Narrow Supreme Court ruling allows SEC to obtain disgorgement, but leaves questions unresolved

Equitable disgorgement and the SEC

Although the SEC has long claimed the authority to ask courts for disgorgement awards, Congress did not address explicitly the SEC’s equitable remedies authority until 2002, when it authorized the SEC to seek “any equitable relief that may be appropriate or necessary for the benefit of investors” (15 U.S.C. § 78u(d)(5)). In 2020, the Supreme Court held in SEC v. Liu that this provision authorizes disgorgement, but only when cabined to the traditional boundaries for equitable relief aimed at restoring the status quo for the benefit of victims (591 U.S. 71 (2020)).  As a result, the Supreme Court held that disgorgement must be “awarded for victims” (Id. at 79). Shortly after Liu was decided, Congress passed a new statute explicitly adding “disgorgement” to the SEC’s list of available remedies (15 U.S.C. § 78u(d)(7), known as the 2021 Statute).

The question presented to the Supreme Court

The question before the Court in Sripetch was whether the SEC, in light of Liu, must prove that victims suffered a financial loss in order for the SEC to seek disgorgement from a defendant. The petitioner (who had been found liable for multiple pump-and-dump schemes) argued that the 2021 Statute had codified the Court’s definition of disgorgement under Liu, together with the equitable limitations imposed by the Court. In his view, one such equitable limitation was that disgorgement be awarded to investors. Because the SEC had failed to prove financial investor losses, he reasoned, disgorgement could not meet this test. Widening a circuit split, the Ninth Circuit disagreed, reasoning that the SEC need only show “actionable interference by the defendant with the claimant’s legal protected interests,” which petitioner had conceded.

The Supreme Court views disgorgement in equitable terms

The Court in Sripetch held that the SEC may obtain disgorgement even when investors have not suffered a measurable financial loss. Relying on traditional principles of equity, the Court explained that disgorgement focuses on the defendant’s unjust gains rather than the victim’s losses. The Court concluded that a defendant may profit from conduct that invades another’s legally protected interests without causing measurable pecuniary harm. In those situations, the Court reasoned, equity traditionally favors stripping the wrongdoer of those ill-gotten gains. On that basis, the Court concluded that proof of pecuniary harm is not a prerequisite to disgorgement.

What the Supreme Court left open

The decision’s significance lies as much in what it declined to resolve. The Court expressly left open “whether Congress’s recent amendments free the SEC from the traditional equitable rule that disgorgement must be ‘awarded for victims.’” Of course, answering that question in the negative raises yet another question: What must the SEC show to meet that standard?  (The Court suggested that the SEC’s practice of retaining investor funds, rather than distributing them to investors, could make it difficult for the SEC to win on this point.)  Relatedly, the Court’s decision did not examine whether Congress overrode the piece of Liu’s holding that limited disgorgement to net profits.

Even if the Court ultimately decides that Section 78u(d)(7) overrides Liu, at least two other significant questions remain:

• Are technical violations different? In the lower courts, Sripetch conceded that the pump-and-dump scheme violated investors’ “legally protected interests.” Thus, neither the Ninth Circuit nor the Supreme Court reached the meaning of that phrase in the SEC enforcement context, much less in a case outside a traditional fraud context. Consequently, the decision leaves open whether disgorgement is available for more technical regulatory violations that do not invade legally protected investor interests, in a pecuniary way or otherwise. The SEC almost certainly cannot be considered a “victim” without converting disgorgement into a penalty.
• What are the implications if disgorgement under Section 78u(d)(7) is unconstrained by Liu’s equitable limitations? To expand its disgorgement authority, the SEC has argued that Section 78u(d)(7) authorizes a form of statutory disgorgement that is not constrained by the equitable limitations recognized in Liu. The Court declined to decide that question in Sripetch. But the further disgorgement moves away from traditional equitable relief, the stronger the argument becomes that it is a penalty or legal remedy requiring a jury trial under the Seventh Amendment, with potentially significant consequences for SEC administrative proceedings.

The Sripetch decision also did not answer several other ancillary questions raised by the statute. For example, as the Court observed, Section 78u(d)(3) requires the SEC to show that a person received unjust enrichment “as a result of” the violation. We expect defense attorneys and experts to continue to argue about the connection between the conduct and any profits earned by a defendant.

Takeaways

Even when the SEC may have an argument for liability, questions of monetary relief are often a critical component of a decision to settle or litigate.  For years to come, negotiating or litigating disgorgement will require careful analysis. Early in an examination or investigation, and throughout the matter, individuals and entities subject to SEC scrutiny should consider:

• Balancing judicial and SEC perspectives on disgorgement when confronting demands from the Division of Examinations for repayment to allegedly harmed investors, particularly outside the fraud context.
• Developing a record on whether putative victims exist, whether their legally protected interests were invaded, and whether they suffered actual loss, both to preserve arguments and to constrain disgorgement under causation principles.
• Evaluating the SEC’s ability to pursue disgorgement in administrative proceedings and the effect on litigation and settlement strategy.

As the concurring opinion noted, cases continue to work their way through the courts. McDermott Will & Schulte’s national bench of SEC enforcement defense lawyers stand ready to answer questions about SEC enforcement risk and strategy.