The Supreme Court in Liu v. SEC, decided June 22, 2020, has at last brought some clarity to and placed some significant limitations upon the disgorgement powers of the courts in SEC civil actions. In Liu, the SEC had accused the defendants of effecting a fraudulent securities offering by misappropriating some of the investors’ funds for personal use, and sought disgorgement of the entire amount of the offering against all the defendants jointly and severally. Rejecting the SEC’s claim for such extensive disgorgement, the Court found that disgorgement is a longstanding equitable principle that “deprive[s] wrongdoers of their net profits from unlawful activities…” such that a disgorgement order is within the equitable powers of the courts. However, the Court noted that the traditional equitable remedy encompassing the disgorgement doctrine was not intended to be penal in nature, and is therefore subject to three limits: (1) its purpose can only be to return a defendant’s gains to the investors who were wronged; (2) it applies solely to each defendant’s individual profits, such that the defendants cannot be jointly and severally liable for the cumulative unlawful gains of all the defendants; and (3) the amount of disgorgement is limited to the net profits, i.e., gains after deduction of legitimate expenditures. The Court also chided the SEC for claiming that the primary purpose of disgorgement was to deprive wrongdoers of their profits, rather than to return funds to investors as a form of restitution. As Justice Thomas noted in his dissenting opinion, funds claimed for disgorgement often end up in the U. S. Treasury and are not distributed to the victims, yet the purpose of disgorgement is to compensate victims, not to “enrich the government.”
The Liu case therefore stands as a significant limitation on the SEC’s powers to seek engorgement, and will have an impact on the settlement of SEC actions. It also highlights the difficulties in, if not the dangers of, the SEC’s tendency to seek to expand its remedial powers through court proceedings rather than through the legislative process.