News & Insights

Supreme Court Limits Securities And Exchange Commission’s Power Of Disgorgement

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.