Executive Summary
The Supreme Court will address Securities and Exchange Commission (SEC) disgorgement authority in enforcement matters that do not allege investor harm. Our White Collar, Government & Internal Investigations and Investment Funds Teams examine the circuit split prompting the review and the potential implications for compliance-related enforcement actions.
- How Liu v. SEC and Section 21(d) of the Securities Exchange Act frame the disgorgement issue
- Why the federal courts of appeals are divided on no-loss disgorgement
- How the Supreme Court’s decision could affect future SEC enforcement exposure
The Supreme Court will consider this term whether the U.S. Securities and Exchange Commission (SEC) may seek disgorgement in enforcement actions lacking identifiable victims or pecuniary harm, resolving a split among the federal courts of appeal. The Court’s decision could significantly impact registrants’ exposure to disgorgement in no-loss enforcement matters involving structural or compliance-related issues.
Supreme Court Guidance on Disgorgement: Liu v. SEC
Section 21(d) of the Securities Exchange Act of 1934 authorizes the SEC to seek equitable relief in enforcement actions, including disgorgement. In Liu v. SEC (2020), the Supreme Court considered the scope and substance of the SEC’s equitable disgorgement power. The Court construed Exchange Act Section 21(d)(5) to permit disgorgement only if there are identifiable victims. Liu rejected the position that disgorgement is intended fundamentally to deprive a wrongdoer of profits. Rather, the Court held, it is confined to pecuniary harm suffered by identifiable victims and is otherwise limited by traditional notions of equity.
Congressional Action in Response to Liu
In 2021, Congress added Section 21(d)(7) to the Exchange Act, which expressly authorizes courts and the SEC to order disgorgement in SEC enforcement actions. However, the amendment did not clarify whether this new authority is subject to the equitable limitations set forth in Liu or allows for a broader, legal mode of disgorgement.
Circuits Split on the Scope of Disgorgement
Federal courts of appeal have since split over whether subsection (d)(7) of the Exchange Act’s disgorgement provision is constrained by considerations of equity—specifically, those identified in Liu—or whether it reflects congressional intent to permit the SEC’s pursuit of disgorgement in the absence of financial harm to identifiable victims.
In SEC v. Ahmed and SEC v. Govil, the Second Circuit has come out strongly in favor of the principle that SEC disgorgement is inequitable and, therefore, barred by Liu in cases involving no investor harm. The Second Circuit has interpreted “disgorgement” under subsection (d)(7) to refer to equitable disgorgement as constrained by Liu, and to require pecuniary harm for an investor to qualify as a victim for equitable purposes. The Fourth Circuit has agreed, holding in SEC v. Johnson that disgorgement for purposes of Section 21(d) of the Exchange Act should not test the bounds of equity practice.
By contrast, the Fifth Circuit and, more recently, the Ninth Circuit have ruled that subsection (d)(7) reflects congressional intent to legislatively overrule Liu. In SEC v. Hallam, the Fifth Circuit held that subsection (d)(7) authorizes disgorgement in a legal, not equitable, sense. This means the scope of disgorgement under subsection (d)(7) is not cabined by the equitable principles announced in Liu but rather is defined by the federal court standards developed before Liu.
Supreme Court Grants Review to Resolve Disgorgement Circuit Split
Following its Ninth Circuit victory on a broad conception of disgorgement under Section 21(d) of the Exchange Act in Sripetch v. SEC, the SEC agreed with the petitioner’s request that the Supreme Court decide whether a showing of investor pecuniary harm is a prerequisite to an award of disgorgement in a civil enforcement action brought by the SEC. The Court’s ruling, expected this term, could reshape the scope of the SEC’s enforcement powers by clarifying whether disgorgement must be tied to identifiable victims and whether victim status requires pecuniary harm.
Implications for SEC Enforcement
The likelihood the Supreme Court will conclude that the SEC has unfettered disgorgement authority is constrained by the following considerations.
First, Liu was decided fewer than six years ago, and the seven-justice majority included both liberal and conservative Justices.
Second, the Supreme Court has recently found, most notably in Jarkesy v. SEC, that when the SEC intends to punish rather than regulate, it must proceed in federal court rather than through an administrative proceeding. This demonstrates the Court’s wariness of the SEC’s unilateral deployment of punitive remedies, particularly when punishment is defined as exceeding traditional notions of equity.
It follows that, even if the Supreme Court were to decide that no-loss disgorgement is an available SEC remedy, the limitations the Court would likely impose on its use should mitigate SEC enforcement risk for most regulatory or compliance issues.
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