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Regulation and Compliance > Federal Regulation > SEC

Supreme Court to Consider SEC Disgorgement Limits

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The U.S. Supreme Court building in Washington. (Photo: Andrew Harrer/Bloomberg)

On Nov. 1, the Supreme Court agreed to hear the appeal of Charles Liu and Xin Wang, against whom the Securities and Exchange Commission obtained a $35 million judgment. Liu and Wang argue that the SEC has no authority to seek disgorgement of that $35 million, and there is a decent chance the Supreme Court will agree.

On its face, the case would not appear to have broad applicability: The SEC accused the defendants of defrauding Chinese investors out of money that was supposed to be used for an EB-5 immigrant investor program. Liu and Wang allegedly pocketed the proceeds.

However, the legal issue to be decided would impact every case the SEC brings in federal court in which the SEC wants a defendant to disgorge so-called ill-gotten gains.

According to the SEC’s recently released annual report, “parties in the Commission’s actions and proceedings were ordered to pay a total of $3.248 billion in disgorgement of ill-gotten gains.”

According to that same report, more than 40% of all SEC enforcement actions initiated during the year involved investment advisors, investment companies or broker-dealers.

Thus, whether or not the SEC has the authority to seek disgorgement in federal court will have an enormous impact on the financial services industry and anyone else who crosses paths with federal securities laws.

The SEC has sought and obtained disgorgement from federal court defendants for many decades, so one might assume the SEC will easily prevail in this case before the Supreme Court.

But many of the SEC’s decades-long practices have come under heavy criticism by the Supreme Court in recent years.

For example, the SEC took the position that it did not have to abide by statutes of limitation that apply to most other parties in litigation. But in 2013, the Supreme Court said no — the SEC must bring enforcement actions within five years of the conduct if it wants to obtain civil monetary penalties.

Following that 2013 case, the SEC continued to take the position that it could obtain disgorgement of ill-gotten gains (rather than civil money penalties) for conduct stretching back more than five years.

However, in 2017, in a case called Kokesh v. SEC, the Supreme Court again said no.

Even though the SEC had for decades been seeking and obtaining disgorgement from defendants for very old conduct, the Supreme Court held that disgorgement, like civil money penalties, could only be obtained if the SEC filed its case within five years of the conduct at issue.

A funny thing happened at the Supreme Court during the oral argument in the Kokesh case.   While the issue before the Court was simply when the SEC must bring a disgorgement claim, the justices began asking a question that neither party had presented: whether federal courts even had the authority to grant a disgorgement request by the SEC.

The following excerpts are from the transcript.

Justice Kennedy: Is it clear that the district court has statutory authority to do this? … [I]s there specific statutory authority that makes it clear that the district court can entertain this remedy?

. . .

Justice Sotomayor: Can we go back to the authority? … [I]f they’re not doing restitution, how could that be the basis of disgorgement?

. . .

Justice Alito: [I]t would certainly be helpful and maybe essential to know what the authority for [disgorgement] is.

. . .

Chief Justice Roberts: [T]he SEC devised this [disgorgement] remedy or relied on this remedy without any support from Congress.

. . .

Justice Gorsuch: Well, here we don’t know [when the disgorged money goes to the victim], because there’s no statute governing it. We’re just making it up.

In the end, the Supreme Court ruled in Kokesh that the SEC must bring disgorgement claims within five years of the conduct, and the court merely observed in a footnote that it was not deciding “whether courts possess authority to order disgorgement in SEC enforcement proceedings or … whether courts have properly applied disgorgement principles in this context.”

Now, two years after Kokesh, the Supreme Court has decided to squarely address the question left unanswered in 2017.

If the court concludes that federal courts cannot award disgorgement in SEC enforcement actions, that decision will have multibillion-dollar repercussions.


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