Liu Limits SEC's Ability to Seek Disgorgement in Federal Securities Cases
In 2016, the SEC charged Charles Liu and Xin Wang with defrauding Chinese investors in a project that the couple falsely claimed met the requirements of the EB-5 Investment Program, which is subject to federal securities laws. Fifty investors paid nearly $27 million to fund construction of a cancer treatment center in California. The SEC claimed the couple misappropriated investors’ funds by diverting them to overseas markets and by paying themselves generous salaries. Because of this, the SEC was seeking a judgment that would require disgorgement of profits.
In 2017, the U.S. District Court for the Central District of California granted summary judgment in favor of the SEC, finding that the couple violated Section 17(a)(2) of the Securities Act. The couple was ordered to pay $8.2 million in civil penalties and approximately $26.7 million in disgorgement of profits. The couple argued, unsuccessfully, that the disgorgement penalty should be offset by millions of dollars in business expenses.
On appeal, the Ninth Circuit Court of Appeals upheld the disgorgement award, finding that it would be “unjust to permit the defendants to offset against the investor dollars they received the expenses of running the very business they created to defraud those investors into giving them money in the first place.”
The U.S. Supreme Court agreed to hear the case in November 2019 and issued its opinion in June of 2020. In an 8-1 decision, Justice Sotomayor wrote for the majority that “a disgorgement award that does not exceed a wrongdoer’s net profits and is awarded for victims is equitable relief permissible under §78u(d)(5).” The Court found that the SEC could continue to use disgorgement of profits as a penalty in federal court but severely limited the extent to which disgorgement could be used.
Limits on Disgorgement of Profits as Equitable Relief
Disgorgement is a form of equitable relief that requires wrongdoers to repay ill-gotten gains. However, the SEC’s authorizing statutes do not specifically include disgorgement as a remedy that the SEC is authorized to impose.
In Liu v. SEC, the Supreme Court upheld disgorgement of profits as an available remedy, but limited disgorgement awards to wrongdoers’ net profits, as opposed to the gross amount of illicit gains. The Court also questioned whether disgorgement would be available if the funds were to be returned to the U.S. Treasury as opposed to identifiable victims.
The Court noted that American jurisprudence has a long-standing practice of allowing courts to strip wrongdoers of their ill-gotten gains and that courts have used various labels for that type of relief, including restitution, accounting for profits, and disgorgement. All of these remedies reflect the same foundational principle that it “would be inequitable that [a wrongdoer] should make a profit out of his own wrong.” Yet the Court also recognized that a wrongdoer should not be punished by paying “more than a fair compensation to the person wronged.”
The Court recognized three ways in which disgorgement could be “in considerable tension with equity practices.” First, by ordering funds deposited into the Treasury instead of distributing them to victims; second, by imposing joint-and-several liability on disgorgement awards; and third, by declining to deduct legitimate business expenses from the receipts of fraud.
Liu Creates Opportunities to Challenge SEC Disgorgement Penalties
The Court’s decision in Liu does not impact whether the SEC can order disgorgement of profits; rather, it specifies the circumstances under which the SEC can obtain such relief. The limiting principles that the Court enunciated may encourage the SEC to change the circumstances in which it seeks disgorgement of illegal gains and will require that the SEC deduct “legitimate” business expenses from disgorgement amounts.
The SEC will also need to evaluate how it considers joint-and-several liability. Holding partners-in-wrongdoing equally liable may present a challenge in insider trading cases where the SEC has traditionally held that the tipper is responsible for the profits of the tippee, even when the relationship between the two is attenuated.
But the most significant aspect of the Court’s opinion in Liu is that disgorgement of profits can only be invoked as “appropriate or necessary for the benefit of investors.” While the Court left open the possibility in unique circumstances, it questioned whether disgorgement is appropriate where the money collected will simply be deposited in the Treasury as opposed to being returned to the victims.
In response, the SEC may seek to impose higher monetary penalties, or choose to bring more contested actions as administrative proceedings where disgorgement has faced little challenge.
Regardless, the Court’s decision in Liu gives people who are under investigation by the SEC additional tools to use when negotiating a resolution with the SEC. Businesses and individuals who are under investigation can rely on the limitations expressed in Liu to negotiate lower disgorgement penalties, demand that legitimate business expenses be deducted from the disgorgement amount, and press the SEC regarding its planned use for any disgorgement funds that are received.
Hope Lefeber: White Collar Criminal Defense in NYC
If you are under investigation by the SEC, you should contact an experienced federal white-collar criminal defense attorney as soon as possible.
New York City criminal defense attorney Hope Lefeber has been defending people accused of crimes in federal court for more than 30 years. She began her career as an enforcement attorney with the SEC where she learned first-hand how the government prepares and investigates federal white-collar criminal cases.
Today, she uses that experience to defend people who are facing criminal charges in federal court.
Ms. Lefeber is a tenacious and fierce defender of her clients’ rights. She is thorough and meticulous in her preparation and has defended numerous high-profile clients in high-stakes litigation. Her clients include executives at Fortune 500 Companies, businessmen and women, doctors, lawyers, professors, healthcare professionals, and other people who have been charged with crimes in federal court.
If you are under investigation or have been charged with a crime in federal court, Hope Lefeber should be your first call. Contact Ms. Lefeber today to schedule a confidential consultation to discuss your case.