These restrictions are intended to ensure that the SEC’s use of disgorgement conforms to traditional equity principles and is not punitive by imposing liability on individual participants in excess of net gains.  However, the Liu opinion also points out potential exceptions to each of these new restrictions that substantially enhances the array of arguments available to defend against SEC disgorgement claims—whether in court or in settlement negotiations of an administrative proceeding.  The scope of these announced exceptions will become the new legal battleground as the SEC seeks to preserve its power to impose disgorgement and defendants seek to restrict that power.

Background of Disgorgement for Securities Violations

Disgorgement is a commonly sought remedy in SEC civil enforcement actions.  The SEC’s reliance on the enforcement tool has grown steadily over the years, with the SEC collecting $1.5 billion in disgorgement and penalties in 2019.  Although the SEC has express statutory authority to seek disgorgement in administrative proceedings, it lacks express authority to seek disgorgement in civil actions. Rather, 15 U.S.C. §78u(d)(5) (“§78u(d)(5)”) authorizes the SEC to seek civil penalties and “equitable relief.”[1]

Whether disgorgement constitutes “equitable relief” for the purposes of §78u(d)(5) was the issue in Liu where the SEC alleged that Petitioners Charles C. Liu and Xin Wang operated a fraudulent EB-5 Fund and misappropriated $27 million in investor funds in violation of federal securities laws.  In granting summary judgment in favor of the SEC, the district court ordered disgorgement of that entire amount (all of the money that had been raised from investors), imposed civil penalties equal to the $8.2 million Liu and Wang had personally received from the project, and permanently enjoined them from future solicitations of EB-5 Program investors.

Liu and Wang’s challenge to the SEC’s power to seek disgorgement was basically invited by the Supreme Court’s decision in Kokesh v. SEC, 581 U. S. ___, (2017).  The Supreme Court held in Kokesh that disgorgement orders in SEC enforcement actions constituted a “penalty” under 28 U.S.C. § 2462, and pointedly remarked in a footnote that the Court was not deciding whether courts could properly order disgorgement in SEC enforcement proceedings at all.[2]  Liu and Wang accordingly argued that disgorgement could not qualify as “equitable relief” for purposes of § 78u(d)(5) because—as the Supreme Court had said on numerous occasions, traditional principles of equity exclude punitive sanctions—and the SEC, therefore, lacked statutory authority to seek disgorgement in civil enforcement actions.[3]

Disgorgement Is “Equitable Relief” So Long As It Comports with Limitations Set by Traditional Equitable Principles

By an 8-1 vote, the Supreme Court held that disgorgement is equitable relief, and seeking disgorgement falls within the scope of the SEC’s authority under § 78u(d)(5), so long as the disgorgement award (i) does not exceed a wrongdoer’s net profits, (ii) imposes individual rather than joint-and-several liability, and (iii) provides for the proceeds from disgorgement to be returned to the wrongdoer’s victims.

Justice Sotomayor’s opinion reasons that although the term “disgorgement” was not widely used until relatively recently, the principles underlying disgorgement are similar to those underlying traditional equitable remedies, such as an accounting or restitution, and that this family of remedies has long been a mainstay of U.S. federal court practice and the Supreme Court’s own jurisprudence, writing “equity practice long authorized courts to strip wrongdoers of their ill-gotten gains, with scholars and courts using various labels for the remedy.”

Justice Sotomayor then explains that courts have traditionally “avoided transforming” such equitable remedies into “punitive sanction[s]” by restricting the remedy to an individual wrongdoer’s net profits to be awarded for victims.”  Contrary to this principle, the Court says, courts imposing disgorgement in SEC civil actions “have occasionally awarded disgorgement in three main ways that test the bounds of equity practice: by ordering the proceeds of fraud to be deposited in Treasury funds instead of disbursing them to victims, imposing joint-and-several disgorgement liability, and declining to deduct even legitimate expenses from the receipts of fraud.”  Justice Sotomayor emphasizes that “[t]he SEC’s disgorgement remedy in such incarnations is in considerable tension with equity practices.”

Limitations of Defendant’s Liability

The limitations on the SEC’s power to seek disgorgement in civil actions enumerated in the Liu opinion—in particular that the funds recouped should be returned to victims and that legitimate business expenses should be deducted—can be expected to have significant implications for the scope of defendants’ liability and for the bargaining power that they are able to apply in settlement negotiations with the SEC.[4]  In the context of an insider trading suit or an FCPA investigation, for example, it is not obvious how the SEC could reasonably identify harmed investors or administer the distribution of money recouped through disgorgement.  Absent any express guidance from the Supreme Court, defendants may have broad latitude to argue with the SEC, or before a federal court, about what constitutes a “legitimate expense” that should be deducted from the disgorgement award.  The SEC’s diminished power to threaten defendants with an aggregation of fines and penalties exceeding (or sometimes even wholly out of proportion to) the original wrongdoing will likely increase defendants’ leverage in settlement negotiations.

