by John F. Savarese, Wayne M. Carlin, and David B. Anders

In an 8-1 decision issued yesterday in Liu v. SEC (PDF: 193.50 KB), the Supreme Court upheld the SEC’s authority to obtain disgorgement from securities law violators, but also indicated some limitations on the scope of the remedy. Some observers had raised questions about the continued viability of the disgorgement remedy after the Court’s 2017 decision in Kokesh v. SEC (PDF: 2112 KB). Today’s decision makes clear that SEC disgorgement is alive and well. Nevertheless, in light of some comments in today’s opinion, the SEC will likely need to rein in some of its prior practices.

The SEC has statutory authority to obtain “equitable relief” in federal court. The agency has long taken the position that orders of disgorgement are within the inherent equitable powers of a court. In Kokesh, the Court held that disgorgement is a penalty for statute-of-limitations purposes, which raised the question of whether the SEC’s view of the scope of equitable relief is correct. In today’s decision, the Court noted that courts of equity have routinely deprived wrongdoers of their net profits in order to provide fair compensation to their victims. This led to the conclusion that Kokesh does not preclude the SEC from recovering ill-gotten gains from wrongdoers, with certain limitations.

First, the Court cast doubt on the SEC’s practice in some cases of causing disgorgement funds to be paid to the U.S. Treasury, rather than distributed to injured investors. The SEC typically takes this approach when it believes the administrative costs of a distribution are not warranted in light of the size of the recovery. There was no holding on this issue, as Liu does not involve a proposed distribution plan. But going forward, the SEC may need to forego disgorgement in cases in which it does not propose to distribute the funds to investors.

Second, the Court expressed some reservations about the SEC’s practice of seeking disgorgement from multiple parties on a joint-and-several-liability basis. The Court left this issue to be sorted out by the lower courts on remand. Going forward, we can expect courts to be more rigorous in requiring the SEC to demonstrate that a particular participant in unlawful activity was sufficiently connected with the resulting profits to be within the scope of a disgorgement remedy.

Finally, the Court found that disgorgement awards cannot exceed the wrongdoer’s net gains. This is in conflict with the SEC’s typical approach, which has been to seek recovery of gross profits. The Court instructed that a court of equity should deduct “legitimate expenses” before ordering disgorgement. The Court again left it to the lower courts to determine which expenses in Liu were “legitimate.” This definitional issue will likely be the subject of future litigation and a point of debate in settlement discussions with the SEC.

The SEC has succeeded in preserving one of its most significant remedial tools in federal court. But the agency’s future use of this remedy will now be constrained. The existence of the disgorgement remedy in SEC administrative cease-and-desist proceedings was never in doubt, as it is expressly authorized by statute. It remains to be seen to what extent the equitable limitations on disgorgement spelled out in Liu may also be imported to the administrative context. It would certainly be anomalous for the scope of disgorgement to vary depending on the SEC’s choice of forum.

John F. Savarese, Wayne M. Carlin, and David B. Anders are partners at Wachtell, Lipton, Rosen & Katz.

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