The U.S. Court of Appeals for the Fifth Circuit on Oct. 12, 2021, became the first federal appellate court to decide whether a disgorgement award entered against defendants in an U.S. Securities and Exchange Commission (SEC) civil enforcement proceeding was "for the benefit of investors," as required by the U.S. Supreme Court in Liu v. SEC, 140 S. Ct. 1936, 1949 (2020). As discussed in a previous alert (see "Supreme Court Permits SEC Disgorgement of Net Profits, in Liu v. SEC," June 22, 2020), the Court held in Liu that disgorgement is an "equitable" remedy that may be ordered in securities cases so long as the disgorgement amount 1) does not exceed a defendant's "net profits," and 2) is awarded for the benefit of the victims of the defendant's misconduct. Liu, 140 S. Ct. at 1942.
The Fifth Circuit addressed Liu's second prong in SEC v. Blackburn, No. 20-30464 (5th Cir. Oct. 12, 2021). In Blackburn, the U.S. District Court for the Eastern District of Louisiana initially ordered the disgorged amounts to be distributed by the SEC to the U.S. Treasury. Id. at 9 & n.6. After the defendants appealed to the Fifth Circuit, the Supreme Court decided Liu. The Fifth Circuit granted the SEC's request for a limited remand to the district court to modify the disgorgement order in light of Liu. The district court amended its order so that, rather than the disgorgement amounts going to the U.S. Treasury as initially ordered, the disgorged amounts would be paid to the SEC, as "de facto trustee," to then distribute to the identified investors upon the district court's approval. Id. at 8. The district court's amended order specifically states that the SEC's plan to distribute the disgorged amounts to harmed investors may provide for distribution pursuant to the Fair Fund provisions of Section 308(a) of the Sarbanes-Oxley Act of 2002. See 15 U.S.C. § 7246(a).
The defendants appealed the district court's amended disgorgement order. The Fifth Circuit rejected the defendants' argument and affirmed the district court's judgment in favor of the SEC, holding that, by establishing a mechanism for identifying harmed investors and returning funds to them, "the disgorgement thus is being 'awarded for victims' " and "[t]he district court's order—requiring disbursements to already-identified victims with court supervision to ensure compliance with that edict—easily satisfies Liu." Order at 9. Blackburn does not answer the harder question of whether disgorgement is "awarded for victims" when proceeds are paid to the U.S. Treasury where, for instance, it is infeasible for the SEC to distribute to the investors (e.g., because of difficulty identifying investors or where the cost to distribute exceeds the amount to be distributed). Id. However, under Blackburn, in cases where harmed investors can be identified and distribution is feasible, establishing a mechanism for identifying and returning funds to investors, including through a Fair Fund, satisfies Liu in the Fifth Circuit.