Supreme Court to Review SEC Authority in Enforcement Actions
Loyola University Chicago School of Law, JD 2020
The Supreme Court has granted certiorari to consider whether the Securities and Exchange Commission (“SEC”) has the authority to obtain disgorgement in district court actions. Disgorgement is the repayment of “ill-gotten gains” imposed as a court sanction to recover funds that were received through illegal or unethical business transactions. These recovered or disgorged funds are paid back with interest to those who the practice affected. Each year, the SEC obtains billions of dollars in disgorgement, so an adverse ruling by the Supreme Court could eliminate one of the SEC’s most important remedies for securities violations. In 2018, for example, the agency returned $794 million to harmed investors.
Unanswered Questions about the Court’s Authority to Order Disgorgement
In Kokesh v. SEC the Supreme Court held that a five-year statute of limitations applies to disgorgement in enforcement actions because it operates as a penalty. In this decision, the Court reasoned that a penalty is a sanction imposed in a punitive way for infracting public law. The Court further reasoned that when the SEC seeks disgorgement, it is acting as an agent of the public to remedy harm to the public at large. In Kokesh, however, the Court declined to rule whether the courts have the authority to award disgorgement in enforcement actions.
Liu v. SEC began in May of 2016, when the SEC sued Charles Liu and his wife Xin Wang for defrauding Chinese investors by misusing funds solicited from investors under the EB-5 Immigrant Investor Program, a program where foreign investors are able to obtain U.S. citizenship after meeting a minimum investment in a for-profit, job-creating enterprise. The fund was advertised as an investment towards a cancer treatment center, but Liu misappropriated millions of dollars in violation of Section 17(a) of the Securities Act of 1933, which prohibits the making of false statements in the context of a securities offering. The district court, in this case, ordered Liu to pay back the $27 million that investors had paid into the EB-5 fund as well as an $8.2 million civil monetary penalty against them, and the United States Court of Appeals for the Ninth Circuit affirmed.
In his petition for the Supreme Court’s review, Liu argued the SEC lacked authority to obtain disgorgement under the standard set in Kokesh, where the Court held that disgorgement is, for the purposes of the statute of limitations, a penalty. Defendants contend that the disgorgement amount awarded by the district court exceeded the number of their ill-gotten gains and is not required to be returned.
In its response, the SEC maintains the court’s power to equitable relief encompasses the right to order disgorgement, and that numerous statutes including the Securities Act of 1933, the Securities Exchange Act of 1934, and the Sarbanes Oxley Act of 2002 authorize these penalties. The SEC adds that disgorgement may qualify as a form of equitable relief for some purposes, even though it has been used as a penalty for others, such as the statute of limitations.
How a Negative Ruling for the SEC Could Affect Enforcement Moving Forward
In a sense, the Kokesh ruling left much to be desired in clarifying the scope and power that the SEC has in seeking disgorgement in cases. Liu v. SEC has the potential to take away the SEC’s ability to seek disgorgement at all or to carve out the instances in which it is appropriate further.
This case is particularly exciting as it deals with EB-5 investments, an extremely complex and convoluted area of immigration law. EB-5 cases are often dealt with behind closed doors, and the Supreme Court has not heard many cases about the visa program. Any opportunity to clear up some of the contours of this program is beneficial for practitioners and fund managers.
The SEC is not the only agency in the wake of Dodd-Frank that relies on equitable powers to seek disgorgement, so a negative ruling could have consequences for other enforcement bodies. However, a negative ruling from the Supreme Court does not preclude Congress from passing legislation permitting disgorgement in district court.
The principal goals of the SEC are to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. It’s arguable that the authority to seek disgorgement in cases where investors have been harmed is precisely aligned with the SEC’s mission.