The SEC Loses an Arrow from Its Quiver in Liu v. SEC

Footnotes for this article are available at the end of this page.

On June 22, 2020, the U.S. Supreme Court published its decision in Liu v. Securities and Exchange Commission, confirming the SEC’s authority to seek disgorgement from federal courts in enforcement actions. This was an important question that the Court raised but did not answer in 2017. The confirmation, however, comes with limitations not previously imposed on the SEC, which include a limit on the SEC’s recovery to the net profits of the unlawful activity and a requirement that recovered proceeds be returned to investors whose money is disgorged.

The Court had granted certiorari in this case “to determine whether § 78u(d)(5) (“Section 21(d)(5)”) authorizes the SEC to seek disgorgement beyond a defendant’s net profits from wrongdoing.” 589 U.S. __ (2019). That provision authorizes the SEC, “[i]n any action or proceeding brought or instituted . . . under any provision of the securities laws,” to seek and obtain from Federal court “any equitable relief that may be appropriate or necessary for the benefit of investors.”1   In interpreting Section 21(d), Justice Sotomayor, writing for the 8-to-1 majority, noted that Congress had incorporated traditional equity principles into this provision, and those principles include limiting recovery only to “ill-gotten gains” and refunding recovered proceeds to the victims of unlawful activity. The Court’s decision in Liu,  absent Congressional intervention, will impose limitations and additional work on the SEC, requiring it to account for net profits in seeking disgorgement relief and to disburse those net profits to investors.

Kokesh’s Anticipation of Liu

As noted in a previous AGG alert, the SEC has long been relying on equity jurisprudence to seek and obtain disgorgement recoveries against defendants in federal court enforcement actions. While Congress explicitly authorized the SEC to obtain disgorgement in administrative proceedings, it did not grant that remedy specifically to the SEC for federal court actions. In Kokesh v. SEC, 137 S. Ct. 1635 (2017), the Court asked whether the 5-year statute of limitations of 28 U.S.C. § 2462, used for enforcement of “any civil fine, penalty, or forfeiture,” applies to [SEC] claims for disgorgement imposed as a sanction for violating federal securities law.”2   Characterizing disgorgement in the “securities-enforcement context” as a penalty, the Kokesh Court found that § 2462 applied. The Court raised—but declined to answer—the more fundamental question concerning the SEC’s authority to seek disgorgement in the first instance.

Background of the Liu Case

Petitioners Charles Liu and Xin Wang (“Defendants”), husband and wife, fraudulently used an investment fund to raise almost $27 million from foreign-national investors. The fund targeted foreign nationals seeking permanent residence in the United States under the EB-5 Program, which allows applications for residence based on investments “in approved commercial enterprises that are based on ‘proposals for promoting economic growth.’”   Defendants claimed that the bulk of contributions would be used to construct a cancer treatment center but spent nearly $20 million on “ostensible marketing expenses and salaries,” far in excess of the offering memorandum’s representation, and diverted almost $7 million to themselves. The District Court, found Defendants jointly and severally liable and ordered them to disgorge the entire amount that the investors had paid them and to pay a civil money penalty equal to their personal gain on the scheme. In the District Court and on appeal to the Ninth Circuit Court of Appeals, Defendants unsuccessfully argued that the disgorgement award should also be net of the business expenses incurred in the scheme.

The Decision

The majority opinion affirmed the SEC’s right to seek disgorgement, relying upon the longstanding tenet of equity that has “routinely deprived wrongdoers of their net profits from unlawful activity, even though that remedy may have gone by different names.” The court specified two principles of equity: first,  the wrongdoer should not profit from his or her wrong and, second, the wrongdoer should not be punished by paying more than a fair compensation to the person wronged. The Court also confirmed that disgorgement is a limited form of penalty, inasmuch as it “takes money out of the wrongdoer’s hands,” and a type of restitution, inasmuch as it restores the parties to the status quo prior to the wrongful conduct. This situates disgorgement “squarely within the heartland of equity.”4

The Court noted that Defendants “briefly argue” that the SEC’s disgorgement award in this case violated traditional equity principles because (1) it does not return funds to victims; (2) it imposes joint-and-several liability on Defendants; and (3) it failed to deduct business expenses. The Court makes the point that the SEC’s pursuit of disgorgement in general, and potentially also in the case of Liu and Wang, has encroached upon each of those limitations.  Because petitioners did not fully brief the narrow questions of whether the SEC had “cross[ed] the bounds” specifically in the case before it, the Court declined to decide whether that had happened in this instance and remanded to the District Court to conduct further review in light of their opinion.

As to the first point, the SEC argued that “the primary function of depriving wrongdoers of profits is to deny them the fruits of their ill-gotten gains, not to return the funds to the victims as a kind of restitution.”5   According to the SEC, Section 21(d)(5)’s requirement that disgorgement “be appropriate or necessary for the benefit of investors” does not refer to the specific investors of the case but to all investors, and for that reason the SEC is not required to refund ill-gotten funds from the harmed investors to the specifically harmed investors. The Court disagreed, but left open the question of situations in which the administrative costs of redistributing disgorgements exceed the total disgorgement amount.

As to the second point, the Court observed that the SEC’s common imposition of “joint-and-several liability” in disgorgement cases is “at odds with the common-law rule requiring individual liability for wrongful profits” because it “could transform any equitable profits-focused remedy into a penalty.” It noted that in this matter, however, Defendants were married and no evidence suggested their finances were not, in fact, commingled.

To the third and arguably most important point, the Court noted that “legitimate expenses” may be deducted from gross amounts received, which may require an analysis of whether the expenses or some portion of the expenses were legitimate as opposed to wrongful and inequitable deductions, for example, for personal services. The Court noted that in a case of an “entirely fraudulent scheme,” “personal services” expenses incurred by the defendants should be disallowed as “inequitable.”


The Liu decision resolves the Kokesh issue, namely whether disgorgement is necessarily a penalty and thus not available as equitable relief. As long as the award does not exceed net profits and is refunded to the victims, it is equitable relief and not a penalty. The Court expressly notes that the Kokesh decision “has no bearing on the SEC’s ability to conform future requests for a defendant’s profits to the limits outlined in common-law cases awarding a wrongdoer’s net gains.”

The SEC’s broad argument that “the very fact that it conducted an enforcement action” is enough to show that the relief benefits investors did not convince the Court; the Court notes that the SEC’s conception of “investor benefit” would “render [the statute] meaningless.” The decision envisions a case where the government might retain funds when “it is infeasible to distribute the collected funds to investors,” but it is unclear what set of facts would meet this test in light of the Court’s directives.6


[1] Other subsections of 15 U.S.C. § 78u provide the SEC with other forms of relieve in federal court, including the right to have courts order payment of monetary penalties and grant officer-and-director bars.

[2] Justice Sotomayor also wrote the opinion in Kokesh.

[3] Slip op., at 4.

[4] Slip op., at 7.

[5] Id. at 15.

[6] In November of 2019, the U.S. House of Representatives passed H.R. 4344 “Investor Protection and Capital Markets Fairness Act,” which would provide, among other things, the SEC statutory authority to seek disgorgement in action brought in federal court.  It remains to be seen if and how the Bill would abrogate the Court’s decision in Liu. Indeed, in light of Liu, Congress may well revisit the proposed fix to address the Court’s concerns or render them moot.