On June 22, the US Supreme Court (the Court) weighed in on a question it explicitly left open in Kokesh v. SEC – whether, and to what extent, the Securities and Exchange Commission (SEC) in a civil enforcement action may seek "disgorgement" as "equitable relief that may be appropriate or necessary for the benefit of investors" under §78u(d)(5). In an 8-1 decision, the Court in Liu v. SEC concluded that a disgorgement order can indeed qualify as "equitable relief," subject to certain limitations.
In the 2017 Kokesh decision, the Court determined that a disgorgement order in an SEC enforcement action constitutes a "penalty," and is therefore subject to the federal five-year statute of limitations under 28 U.S.C. §2462. However, the Court noted in a much analyzed footnote that:
Nothing in this opinion should be interpreted as an opinion as to whether the courts possess authority to order disgorgement in SEC enforcement proceedings or on whether courts have properly applied disgorgement principles in this context.
Three years later, the Court has now answered both questions – a disgorgement award can constitute permissible equitable relief under §78u(d)(5), provided that it "does not exceed the wrongdoer's net profits and is awarded for victims," and does not exceed one’s individual liability for wrongful profits.
In Liu, the SEC brought a civil action against Charles Liu and his wife, Xin Wang, for a scheme to defraud foreign investors under the EB-5 Immigrant Investor Program pursuant to which they misappropriated millions of dollars in funds they had received primarily to construct a cancer treatment center. Among other relief, the District Court ordered disgorgement equal to the full amount the petitioners had raised, less the amount remaining in the corporate accounts for the project. The petitioners challenged the District Court's disgorgement award, arguing that it failed to account for legitimate business expenses. The District Court disagreed, concluding that the sum was a '"reasonable approximation of the profits causally connected to [their] violations'" and ordered the petitioners jointly and severally liable. The US Court of Appeals for the Ninth Circuit affirmed, holding that the appropriate disgorgement amount was "the entire amount raised less the money paid back to investors" and citing SEC v. JT Wallenbrock & Assocs., 440 F.3d 1109, 1113,1114 (CA9 2006) (it would be "unjust to permit the defendants to offset…the expenses of running the very business they created to defraud…investors").
The Court ruled on the broader question that petitioners focused on in their briefs – whether disgorgement is the kind of relief traditionally available at equity. The Court rejected both the petitioner’s claim, relying on Kokesh, that disgorgement is exclusively a penalty, and the government's argument that Congress, having enacted other statutes using the term "disgorgement," had implicitly endorsed the SEC's interpretation of disgorgement as extending beyond net profits from wrongdoing, "even if it exceeds the bounds of equity." In addressing this question, the Court compared disgorgement to other historical equitable remedies, such as restitution, and noted the general principle that it is equitable to "deprive wrongdoers of their net profits from unlawful activity." However, the Court recognized that in SEC civil actions "courts have occasionally awarded disgorgement in ways that test the bounds of equity practice" such as by "ordering proceeds of fraud to be deposited to 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."
Because the parties focused on the broad question of whether any form of disgorgement could be ordered, the Court expressly declined to decide narrower questions that had not been fully briefed. These included whether the disgorgement sought was unlawful because it "fails to return funds to victims,  imposes joint-and-several liability, and  declines to deduct business expenses from the award." The Court, however, provided guidance for the lower courts to assess these arguments on remand:
- The Court noted that Section 78u(d)(5) "restricts equitable relief to that which 'may be appropriate or necessary for the benefit of investors,'" and in addressing the SEC's practice of depositing disgorgement into the US Treasury, rejected the government's argument that "the primary function of depriving wrongdoers of profits is to deny them the fruits of their ill-gotten gains, not to return the funds to victims as a kind of restitution." It posited that the "equitable, profits-based remedy must do more than simply benefit the public at large by virtue of depriving a wrongdoer of ill-gotten gains" or else the statute would be meaningless. However, the Court explicitly left open on remand the question of whether, and the extent to which, depositing disgorgement funds with the Treasury would satisfy the SEC's obligations to award relief "'for the benefit of investors' consistent with the limitations of §78u(d)(5)" when it is not feasible to distribute such funds to investors.
