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On March 3, 2020, the US Supreme Court heard oral argument on whether the SEC has the authority to obtain disgorgement of “ill-gotten gains” in federal court for securities law violations. During the oral argument, in their questioning, the Justices frequently referred back to district courts’ inherent authority to enter equitable relief. Based on this long-recognized equitable authority, and the specific grant of that authority in the federal securities laws, we expect the Court to determine that disgorgement is properly ordered in SEC enforcement actions in federal court.

The courts’ equitable authority to order disgorgement was considered in the argument as an appropriate remedy intended to promote deterrence by ensuring that one held liable for wrongdoing is not permitted to benefit from his or her ill-gotten gains. This, of course, is distinguished from restitutionary remedies, which focus solely on returning assets to victims; however, while those distinctions were not significantly probed, the issue of returning funds to investors was an important point of the discussion.

And, a good deal of the Justices’ questions focused on the circumstances where a disgorgement order can appropriately be described as equitable, as opposed to penal. Based on the Justices’ questions, while it is very possible that the Court will not impose actual limitations on district courts’ exercise of equitable jurisdiction, we anticipate some language in the Court’s decision that recognizes the limits of disgorgement to the actual “ill-gotten gains,” and cautions that any amounts included in an order that might be seen as more than that, could be limited by an appeals court as, in fact, a penalty.

Challenge to SEC Disgorgement Power

In SEC v. Liu, the Ninth Circuit affirmed the trial court’s decision to grant summary judgment in the SEC’s favor imposing disgorgement of approximately USD 27 million in addition to an USD 8 million civil penalty against the defendants. 1 The defendants appealed, arguing that the SEC does not have the authority to seek disgorgement for violations of the federal securities laws. For decades, the SEC has sought disgorgement in federal court as a form of “equitable relief.” The defendants argue, however, that because equitable relief is meant to be remedial rather than punitive, disgorgement is not an equitable remedy. This argument stems in part from the Supreme Court’s decision in Kokesh, in which the Court held that SEC disgorgement operates as a “penalty” and thus is subject to the five-year statute of limitations that governs such penalties. 2 The Supreme Court granted the writ of certiorari by petitioners Liu and others.

In its appeal to the Supreme Court, the Petitioners argue in their brief that SEC disgorgement is a penalty and does not have the characteristics of traditional equitable relief. Petitioners argue that unlike traditional equitable relief to make victims whole, the SEC often deposits disgorgement funds into the US Treasury and does not return the funds to harmed investors. They point to the SEC’s practice of seeking disgorgement beyond the “net profit” of the alleged wrongdoer and not discounting legitimate costs, contrary to traditional equitable relief.

Our Takeaways

District Courts Will Continue to Be Able to Enter Disgorgement Orders

During oral argument, the questioning by a number of the Justices suggested that the Court might be willing to allow the SEC to continue to seek disgorgement in federal district court actions as an equitable remedy. This inclination seems based on the specific grant of equity jurisdiction provided to federal district courts by the federal securities laws. For example, Section 21(d)(5) of the Securities Exchange Act of 1934 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, any equitable relief that may be appropriate or necessary for the benefit of investors.” The Justices appeared willing to permit the SEC to seek, and a federal district court to issue, disgorgement orders based on this and other similar grants of authority.

Disgorgement Amounts Should More Closely Reflect the Real-World Economic Reality

In recent years, the Staff has been very aggressive in calculating disgorgement amounts, often disregarding any costs or expenses borne by potential defendants in any business enterprise against which the Staff alleges securities fraud. Often in the context of settlement dialogues, the SEC Enforcement Staff has taken the position that, at most, only certain variable costs, but not legitimate fixed costs, could be offset against the gross profits number when calculating disgorgement. In FCPA cases, in particular, these SEC-imposed limitations can result in public companies paying back amounts greater than their economic benefit from a particular transaction or course of conduct. Any language in the opinion that purports to draw a line between “disgorgement” and “penalty” that suggests more care in determining what comprises “ill-gotten gains,” could open the door to arguments over whether any particular “gain” is causally connected to an alleged securities law violation — for example in FCPA cases alleging books and records and internal controls violations, where the SEC seeks disgorgement of the value of an entire contract or set of transactions.

