Liu v. SEC
Posted on Categories Court Decisions, Securities/Commodities Regulation

By Burton W. Wiand

Disgorgement, as an SEC enforcement remedy, is permissible, given that courts observe restrictions that might otherwise make the disgorgement order a “penalty.”

Liu vs. SEC, Dkt. No. 18-1501 (U.S. Sup. Ct., 6/22/20).

On June 22, 2020 the United States Supreme Court entered a much-anticipated decision in the Liu v. SEC case. The case follows an earlier Supreme Court decision, Kokesh v. SEC, 589 U.S. ____ (2017), where the Court held a disgorgement order in a SEC enforcement action constitutes a “penalty” for purposes of the application of the statute of limitations. However, at that time the Court did not address whether disgorgement qualified as “equitable relief” under 15 U.S.C. 22(d)(5), given that equity historically excludes punitive sanctions. Liu v. SEC closes that circle.

The case involved an enforcement action by the Commission against Charles Liu and Xin Wang, his wife, who solicited foreign nationals to invest in a construction project relating to a cancer treatment facility. The investors were lured into the investment in hopes of qualifying for a U.S. residency through the immigrant investor program (EB-5 Program). The Lius raised $27 million from foreign investors, but, instead of developing a cancer treatment facility, they spent most of the money on marketing expenses and salaries. They also diverted a sizeable portion of the funds that they’d raised to a company under Wang’s control. Only a small amount of the funds was ultimately used to establish a cancer treatment facility.

The SEC brought a civil injunctive action, charging that the Defendants misled investors and misappropriated millions of dollars. The District Court entered an injunction against the Defendants and ordered them to disgorge the full amount they had raised from investors, less $234,899 that remained in the corporate account for the project. Mr. Liu and Ms. Wang objected to the disgorgement award because it failed to account for business expenses and that liability was joint and several. The Ninth Circuit Court of Appeals affirmed the District Court’s ruling and also indicated that the proper amount of disgorgement was the entire amount raised, less the money paid back to the investors.

The initial question presented to the Court, whether or not disgorgement as used in SEC enforcement actions was permissible, is promptly dealt with. The Court refers to a long history of common law decisions and decisions under regulatory statutes where disgorgement was routinely used as an equitable remedy to deprive wrongdoers of the benefit of their misdeeds. Numerous equitable remedies related to or similar to disgorgement were routinely utilized by courts in similar situations, whether called restitution, accountings or constructive trust. Equity courts habitually awarded profits-based remedies in a broad variety of cases where wrongdoing had occurred. Indeed, “decisions from this Court confirmed that a remedy tethered to a wrongful and unlawful profits, whatever the name, has been a mainstay of equity courts.”

Having easily found that disgorgement was a permissible, equitable remedy, the Court then turns to the issue of what limitations apply to such a remedy. Noting that these matters were not substantially briefed before the Court, it discusses only the various issues that this case presents. First the Court indicates that joint and several liability is improper generally; only where the malefactors act as partners, would joint liability be proper. Second, in order not to be an impermissible penalty, disgorgement should be limited to “net profits” and legitimate business expenses should be deducted from the proceeds of a scheme, unless the entire venture was a fraud. Third, the SEC practice of paying disgorgement into the Treasury seems inconsistent with Section 78u(d)(5), which states that disgorgement should be for “the benefit of investors.” Disgorged funds should be paid to victims, absent practical circumstances preventing such distributions.

Thus, the Court affirms that the use of disgorgement in SEC actions is proper. It refers the rest of these matters back to the Ninth Circuit for determination consistent with the Court’s guidance regarding the amount of disgorgement, use of disgorged funds, and whether liability should be joint or several.

(B. Wiand: While the question of whether the SEC disgorgement tool is alive and well was answered, the three unanswered questions will leave significant issues to be resolved in the defense of SEC enforcement actions.)

(SOLA Ref. No. 2020-25-01)

NOTICE: The court decision synopsis published above represents an abbreviated description of the actual decision and is re-printed here for its educational value. The author's effort is to report concisely the substance of the decision or a selected portion of the decision; commentary or analysis is generally reserved for the italicized section at the bottom of the summary. Subscribers to SAC's Online Litigation Alert (SOLA), from which this synopsis is excerpted, have immediate access to the full decision, in addition to the synopsis. 

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