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Fair and Unfair in Creating Funds for Securities Fraud

A discussion of 'Liu v. SEC,' where the Supreme Court clarified the scope of the disgorgement remedy, and limited the SEC's discretion in making restitution to victims of securities fraud.

New York Law Journal
August 13, 2020

By Eric Lewis

In an important ruling on the scope of the powers of the Securities and Exchange Commission to order disgorgement of the proceeds of fraud as well as disbursement to victims, the United States Supreme Court issued an 8-1 opinion in the case of Liu v. SEC. Justice Sonia Sotomayor, writing for the majority, affirmed the power of the SEC to order disgorgement as a remedy independent from civil money penalties but circumscribed the scope of the remedy.

The remedy was limited by equity to the net profits of the wrongdoing and that there was no joint and several liability with respect to multiple wrongdoers, with each one accountable for his or her own unjust receipt of profits. She also suggested that the SEC had obligations to make disgorgement funds available to victims of the specific frauds, but the likely amounts available to victims will be lower.

The petitioners were husband and wife securities fraudsters who solicited $27 million from foreign investors investing under a federal immigrant visa investment program, allegedly to fund cancer treatment centers. Around $20 million was diverted for various purposes other than developing the project including the personal use of the promoters.

The SEC sought to recover as disgorgement the entire amount raised from investors less a small amount remaining in company bank accounts. The government had asserted that the SEC had broad powers to order disgorgement, even beyond what equity would require—the payment of all ill-gotten gains.  The petitioners asserted that the SEC was treating disgorgement as a penalty, which was beyond the limited civil penalties permitted by the statute.

The Supreme Court by 8-1 held that disgorgement is not a penalty, but that it is a distinct equitable remedy that is limited to the net profits made from the scheme by the wrongdoers. The court rejected the approach usually taken by the SEC, and adopted by the lower court, of ordering disgorgement of net proceeds, explaining that “courts must deduct legitimate expenses before ordering disgorgement.” The court’s ruling clarified that the disgorgement remedy, although not provided for specifically by statute, is within the SEC’s statutory authority to obtain equitable relief, in addition to monetary penalties, but that equitable relief is limited by the traditional remedies of courts of equity.

The Supreme Court’s 2017 case, Kokesh v. SEC, 137 S. Ct. 1635 (2017), had suggested that the disgorgement remedy was a penalty in the context of assessing the relevant statute of limitations. The Court rejected that construction of Kokesh, but in doing so substantially limited the power of the SEC to force some of the huge restitution agreements that have created large fair funds in the past in two important ways.

Traditionally, the monetary penalties imposed by the SEC had been limited and the much larger awards came through disgorgement. With disgorgement limited to net profits, the amounts paid through resolution of enforcement actions is likely to diminish significantly, especially where there was a real underlying project in which significant funds were invested and the fraudulent diversion of funds was a relatively minor proportion of the total proceeds.

Thus, a Madoff-type fraud, where there were no real investments, would continue to generate a large fund for victims, but a scheme in which a legitimate project goes wrong or asset values plummet and are not disclosed would likely lead to much smaller disgorgement.

The court also found that the remedy could only be ordered based on individual action and not based on joint and several liability.  Thus, the SEC would need to adjudicate how the profits from a fraudulent scheme were allocated among multiple wrongdoers and could only recover the portion received by each of the wrongdoers, unless the wrongdoers were actually acting in concert.

To the extent that some tortfeasors may be judgment proof, it may be the case that defendants with assets independent of the scheme may have smaller amounts to pay, while those with large awards against them will be unable to satisfy them.

The decision is likely to lead to extensive litigation of both the scope of the disgorgement penalty and whether its calculation of net profits to wrongdoers is accurate. It is also likely to lead to disputes in multi-defendant cases as to which defendant is responsible for what portion of the disgorgement. Because awards may be smaller and enforceability more doubtful, we can also expect to see victims become more aggressive in claiming greater harm than others so that they should receive a larger share of a smaller and incomplete pie.

The SEC also asserted that it did not need to pay victims and could remit proceeds to Treasury to reimburse for costs of investigation and for other internal costs, including for its inspector general.  Effectively, the SEC has traditionally claimed broad discretion to distribute funds in the public interest generally. While it frequently makes payments to defrauded investors, it has also retained investigative and other costs and made payments to the Treasury. Victims were viewed as able to seek restitution but not to have enforceable rights.

The Liu court strongly suggested that disgorgement should be returned to those who were defrauded rather than distributed more generally. While the court declined to specifically decide the issue, it strongly suggested that the SEC could not just pay all funds to the Treasury as restitution to the general public which has a generalized interest in the integrity of the securities markets.   Payments needed to be tied to a program of specific victim restitution for that fraud rather than collected for the Treasury unless it is “infeasible to distribute the collected funds to investors.”

Because no disgorgement funds had been remitted to the SEC, the Supreme Court left the issue to be decided in the first instance by the lower courts. Certainly, there will be more conflict with the SEC and victims if the SEC tries to carve out a major slice of the proceeds for its own costs or for general benefits to investors.

The Liu decision drew a rare 8 votes and reflects benefits and costs for all stakeholders. The disgorgement penalty was affirmed as an independent source of recovery distinct from monetary penalties. But it was limited to ill-gotten gains, which requires complex calculations that the SEC previously did not need to make when it tried to force disgorgement of gross proceeds. It also rejected joint and several liability, which makes individual defendants only liable for their own activity and own profits. Again, this will lead to complex considerations of allocation of responsibility and profits. Victims are likely to see smaller pots available for distribution, but the court clearly signaled that the SEC’s discretion to ignore specific victims and remit to the Treasury is limited.

Reprinted with permission from the August 13, 2020 edition of the New York Law Journal © 2020 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or


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