On Nov. 1, the U.S. Supreme Court agreed to review a 9th Circuit decision to determine whether the Securities and Exchange Commission may seek disgorgement from defendants in civil injunctive actions filed in federal courts. The high court granted the petition to review the case at the request of two individuals the SEC had filed suit against for violating securities laws. A lower court had ordered the defendants to disgorge funds received from their illegal misconduct, and the 9th Circuit affirmed.
The outcome of the matter could have a significant impact on SEC activity moving forward. According to the SEC Division of Enforcement’s Annual Report, in fiscal year 2018 parties were ordered to pay $2.5 billion in disgorgement (as compared to just $1.4 billion in penalties in the same timeframe).
The misconduct at issue
The SEC had filed suit against Charles Liu and Xin Wang for allegedly scamming investors in a planned cancer treatment facility. A federal program for immigrant investors offers them permanent residence and an opportunity to seek citizenship if they make significant investments in a commercial enterprise in the United States. The SEC maintained Liu and Wang set up a fraudulent center to recruit Chinese investors seeking U.S. visas. Investors were told their money would be used for a cancer treatment facility in California.
The project was not completed. Instead, the SEC filed suit against Liu and Wang claiming they defrauded investors and misappropriated millions of dollars for their personal use. The U.S. District Court for the Central District of California held Liu and Wang had violated the Securities Act. The court granted the SEC’s request for an injunction preventing Liu and Wang from participating in any additional investments in the program for immigrant investors.
As a remedy, the SEC also sought civil monetary penalties from Liu and Wang, which the district court granted as well. Liu was directed to pay $6.7 million, and Wang had to pay $1.5 million.
In addition, the SEC asked the lower court to order Liu and Wang to “disgorge all funds received from their illegal conduct, together with prejudgment interest thereon, and to repatriate any funds or assets they caused to be sent overseas.” The district court determined disgorgement of $26 million was appropriate. Liu and Wang, however, argued unsuccessfully they should not be required to disgorge about $16 million they had spent on legitimate business expenses associated with their immigrant investment fund.
They were unsuccessful again when they appealed the decision to the 9th Circuit. The appeals court noted it would be unfair to allow defendants to offset business expenses where the business was created to defraud investors in the first place. The 9th Circuit determined “the proper amount of disgorgement in a scheme such as this one is the entire amount raised less the money paid back to investors.” In short, Liu and Wang would not be allowed to simply write off $16 million in business expenses but would have to disgorge it.
The meaning of ‘disgorgement’ gets complicated
Not long before the 9th Circuit reached its conclusion, though, the Supreme Court had issued a decision in a different case that also touched on disgorgement. In Kokesh v. SEC, the high court determined the relevant statute of limitations applied to “any civil fine, penalty, or forfeiture.” The Supreme Court deemed disgorgements to actually be penalties for statute of limitations purposes. Interestingly, the Court in Kokesh specifically declined to resolve the question of whether courts have the authority to order disgorgement in SEC enforcement cases.
Who OK’d disgorgement in the first place?
In seeking Supreme Court review, Liu and Wang argue Congress never actually authorized the SEC to seek disgorgement in cases like this. According to the petitioners, Congress only authorized the SEC to obtain injunctions, civil monetary penalties, and equitable relief. Indeed, Liu and Wang noted five Supreme Court justices (Chief Justice Roberts and Associate Justices Kennedy, Sotomayor, Alito, and Gorsuch) asked about statutory authority for disgorgement during oral argument in the Kokesh case.
Liu and Wang acknowledge the SEC has been seeking disgorgement as a form of equitable relief since the 1970s.
Lori Tripoli is a writer based in the greater New York City area who focuses on legal and regulatory issues.