By Bill Flook
Two years ago, the Supreme Court told the SEC that its practice of recouping ill-gotten gains on behalf of defrauded investors was tantamount to a penalty, and therefore subject to a five-year statute of limitations. Now, it is mulling whether the SEC has the authority to collect so-called disgorgement in the first place.
For advocates of a strong SEC enforcement regime, the Supreme Court’s November 1, 2019, decision to take up Liu v. SEC represents a worrying development. In many ways, the case is a sequel to the 2017 ruling in Kokesh v. SEC, in which the High Court sharply limited the SEC’s ability to reach into the past to restore funds to wronged investors but sidestepped the question of whether the SEC had any underlying statutory basis for collecting disgorgement through enforcement actions in federal court.
In her 11-page Kokesh opinion, Justice Sonia Sotomayor concluded that a disgorgement “bears all the hallmarks” of a penalty, which means any enforcement action must start within the five-year window. The rest of the court agreed.
“It is always difficult to predict the outcome in a Supreme Court case, but the unanimous decision in Kokesh is worrisome,” said Stephen Hall, legal director and securities specialist at Better Markets. “And it does suggest how the justices might view the fundamental question of whether the SEC can seek disgorgement at all and whether a federal court can award it at all.”
SEC officials have warned that the Kokesh ruling has forced them to forego reclaiming more than $900 million in investor losses, a figure that could grow in the event of an unfavorable ruling in Liu v. SEC.
Better Markets is going to give “serious consideration” to filing an amicus brief in Liu v. SEC, according to Hall.
In October 2018, the Ninth Circuit Court of Appeals upheld a $35 million judgment against Charles Liu and his wife, Xin Wang, for misappropriating funds raised under the EB-5 Immigrant Investor program. As part of that judgment, the two were ordered to disgorge $26 million they had raised from investors.
The two petitioned the Supreme Court in late May, saying the court should take up the case “to address the fundamental and frequently litigated issue that Kokesh raised, but did not reach, and to clarify and harmonize the law as to the availability of agency disgorgement in the absence of statutory authority.”
Liu and Wang, in their petition, argued that circuit courts have “struggled to align their precedents with” the Supreme Court’s analysis and require post-Kokesh guidance.
In a September 4 Supreme Court brief, the SEC argued that the petitioners failed to identify any disagreement among courts of appeals “regarding the availability of disgorgement in SEC enforcement actions,” pointing to decades of appeals court rulings that upheld the commission’s disgorgement authority.
“That uniform understanding has remained in effect since this Court decided Kokesh,” the SEC wrote in the brief. “Every court of appeals and every district court that has considered the issue after Kokesh has determined that nothing in that decision calls into question the availability of disgorgement in SEC enforcement actions.”
Hall echoed the SEC’s arguments.
With Liu v. SEC, “you are talking about upending decades of law where there has not been any significant disagreement among the lower courts,” he said. “It’s been taken as a given in the district courts and the appellate courts that this is an appropriate and necessary form of relief that the SEC needs to police wall street.”
In a November 4 memo, Sullivan & Cromwell LLP noted that the Supreme Court’s decision to hear the case “injects uncertainty into the SEC’s practice of obtaining equitable disgorgement in civil enforcement actions.”
The law firm advised parties litigating with the commission to be “certain to preserve arguments that the SEC lacks statutory authority to obtain disgorgement as an equitable remedy.”
Should the Supreme Court strip the SEC of its power to collect disgorgmeent via federal courts, Sullivan & Cromwell predicted that the market regulator may shift more of its enforcement actions to administrative proceedings, where it has explicit statutory authority to collect both disgorgement and penalties.
This article originally appeared in the November 19, 2019 edition of Accounting & Compliance Alert, available on Checkpoint.
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