- Regarding whether the SEC can seek to impose disgorgement on a defendant for benefits that accrue to his or her affiliates, through such theories as joint-and-several liability, the Court noted that this could potentially be "at odds with the common-law rule requiring individual liability for wrongful profits." The Court did not address all potential relationships that could arise in this context but did specifically cite insider trading cases where traders not only disgorged their own profits but those of their tippees. According to the Court, this practice could "transform any equitable profits-focused remedy into a penalty" and contradict the rule that the disgorgement liability should be limited to what the defendant accrued. It did, however, note that common law permits "liability for partners engaged in concerted activity." The Court cited that the petitioners were married but that petitioners did not introduce evidence to suggest that one spouse was a "passive recipient of profits," that "one spouse did not enjoy the fruits of the scheme, or that other circumstances would render a joint-and-several disgorgement order unjust." The Court, therefore, left the question open on remand as to whether both could be found jointly liable for profits as partners.
- The Court seemingly offered its most direct advice to the courts on remand on the issue of what legitimate business expenses should be deducted before ordering disgorgement, perhaps because the District Court had explicitly previously declined to deduct any business expenses based on a theory that all expenses were incurred as part of a fraudulent scheme. Although the Court recognized that when the "'entire profit of a business or undertaking' results from the wrongdoing, a defendant may be denied 'inequitable deductions'…that exception requires ascertaining whether expenses are legitimate or whether they are merely wrongful gains 'under another name.'" While this analysis was left to the lower court on remand, the Court specified that some expenses (such as lease payments and cancer-treatment equipment) "arguably have value independent of fueling a fraudulent scheme."
As the lone dissenting voice, Justice Thomas argued that disgorgement could never be awarded under 15 U.S.C. §78u(d)(5) because disgorgement "is not a traditional equitable remedy" but was a "20th-century invention." He cautioned that "[t]he majority's treatment of disgorgement as an equitable remedy threatens great mischief" and could potentially allow the SEC and the courts to circumvent limitations for equitable remedies.
Practical Implications for FCPA Cases
As we noted in our 2019 FCPA/Anti-Corruption Year in Review, although Liu itself was unrelated to the US Foreign Corrupt Practices Act (FCPA), the SEC frequently seeks disgorgement in FCPA cases, and Liu has important implications for how the SEC may seek remedies in future FCPA cases.
One such issue, and one which the Court left open in Liu, is whether disgorgement in the FCPA context – in which individual victims would typically be very difficult to identify, and distribution to those victims, many of whom will be in a foreign country, would be even more challenging – would be considered an equitable remedy. It also remains unclear whether and to what extent the SEC would be required to make recovered funds available to investors in the event that securities class actions arise from the alleged conduct. The scope of the potential "infeasibility" exception remains to be determined; but the decision clearly signals that the failure to identify victims and return a wrongdoer’s profits could make disgorgement unavailable as a remedy.
Where disgorgement does remain available as an equitable remedy, the question of legitimate expenses nonetheless has the potential of significantly reducing disgorgement amounts sought by the SEC (particularly where no profits resulted from corrupt activities), and raises some interesting questions of what is or is not a legitimate expense (payments to third parties, for example). As we noted in our analysis of Kokesh, the SEC's (and DOJ's) method of calculating "gains" to a company has been inherently punitive in nature. The Court's discussion of this issue in Liu will require the SEC and courts ordering disgorgement to conduct a more precise and thoughtful analysis and deduction of legitimate expenses, and we expect greater transparency from the SEC in making these calculations moving forward.
Practical Implications for Other Securities-Related Cases
In the immediate aftermath of the Liu decision, an SEC spokesperson stated that the decision "allows [the SEC] 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 [the SEC's] efforts embody principles of equity and fairness." To be sure, the Liu decision was not a loss for the SEC, as it preserved its disgorgement remedy; however, just how hobbled the SEC will be in the wake of Liu remains to be seen.
Clearly the decision affords potential defendants powerful new defenses to the calculation of disgorgement. This may lead to more extensive and granular challenges during the Wells process or in settlement discussions, including the presentation of expert evidence. Some potential defendants might consider litigating, rather than agreeing to an amount of disgorgement they consider to be unjustified, or consenting to SEC relief except for disgorgement so they can challenge at a hearing before a judge whether disgorgement is appropriate and what the amount should be. However, it is also possible that in certain cases, for example where modest amounts of disgorgement make it uncertain that the SEC will be able to return disgorgement to investors, that the SEC could shift away from disgorgement and seek higher civil penalties, including based on the "gross amount of pecuniary gain" to a defendant as a result of the violation.