Regarding deduction of business expenses, the Court noted that the district court in Liu had refused to deduct expenses from the disgorgement award on the grounds that amounts spent by defendants on a lease and cancer-treating equipment (their EB-5 Project was purportedly to finance a cancer treatment facility) were “for the purposes of furthering an entirely fraudulent scheme.”  Again, the Court left it to the lower courts to decide whether these amounts were deductible business expenses or “merely wrongful gains under another name”.  As a result of these lacunae, the SEC may be able to succeed in limiting the equity-based restrictions on disgorgement articulated in Liu.

Justice Sotomayor’s opinion also left open avenues that the SEC may pursue to resist the impact of these restrictions.  For example, in conformity with both traditional equitable principles and the requirement in § 78u(d)(5) that equitable relief be “for the benefit of investors,” the Court noted that disgorgement “must do more than simply benefit the public at large by virtue of depriving a wrongdoer of ill-gotten gains” in connection with the requirement that disgorgement awards be distributed among the victims.  However, while implicitly acknowledging that there may be circumstances where returning funds to victims is not feasible, the Court left open the question of whether a disgorgement award may ever properly be deposited with the Treasury, defaulting to lower courts to determine what showing the SEC needs to make for such an award to be valid for the “benefit of investors” under § 78u(d)(5).

Moreover, in considering the facts at issue in Liu, the Court acknowledged that the general restriction against joint-and-several liability may not obtain, since the defendants were husband and wife who appeared to jointly participate in the fraud and may have had comingled finances. 

Key Takeaway

SEC staff and litigants must anticipate that future SEC disgorgement settlements and awards will be more difficult to negotiate, achieve after trial, and will be closely scrutinized as the basis for an appeal.  New legal battles will now be joined over the scope of the restrictions on disgorgement established in Liu. For now, these restrictions give defendants a new line of defense in SEC civil proceedings and settlement negotiations. Going forward, it will be important to see what, if any, limitations district courts impose on the presentations of a deductible “legitimate business expense” and, more significantly, to see how courts answer questions about whether it is permissible in the circumstances for the SEC to deposit proceeds from disgorgement with the Treasury.  At a minimum, as a result of Liu the SEC may now be compelled to return disgorgement proceeds to victims whenever it appears feasible to do so. The impact of this decision may also be felt in enforcement actions brought by other regulatory agencies.  The scope of the Federal Trade Commission’s authority to seek monetary equitable relief, for example, is similarly unsettled.


[1] As the Liu opinion by Justice Sonia Sotomayor and the dissent by Justice Clarence Thomas both point out, authored before the SEC’s authority to seek equitable relief was codified at §78u(d)(5), the SEC asked federal courts to order disgorgement as an exercise of their “inherent equity power to grant relief ancillary to an injunction.” Federal courts accepted that invitation. In SEC v. Texas Gulf Sulphur Co., 312 F. Supp. 77, 91 (SDNY 1970), for example, the court ordered disgorgement because it would “deprive . . . defendants of their profits in order to remove any monetary reward for violating” securities laws and would “protect the investing public by providing an effective deterrent to future violations.”

[2] The Kokesh footnote stated that “[n]othing 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.”

[3]The Supreme Court decided Kokesh shortly before Liu and Wang appealed the district court’s decision to the Ninth Circuit.  Citing the Kokesh footnote expressly stating that the Supreme Court was not ruling on federal courts’ power to impose disgorgement orders in SEC civil actions however, the Ninth Circuit relied on pre-Kokesh circuit law that had upheld similar disgorgement awards.

[4] Ironically, notwithstanding that the Supreme Court signaled in Liu that Kokesh remains good law, the Liu decision appears to undermine the rationale for the Court’s conclusion in Kokesh that disgorgement is a penalty. The Liu opinion situates disgorgement “squarely within the heartland of equity,” and the new restrictions on disgorgement are intended to ensure that it remains there.  The result in Liu makes it harder to maintain that disgorgement serves a retributive or deterrent purpose that goes beyond compensation.

If you have questions, please contact us

If you have any questions or if you would like to discuss these issues further,
please contact Paul Lieberman or the Scarinci Hollenbeck attorney with whom you work, at 201-896-4100.