On March 3, 2020, the Supreme Court heard oral arguments on whether the SEC can compel those who commit securities fraud to “disgorge” (give up) the gains from their fraud. An unfavorable decision in this case, Liu v. SEC, could greatly reduce awards to whistleblowers because the amount disgorged is a major factor in determining the size of a whistleblower’s award.

Those who voluntarily provide original information disclosing violations of the federal securities laws can receive monetary awards if the information led to an enforcement action resulting in more than $1 million in “monetary sanctions.” The term “monetary sanctions” includes the penalties imposed on the violator and the illicit gain the violator is ordered to disgorge.

Because an eligible whistleblower is entitled to 10% to 30% of all funds recovered by the SEC, the size of the award depends in large part on the amount disgorged. Since the inception of the awards program, the SEC has collected more than $2 billion based on tips from whistleblowers, with 50% of this amount collected via disgorgement orders.

The Liu case arose when the SEC alleged that Charles Liu and his wife, both California residents, collected almost $27 million by defrauding Chinese investors seeking permanent residence in the US via the EB-5 Immigrant Investor Program. The trial court found that the defendants engaged in “a thorough, long-standing scheme to defraud” and ordered that most of the $27 million generated by the fraud be disgorged. After the Ninth Circuit upheld that decision, the Supreme Court agreed to hear Liu’s challenge to disgorgement.

The federal courts have been ordering fraudsters to disgorge illicit gains since 1971. Additionally, Congress has given the SEC express authority to require disgorgement in administrative proceedings. The appellants in Liu v. SEC are asking the Supreme Court to override that long-standing precedent and find that the courts have no authority to require disgorgement by securities law violators.

The briefs filed in the Supreme Court on Liu’s behalf argued that disgorgement is a “penalty” intended to punish, rather than an “equitable” remedy intended to offset the harm resulting from the fraud. The distinction between a “penalty” and “equitable relief” is crucial in this context because the courts have based their authority to award disgorgement (in the absence of express statutory authorization) on inherent judicial power to remediate the consequences of proven violations.

Liu’s argument that disgorgement is punitive rests on the 2017 decision in Kokesh v. SEC, which held that disgorgement is a form of penalty for purposes of the statute of limitations. Liu’s pre-hearing briefs contended that because “[p]unishment . . . is exactly the aim of disgorgement,” and because the Court has already found that disgorgement is a penalty for purposes of the statute of limitations, disgorgement is necessarily beyond the equitable powers of the courts. Liu also argued that because the SEC can separately recover statutorily-enumerated penalties, disgorgement is unnecessary.

A small army of securities industry representatives and conservative think tanks filed amicus curiae briefs in support of Liu’s position, including the Securities Industry and Financial Markets Association, Americans for Prosperity Foundation, Chamber of Commerce of the United States, Washington Legal Foundation, and Cato Institute. In general, these amici supported Liu’s reliance on Kokesh, attempted to distinguish disgorgement from traditional equitable remedies, claimed that disgorgement is unnecessary, and argued that the SEC and the courts should be confined to their express statutory authority.

The SEC’s opposition brief relied heavily on the multiple lower court decisions holding that the power to order disgorgement is inherent in the authority of the courts to enter injunctions implementing judicial rulings. The SEC also emphasized that Congress has repeatedly enacted legislation that explicitly or implicitly approved of disgorgement. Probably the most sensitive point addressed in the SEC’s brief was the acknowledgement that at times disgorgement has been used to recover not only the violator’s net profits but the entire amount taken in during the fraud. Similarly, the SEC had to acknowledge that the funds gathered through disgorgement do not always go to harmed investors, a factor that distinguishes disgorgement from restitution.

Several amici briefs were submitted in support of disgorgement, including briefs on behalf of members of Congress, securities administrators, former SEC commissioners, law professors, and about half of the states. These amici generally emphasized the importance of disgorgement to securities enforcement and the fact that Congress has recognized the value of this enforcement tool.

Prior to the March 3 argument, it was widely anticipated that the SEC would have a difficult day in court. This was because three years earlier, in the Kokesh case, the Court took the unusual step of implicitly inviting a challenge to disgorgement. Although none of the parties in Kokesh had raised this issue, the Court sua sponte stated that “nothing in this opinion [the Kokesh decision] should be interpreted as an opinion on whether the courts possess authority to order disgorgement in SEC enforcement proceedings.”

The March 3 hearing began as anticipated, with Liu’s counsel asserting that since the Court had already held in Kokesh that disgorgement was a penalty, logic alone put disgorgement beyond the courts’ equitable powers. But that reasoning drew little support from the bench. According to the transcript of the argument, Justice Ginsburg immediately pointed out that it is a mistake to assume that a term used in two different contexts must have the same meaning in both contexts (a fallacy she described as “a notion that has all the tenacity of original sin”). Liu’s counsel of course could not disagree.

Justice Ginsburg then challenged Liu’s counsel to explain why disgorgement could not be seen as an equitable remedy since it was “an equitable principle that no one should be allowed to profit from his own wrong.” This too was something Liu’s counsel could not dispute.

These early exchanges redirected the argument away from Liu’s “all or none” attack on disgorgement and toward a discussion of the appropriate boundaries of disgorgement. Justice Alito asked whether the real question was whether disgorgement had simply been interpreted too broadly in some cases. Specifically, he posited that disgorgement might be considered “a traditional form of equitable relief” if it were limited to net profits and “every effort was made to return the money to the victims of the fraud.” In the face of similar questions from Justice Kavanaugh, Liu’s counsel fell back on unconvincing arguments to the effect that disgorgement was properly available only where there was a breach of fiduciary duties.

Liu’s counsel was also pressed hard by Justices Sotomayor and Kagan to explain why the several references to disgorgement in recent legislation did not indicate that Congress approved of this remedy. This too led the discussion away from Liu’s frontal attack and back into consideration of the proper limits on disgorgement. Much of the subsequent questioning during Liu’s presentation dealt with whether it was appropriate to use disgorgement to recover more than the fraudster’s net profits and how disgorged funds had been and should be used (i.e., returned to harmed investors or transferred to the U.S. Treasury).

During the SEC’s portion of the hearing, the Justices continued to focus on what should be recoverable in disgorgement and how disgorged funds should be used. It was clear that at least certain Justices felt that disgorgement should ordinarily be limited to net profits, an issue important to Liu’s situation because the lower courts required disgorgement of almost all funds gathered in connection with the fraud. It was also clear that the Court would find it easier to approve disgorgement orders if the funds collected were to be returned to investors, if feasible, or otherwise used for the benefit of investors.

In sum, the tone of the March 3 argument was surprisingly favorable to the SEC on the fundamental question of SEC and judicial authority. Judging from the questioning, it would not be surprising if the decision articulates limits on what can be recovered in disgorgement and on how any disgorged funds must be distributed. But it seems unlikely that such limits would significantly reduce the amount recovered via disgorgement in most situations, although the SEC might be required to make greater efforts (possibly before obtaining a disgorgement order) to identify and locate investors eligible to receive the disgorged funds. The Court might also remand the Liu matter itself for inquiry into the proper calculation of disgorgement in that case. However, and most important with regard to the size of future whistleblower awards, none of the questioning on March 3 suggested agreement with Liu’s claim that disgorgement is beyond the equitable power of the courts.

A decision is expected by the end of June.

Whistleblower Aid

The foregoing discussion is provided by Whistleblower Aid for general information purposes and is not intended to be, and should not be, taken as legal advice. For guidance on how to contact Whistleblower Aid, see https://whistlebloweraid.org/contact#whistleblower-contact.