The Supreme Court imposed limits on the Securities and Exchange Commission’s ability to compel defendants through the federal court system to disgorge profits earned through fraud.
In 2019, the SEC reportedly recovered a total of $3.2 billion in profits from people determined to have violated securities law. Disgorgement orders are different from the fines levied by the SEC.
The June 22 ruling came in a case cited as Liu v. Securities and Exchange Commission (SEC). The vote by the justices was 8–1. The majority opinion was written by Justice Sonia Sotomayor, and Justice Clarence Thomas wrote the sole dissenting opinion.
The Supreme Court held that the SEC is allowed to recover funds from those who commit securities fraud provided the agency doesn’t seek to take back an amount greater than the wrongdoer’s actual net profits.
“The Court holds today that a disgorgement award that does not exceed a wrongdoer’s net profits and is awarded for victims is equitable relief permissible” under federal law, Sotomayor wrote for the court.
According to court documents, petitioners Charles C. Liu and his wife, Xin Wang, ran a business called the Pacific Proton EB-5 Fund that used marketing companies to recruit Chinese investors in search of U.S. visas.
The EB-5 Immigrant Investor Program, created by Congress in 1990, is administered by U.S. Citizenship and Immigration Services (USCIS). Noncitizen investors, along with their spouses and unmarried children under 21, are eligible to apply for green cards if they invest in an approved “commercial enterprise in the United States; and plan to create or preserve 10 permanent full-time jobs for qualified U.S. workers,” according to USCIS.
The fund pooled the investments to sponsor a planned cancer treatment center in California. Each investment unit cost $500,000, plus a $45,000 administrative fee.
From October 2014 to April 2016, 50 individuals bought units in the fund, which generated $24,712,217 in capital commitments and $2,255,701 in administrative fees.
Construction on the medical center got underway in 2015, and Liu and Wang were hoping to generate any other needed funds through private equity markets.
Progress on the project stalled over internal management disputes and in May 2016, the SEC sued Liu and Wang, claiming they violated the terms of the offering documents and defrauded investors.
A U.S. District Court found for the SEC, imposed a civil penalty, and issued an injunction preventing the couple from further participation in the EB-5 program. It also ordered the petitioners to surrender all of the money raised through investors, minus the $234,899 remaining in corporate accounts for the project.
The petitioners objected, claiming that the disgorgement award failed to factor in their business expenses. The District Court disagreed, deciding that the sum was a “reasonable approximation of the profits causally connected to [their] violation.”
The petitioners appealed to the 9th Circuit Court of Appeals and lost. The appeals court concluded that the “proper amount of disgorgement in a scheme such as this one is the entire amount raised less the money paid back to the investors,” and that it would be unjust to allow the petitioners to offset the expenses of running the business they established to defraud investors.
But the Supreme Court took a different view.
After acknowledging in its opinion that the courts have long had the authority “to strip wrongdoers of their ill-gotten gains,” Sotomayor wrote that the courts have “restricted the remedy to an individual wrongdoer’s net profits to be awarded for victims.”
Moreover, “Congress prohibited the SEC from seeking an equitable remedy in excess of a defendant’s net profits from wrongdoing,” she added.
The Supreme Court returned the case to the 9th Circuit with instructions that it make certain that the amount to be disgorged does not exceed the net profits.
In his dissent, Thomas agreed with the petitioners, writing that current law doesn’t grant to the SEC the power to order disgorgement.
The Supreme Court is correct not to affirm “the Ninth Circuit’s decision upholding the District Court’s disgorgement order, but I disagree with the Court’s decision to vacate and remand for the lower courts to ‘limi[t]’ the disgorgement.”
“Disgorgement can never be awarded under 15 U. S. C. §78u(d)(5),” which authorizes the SEC to seek only “equitable relief that may be appropriate or necessary for the benefit of investors,” he wrote.
“Disgorgement is not a traditional equitable remedy,” Thomas wrote.
The Supreme Court has yet to issue opinions in 14 cases before it wraps up its current term. Usually, the court concludes its work by the end of June, but disruptions to its schedule this year may force it to continue sitting in July.