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US Securities and Exchange Commission

Supreme Court Agrees to Review SEC Disgorgement Case

Thomson Reuters Tax & Accounting  

Thomson Reuters Tax & Accounting  

By Bill Flook

The Supreme Court on November 1, 2019, agreed to hear a case challenging the SEC’s authority to collect so-called disgorgement, a key enforcement tool used to return ill-gotten profits to defrauded investors.

The petition in Liu v. SEC, involving a couple accused of scamming Chinese investors who sought U.S. visas, represents another significant challenge to the SEC’s disgorgement authority following the 2017 Kokesh ruling, which subjected disgorgement to a five-year statute of limitations.

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.”

In Kokesh, the High Court ruled 9-0 that a five-year statute of limitations applies to disgorgements, but left open the broader question of whether the SEC had the power to collect disgorgement in the first place.

In her 11-page opinion, Justice Sonia Sotomayor concluded that a disgorgement is tantamount to a penalty, which means any enforcement action must start within the five-year window. The funds, Sotomayor noted, are not always used to pay back victims of securities fraud, and in some cases are handed over to the U.S. Treasury.

“SEC disgorgement thus bears all the hallmarks of a penalty: It is imposed as a consequence of violating a public law and it is intended to deter, not to compensate,” she wrote. Disgorgements are generally meant to apply only to ill-gotten profits, not total losses, although Sotomayor, in her ruling, noted that “SEC disgorgement sometimes exceeds the profits gained as a result of the violation.”

And in an oft-cited footnote, Sotomayor wrote that “nothing in this opinion should be interpreted as an opinion on whether courts possess authority to order disgorgement in SEC enforcement proceedings or on whether courts have properly applied disgorgement principles in this context.”

SEC officials have warned that the Kokesh ruling has forced them to forego reclaiming more than $900 million in investor losses.

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, 2019, 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.”

 

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