The US Supreme Court ruled 8-1 Monday that the Securities and Exchange Commission may seek disgorgement awards in securities fraud cases.
The question came to the Court through Liu v. Securities and Exchange Commission, which involves a scheme to defraud foreign individuals seeking permanent residence in the United States through the EB-5 Immigrant Investor Program. The EB-5 program allows noncitizens to apply for permanent residence in the United States by investing in commercial activities that promote economic growth. Petitioner Charles Liu and his wife Xin (Lisa) Wang solicited investment for a cancer-treatment center from foreign investors seeking to use the EB-5 program. However, the Petitioners used only a fraction of the funds for expenses related to the treatment center. Instead, they spent nearly $20 million on marketing expenses and salaries and diverted funds to a personal account in a company under Wang’s control.
In the Court’s opinion, Justice Sotomayor stated that “a disgorgement award that does not exceed a wrongdoer’s net profits and is awarded for victims is equitable relief permissible under §78u(d)(5).” The Court’s decision vacates the Ninth Circuit’s decision by limiting the disgorgement relief and remands the case.
The specific question was whether the disgorgement was a typical “equitable remedy” permitted under § 78u(d)(5). In her opinion, Justice Sotomayor explained that there are two principles that must be considered: that courts may “strip wrongdoers of their ill-gotten gains” and that courts should “avoid transforming an equitable remedy into a punitive sanction.” These two principles guided the Court’s opinion.
Justice Sotomayor explained that there are many names used to describe the remedy stripping a wrongdoer of ill-gotten gains, including “restitution,” “an accounting,” and “disgorgement.” However, the Court stated, “[n]o matter the label, this ‘profit-based measure of unjust enrichment . . . reflect[s] a foundational principle: “[I]t would be inequitable that [a wrongdoer] should make a profit from is own wrong.’”
The Court also explained that “disgorgement” is a relatively recent term used by courts. The fact that the term is recent and was not a remedy when the statute in question was written guided Justice Thomas in his dissent.
Additionally, Justice Sotomayor demonstrated that past decisions have “compared disgorgement to restitution that simply ‘restor[es] the status quo,’ thus situating the remedy squarely within the heartland of equity.”
However, the Court ensured that proper limitations are placed on the disgorgement award. The Court stated that the award must be restricted to “net profits from wrongdoing after deducting legitimate expenses.” Additionally, the Court rejected the government’s argument that disgorgement should be used to deny the wrongdoer their gains rather than make the investor whole. The Court stated, that in this case, the disgorgement must seek to make the investor whole in order to fall within the definition of an “equitable remedy.” Finally, the Court stated the joint-and-several liability is permissible when, like in this case, parties are “engaged in concerted wrongdoing.”
In all, the Court made an important ruling that preserved disgorgement as an equitable remedy in securities fraud cases, but defined the contours of the law with several fact-intensive limitations.