The Court preserved the ability of the SEC to argue that depositing disgorgement funds with the Treasury could satisfy the SEC's obligations to award relief "for the benefit of investors" where it is not feasible to distribute such funds to investors. Its suggestion that a "practicability" exception applies to the requirement that disgorgement proceeds be distributed to investors is consistent with a similar exception under the rules governing criminal restitution. The SEC has limited resources and may be challenged, based on the amount of disgorgement at issue, to create and administer a meaningful return of funds to investors after taking into consideration administrative costs. In such cases the SEC may seek to argue that returning funds to Treasury is consistent with its obligations to award relief "for the benefit of investors." In addition, while the SEC's mission is to protect investors, the Liu decision may bring into relief the related policy question as to whether private actions, rather than SEC enforcement actions, are more appropriately the vehicle to obtain and return funds to investors who have suffered losses.
The Court raised concerns that the application of joint-and-several liability to disgorgement cases may, in certain cases such as certain insider trading tipper-tippee cases, "transform any equitable profits-focused remedy into a penalty" and contradict the rule that the disgorgement liability should be limited to what the defendant accrued. The Court, however, cited a common law exception, permitting "liability for partners engaged in concerted activity," and, therefore, left open the door for both potential defendants and the SEC to argue over whether there was sufficient culpable participation such that a "joint-and-several disgorgement order" would not be "unjust." In all likelihood, though, the Court’s position, with its focus on individual wrongdoing and net profits, will temper the SEC's insistence in settlement discussions that a potential defendant disgorge amounts beyond that which he or she accrued. Finally, disgorgement ordered in insider trading cases is typically turned over to the US Treasury. It remains to be seen whether the SEC, in order to satisfy its obligation that disgorgement be awarded "for the benefit of investors," will determine that corporations and their shareholders should receive the trading profits to be disgorged, and if so, how such delivery of disgorgement proceeds would be administered where there are large numbers of investors with varying loss calculations.
Finally, as the Court noted, the SEC has explicit authority to award disgorgement in administrative cases. Though the Court in Liu did not address whether disgorgement in the administrative context was subject to its analysis, it is likely that the limitations Liu imposed on disgorgement in the civil context will guide the application of disgorgement in the SEC's administrative forum.
While not eliminating disgorgement as a form of equitable relief that may be sought under 15 U.S.C. §78u(d)(5), the Liu decision nonetheless defines some contours for when disgorgement is proper, and puts the SEC and courts on notice for practices which "test the bounds of equity practice" (including instances in which disbursements are not made to victims, imposing joint-and-several liability, and declining to deduct legitimate expenses). It also provides additional ammunition for defendants to challenge the transparency and propriety of such calculations. Liu can be expected to affect SEC policies and practices going forward, and the open issues will likely give rise to significant litigation as stakeholders seek to clarify the contours of permissible disgorgement.
 Liu v. Securities and Exchange Commission, No. 18-1501 (U.S. June 22, 2020). Disgorgement is expressly authorized in cease-and-desist proceedings by 78 U.S.C. § 77k-1(e).
 Kokesh v. Securities and Exchange Commission, No. 16-529 (U.S. June 5, 2017), slip op. at 5 (fn 3).
 Liu, No. 18-1501, slip op. at 1.
 Id. at 5.
 Id. at 12-14.
 Id. at 6.
 Id. at 12.
 Id. at 14.
 Id. at 15-16.
 Id. at 16-17.
 Id. at 17.
 Id. at 18.
 Id. at 19.
 Liu, No. 18-1501, dissent at 1-2.
 Id. at 6-7.
 See Section 21(d)(3) of the Exchange Act of 1934.
 See 18 U.S.C. § 3663(a)(1)(B)(ii) ("To the extent that the court determines that the complication and prolongation of the sentencing process resulting from the fashioning of an order of restitution under this section outweighs the need to provide restitution to any victims, the court may decline to make such an order."); id. § 3663A(c)(3)(A) (mandatory restitution does not apply where "the court finds, from facts on the record, that…the number of identifiable victims is so large as to make restitution impracticable").
 Liu, No. 18-1501, slip op. at 18.
 Id. at 2.
 Id. at 12.