Importantly, this litigation challenged only the ability of the SEC to seek disgorgement in federal district court actions. It does not challenge the SEC statutory power to seek disgorgement through administrative proceedings. However, if the Court opines or cautions on the scope of disgorgement, such a ruling may similarly limit the amount and scope of disgorgement in SEC administrative proceedings.

Pressure on SEC (and Potentially Settling Defendants) to Return Money to Investors

Another area of focus during the argument was the fact that disgorged funds are often not slated to be returned to investors, but instead are ordered to be paid to the US Treasury. Of course, this goes directly to the distinction between disgorgement and restitution, which was not really considered at the oral argument. Although the Justices plainly had some interest in this issue, they did not appear to question whether the SEC was exercising good faith efforts in trying to distribute disgorged funds.

However, the SEC has been struggling to return disgorged funds to investors. For instance, our recent analysis of SEC statistics from 2019 shows that the SEC has taken a significant amount of time to return funds to victims. And in our experience, the process of returning funds to investors is resource intensive and complex. Often, identifying victims and determining the appropriate monetary amounts to which they are entitled is not an easy task. Any comments in the Court’s opinion, even if offered as guidance in dicta, that can be seen as requiring the SEC to make more significant efforts to return funds to victims will increase the pressure on the SEC to accomplish this task. One danger is that the SEC may decide, as it has done in the past, to require defendants, as part of a settlement, to bear the cost and burden of returning funds to victims, including, for instance, the hiring of an independent fund administrator by settling defendants.

We will continue to monitor this matter and offer our insights when the Court does issue its ruling.


1 See SEC v. Liu, 262 F. Supp. 3d 957 (C.D. Cal. 2017), aff’d, 754 F. App’x 505 (9th Cir. 2018).
2 See Kokesh v. SEC, 137 S. Ct. 1635 (2017).

Author

Amy serves as the Co-chair of Baker McKenzie’s North American Financial Regulation and Enforcement Practice, which provides our clients with a full range of regulatory advice and enforcement counseling. Previously, Amy has served as chief litigation counsel at the US Securities and Exchange Commission's (SEC) Philadelphia regional office and managed a team of lawyers overseeing a wide variety of enforcement matters and investigations.

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Jennifer L. Klass serves as the Co-chair of Baker McKenzie's Financial Regulation and Enforcement Practice in North America. Jen is an experienced investment management lawyer with particular focus on investment adviser regulation and the convergence of investment advisory and brokerage services. She regularly represents clients before the US Securities and Exchange Commission (SEC), both in seeking interpretative guidance and in managing examination and enforcement matters. Jen is a leading practitioner in digital investment advice and the use of FinTech in the asset management industry. Jen provides practical advice that is informed by her experience as Vice President and Associate Counsel at Goldman, Sachs & Co., where she represented the asset management and private wealth management businesses.

