Recent developments within two of the three branches of the federal government portend significant potential changes in the SEC’s ability to obtain disgorgement of ill-gotten gains in civil actions brought by its enforcement arm. Early in November, the U.S. Supreme Court decided to hear an appeal of a Ninth Circuit case, SEC v. Liu, involving the issue of whether the SEC has statutory authority to obtain disgorgement at all. Then, not three weeks later, the U.S. House of Representatives responded by passing H.R. 4344, a bill explicitly codifying the SEC’s authority to obtain disgorgement. While the ultimate decision of the high court remains months away, and the House’s action has no legal significance until a companion bill in the Senate is acted upon and the two bills are passed by both chambers, these developments are of great significance to securities litigators and SEC-watchers alike.
Disgorgement has long been a powerful arrow in the SEC’s enforcement quiver, allowing it to obtain, on behalf of aggrieved investors, reimbursement of ill-gotten gains. However, despite it having obtained billions of dollars in disgorgement in civil actions over the last few decades, no statute explicitly confers the SEC with authority to seek this remedy. Rather, lacking any express authority, federal judges have implied it in scores of decisions dating back to the 1970s. Now, that entire foundation has come into question, prompted first by the Supreme Court’s 2017 decision in Kokesh v. SEC, and now by the high court’s acceptance of the Liu appeal.
As we have chronicled on this blog, the landmark Kokesh decision shook up the SEC enforcement bar with its unanimous holding that disgorgement is a “penalty,” thus subjecting SEC claims for disgorgement to the five-year statute of limitations articulated in 28 U.S.C. § 2642. That federal law governs any “action, suit, or proceeding for the enforcement of any civil fine, penalty, or forfeiture.” In reaching its decision, the Supreme Court cited disgorgement’s “punitive purposes” in punishing wrongdoers for violating “public laws” and its deterrent effect on future violations. Highly notable in the Kokesh decision was a footnote, wherein the Court stated that “nothing in this opinion should be interpreted as an opinion on whether courts possess authority to order disgorgement in SEC enforcement proceedings or on whether courts have properly applied disgorgement principles in this context.” That question is now before the Court in Liu.
Indeed, Liu specifically addresses the issue of whether a court has the power to award disgorgement for securities law violations on request of the SEC. In that case, the SEC had sued Charles Liu and his wife for fraud in connection with their raising approximately $27 million from Chinese investors under the EB-5 Immigrant Investor Program, which allows foreign citizens to obtain U.S. visas in exchange for investing in U.S.-based job-creating projects. While the funds were purportedly raised by the Lius to construct and operate a cancer treatment center in California, the SEC alleged that the Lius misappropriated most of the money raised, paying themselves and others exorbitant salaries and finders fees instead. The district court, in turn, ordered disgorgement of the entire amount raised, and this award was affirmed by the Ninth Circuit.
Accordingly, in appealing their case to the Supreme Court, the Lius seek to have the district court’s entire $27 million disgorgement award overturned. While obviously a large amount of money in its own right, the $27 million involved here pales in comparison to the actual amounts at stake were the SEC to lose this equitable remedy. Indeed, in its 2019 Annual Report, the SEC’s Enforcement Division estimated that the Kokesh ruling alone has caused it to forgo approximately $1.1 billion in disgorgement, adding that the “actual impacts of Kokesh are likely far greater than this number reflects.” Moreover, keep in mind that Kokesh merely shortened the statute of limitations on actionable cases to five years. A successful appeal of Liu would effectively curtail disgorgement entirely.
Enter the U.S. Congress. In the wake of Kokesh, both the House and Senate have seen bills introduced in an effort to “fix” the statutory uncertainty exposed by the high court’s ruling. That effort decidedly picked up steam in the House in the weeks following the November 1st Supreme Court acceptance of the Liu appeal. H.R. 4344, passed by a 314-95 vote of the full House on November 18th, amends the Securities Exchange Act of 1934 (“’34 Act”) to expressly allow the SEC to seek disgorgement. Specifically, the amendment provides that “[i]n any action or proceeding brought or instituted by the Commission under any provision of the securities laws, the Commission may seek, and any Federal court may grant . . . [d]isgorgement in the amount of any unjust enrichment obtained.” Additionally, H.R. 4344 clarifies the applicable statute of limitations to be “14 years after the alleged violation.”
Less clear at this point is the progress of a companion bill introduced in the Senate last March by John Kennedy (R, LA) and Mark Warner (D, VA). The Senate bill, as introduced, would also amend the ’34 Act to expressly allow for disgorgement—as well as restitution—in any action “under any provision of the securities laws.” The Senate bill would, however, cap disgorgement at a five year statute of limitations but allow a 14-year period for restitution (while the measure of damages under disgorgement is essentially the ill-gotten gains or profits, under restitution it is the full amount parted with by the investor).
Our take on this matter is that uncertainty will prevail, unless and until the Senate bill is acted upon. Clearly, a compromise bill hashed-out between the Senate and the House would fully resolve the matter—effectively mooting the Liu case and overturning Kokesh. However, with the advent of a potentially bitter election year upon us shortly, any hopes at the SEC for a compromise House-Senate bill may be a bridge too far. We will, of course, keep our eyes on future developments.
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