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For over 40 years, the Securities and Exchange Commission
(SEC) has used disgorgement as a common enforcement tool. In securities
enforcement matters, disgorgement requires wrongdoers to disgorge ill-gotten
profits or commissions. The Ninth Circuit has stated that “disgorgement is
designed to deprive a wrongdoer of unjust enrichment, and to deter others from
violating securities laws by making violations unprofitable.” See Security
and Exchange Commission v. JT Wallenbrock & Associates., 440
F.3d 1109, 1113 (9th Cir. 2006).
While the Supreme Court has discussed disgorgement in the
past, defining it as a penalty with a 5-year statute of limitations, the Court
in Liu v. Security and Exchange Commission upheld the validity of the
commonly used enforcement tool. Liu v. Sec. & Exch. Comm'n,
140 S. Ct. 1936 (2020). In an 8-1 ruling, the Supreme Court held that a
disgorgement award, in an SEC civil enforcement action, that does not exceed a
wrongdoer’s net profits and that is awarded for victims is permissible as
equitable relief under the Securities Exchange Act.
This landmark decision was the result of a civil enforcement
action brought against developers of a proposed proton therapy cancer treatment
center. The SEC alleged that the developers misappropriated millions in
investor funds to themselves and other affiliated companies. Sec. & Exch. Comm'n v. Liu, 262 F. Supp. 3d 957
(C.D. Cal. 2017). The California District Court granted summary judgment to the
SEC, granted injunctive relief, imposed a civil penalty, and ordered
disgorgement equal to the full amount of the investment funds raised. The
developers appealed. Ultimately, certiorari was granted, leaving the Supreme
Court to decide the fate of disgorgement.
While the Supreme Court’s decision in Liu v. Security and
Exchange Commission is technically a victory for the SEC, the SEC’s power
is nonetheless limited. The Supreme Court intentionally defined the parameters
of the SEC’s disgorgement power, holding that disgorgement must be capped at
the wrongdoer’s net profits, and not the total amount invested. Further, the
Court held that a disgorgement award must be awarded for the benefit of
victims, rather than stored with the U.S. Treasury. Going forward, many argue
that the SEC may use disgorgement less often considering the additional costs
of determining a wrongdoer’s net profits and identifying the specific harmed
investors.