Supreme Court Seems Poised to Limit But Not Eliminate SEC Disgorgement in Judicial Proceedings

On Tuesday, the Supreme Court heard oral argument in Liu v. SEC, which concerns whether, or to what extent, the SEC may ask courts to disgorge defendants’ ill-gotten gains. As I discussed in a previous post, disgorgement accounts for most of the SEC’s money judgments, and its elimination would be a significant victory for defendants. Yet if oral argument is any indication, the Court might well curtail the practice, but is unlikely to gut it entirely.

The Court seemed unconvinced by the defendants’ argument that the Securities Exchange Act never authorizes disgorgement in judicial proceedings. But several Justices appeared concerned that the SEC’s current disgorgement practices are inappropriate in two ways. First, the SEC might ask courts to disgorge too much. The SEC often requests disgorgement of all proceeds raised in a fraudulent scheme. But several Justices seemed inclined to limit judicial disgorgement to defendants’ net profits plus the amount spent perpetrating the fraud. If the Court imposes this limit, defendants would be off the hook for legitimate expenses paid with fraudulently-procured funds.

Second, some of the Justices were skeptical of the SEC’s practice of requesting disgorgement of funds that it ultimately gives to the U.S. Treasury rather than defrauded investors. The SEC admitted that it deposits disgorged funds into the Treasury when investors would receive small amounts, making it infeasible to locate them. But it could not rule out that the SEC sometimes deposits disgorged funds in the Treasury even when it could feasibly return them. Several Justices seemed attracted to a rule that the SEC must make a good faith effort to return disgorged funds to investors. But it is unclear what would happen when the SEC’s search is infeasible or unsuccessful. May the SEC deposit the funds in the Treasury, or must it return them to defendants? Hence, even if the Court does limit what the SEC can do with disgorged funds, it’s an open question whether this would mean less disgorgement.

A final issue: Liu concerns only disgorgement in judicial proceedings. It does not address the SEC’s authority in administrative proceedings, where the Securities Exchange Act explicitly authorizes it to seek broad disgorgement. Therefore, if the Court does limit disgorgement in judicial proceedings, the SEC might respond by bringing more actions administratively and seeking broad disgorgement there. On the other hand, courts have more power than SEC administrative law judges to ensure compliance with disgorgement orders, and the SEC might be loath to give that up. Plus, the SEC in the past has shied away from administrative proceedings after many raised concerns about its combined roles of prosecutor, judge, and jury. It might prefer less disgorgement to more such criticism. In short, the Liu argument raised as many questions as it answered. We expect a decision by late June.

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