanding principles of equity and ensure it does not become a punitive measure, as could have been interpreted by the Court’s decision in Kokesh just three years earlier.

The Court declined to make a finding as to whether the particular disgorgement at issue in Liu was unlawful for the fact that the SEC failed to return funds to victims and did not deduct legitimate business expenses from the award. Instead, the Court remanded the case to the Ninth Circuit with some guiding principles to assist the lower court.

Uncertainty remains south of the border

While the Court’s decision in Liu addressed the primary issue of whether the SEC can invoke its disgorgement powers generally, the decision leaves some important questions unanswered with respect to the SEC’s use of this power.

First, the Court’s holding that amounts disgorged must be returned to victims raises the question of how the SEC is to disgorge profits for wrongful acts like insider trading that do not have any identifiable victims. The Court cited American securities legislation to support this finding, which provides that equitable relief is restricted to that which “may be appropriate or necessary for the benefit of investors.”[3]  In Canada, however, securities legislation dictates that the public interest is the primary consideration in ordering disgorgement.[4] Accordingly, funds collected from a disgorgement order for insider trading do not need to be returned to an identifiable victim, as denying the alleged wrongdoer of their ill-gotten gains acts as a general deterrent which can be seen to serve the public interests of those who participate in the Canadian marketplace.

Second, Liu complicates American law by confirming that disgorgement is an equitable remedy, as equitable remedies traditionally are not subject to limitation periods. Therefore, American actors may be uncertain as to whether or not the five-year limitation period applied by the Court in Kokesh will continue to apply to disgorgement awards following the finding in Liu. This complication is unlikely to present itself in Canadian proceedings, where the OSA clearly sets out not only the availability of the remedy, but also a 6-year limitation period that applies to certain proceedings involving monetary sanctions and disgorgement.[5]

This contrast in the regulatory approaches continues to shine a light on the debate over the relative merits of grounding remedies in statutes, and the clarity and certainty that can bring.  We have discussed that previously in the context of ‘insider trading’ prohibitions.  Open questions not only suggest that there may be further attempts to place limits on the SEC’s disgorgement power, but also that a more wide ranging assessment of regulatory enforcement authorities is warranted