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Peter K.M. Chan is a member of Baker McKenzie’s North American Financial Regulation and Enforcement Practice, which provides our clients with a full range of regulatory advice and enforcement counseling. Peter brings two decades of experience at the US Securities and Exchange Commission (SEC) to his litigation and counseling work. His tenure at the SEC, as well as a stint as Special Assistant US Attorney in the Northern District of Illinois, have given Peter experience with civil and criminal matters. At the SEC, Peter served as assistant regional director in the Chicago regional office, where he led investigations and litigations of high-profile enforcement cases. In the course of his SEC career, he handled corporate issuer disclosure and reporting violations, financial fraud, auditor independence violations, insider trading, broker-dealer misconduct and failure to supervise cases, hedge fund and investment company fraud, and Dodd-Frank and Sarbanes-Oxley violations. As the head of the Municipal Securities and Public Pensions Unit at the SEC's Chicago office, he oversaw cases involving municipalities and public pensions throughout the Midwest, including disclosure failures by states, cities, and underwriters in municipal bond offerings; pay-to-play and public corruption; and securities fraud victimizing municipalities and public pensions. Peter also served in national leadership roles within the SEC's Enforcement Division. Peter acted as national leader of the Municipalities Continuing Disclosure Cooperation (MCDC) Initiative. He also served as co-chair of the Priorities and Resources Subcommittee of the Division of Enforcement Advisory Committee and was one of the original architects of the SEC Financial Reporting and Audit Task Force. Peter's experience in criminal securities fraud cases includes serving as Special Assistant US Attorney in the Northern District of Illinois in a criminal investigation into market abuse by a Chicago broker-dealer, resulting in guilty pleas by several senior executives at the firm. In 2014, Peter received the SEC's prestigious Paul R. Carey Award for his [e]xceptional personal commitment and effectiveness as a member of the Division of Enforcement.

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Jerome Tomas is Chair of the Firm's SEC and Financial Institutions Enforcement Group and has been recognized by Chambers for White Collar Crime & Government Investigations. He represents multinational companies faced with government investigations and conducts internal investigations to assess and remediate legal and compliance concerns in domestic and global operations. With his experience as a former member of the SEC Division of Enforcement’s Cyberforce, the agency’s internet and cyber fraud unit, Jerome regularly advises companies involved in data security breaches and incident response. Jerome now leads teams of lawyers to address government law enforcement perspectives and where necessary, meet and refute government legal theories of corporate and individual liability head-on, while also being pragmatic and business-oriented for management and boards to compete internationally.

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A. Valerie Mirko is a partner in Baker McKenzie’s Financial Regulation and Enforcement Practice Group in North America. Valerie has substantial experience in federal and state securities laws and regulations affecting the financial services industry, with a focus on the investment adviser and brokerage industries. Valerie has a background in both regulatory advice and enforcement counseling. Immediately prior to joining the Firm, Valerie was General Counsel of the North American Securities Administrators Association (NASAA). As General Counsel, Valerie advised NASAA’s Board of Directors on developments in the federal securities laws and their impact on state securities regulations. Valerie provided advice on, among other areas, the SEC Regulation Best Interest rule set, fiduciary duty/standards of care, preemption, retail enforcement issues, investment adviser oversight, and data privacy. She also supervised all of NASAA's securities-related legal work and was a resource on multistate enforcement investigations and settlements. Valerie also provided governance support on key NASAA Regtech projects and regulatory coordination initiatives between state and federal regulators. Valerie was a frequent speaker at regulator-only roundtables and training events. Earlier in her career, Valerie advised broker-dealers and investment advisers on regulatory matters and enforcement investigations as an associate at a Washington law firm and held legal and compliance roles at Oppenheimer & Co., Inc., and Merrill Lynch (now BofA Securities). Valerie is currently a member of the adjunct faculty at the George Washington University Law School and a subcommittee chair within the DC Bar Corporation, Finance, and Securities Law Community.

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Jennifer Connors is a partner in Baker McKenzie's Financial Regulation and Enforcement Practice Group. She represents broker-dealers, investment advisers, alternative trading systems (ATSs), private fund managers, financial technology (FinTech) companies and other market participants on securities law and market regulation matters.

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Rebecca Leon is a partner in Baker McKenzie's Financial Regulation and Enforcement Practice Group. She counsels broker-dealer and other financial services clients on a wide range of state and federal securities law issues, as well as on compliance with the rules of the Financial Industry Regulatory Authority (FINRA). She assists clients with a panoply of intercompany, customer and industry agreements and works closely to guide financial services firms on structuring and developing their global operations.