SEC power to recoup illegal gains put at risk in high court case
The SEC is bracing for a Supreme Court ruling that could eviscerate one of the agency’s most potent weapons by slashing its power to recoup billions of dollars in illegal profits from wrongdoers.
The court hears arguments Tuesday on contentions that the SEC can’t use a traditional legal tool known as “disgorgement” to collect money from someone the commission sues in federal court. Disgorgement is distinct from fines and other penalties the SEC seeks, in part because it’s geared toward reimbursing victims.
The SEC is “turning back billions of dollars to investors — that is not small change,” said James Cox, a professor at Duke University School of Law who signed a brief backing the SEC’s ability to seek disgorgement. “This could have a big impact.”
Without the disputed power, the SEC wouldn’t have been able to use federal courts to obtain about $1.5 billion in disgorgement orders last year, according to Urska Velikonja, a professor at Georgetown University Law Center who tracks the agency’s enforcement data.
A ruling against the SEC would especially hamper the agency’s strategy for returning money from Ponzi schemes because those cases are often resolved in federal courts, Velikonja said. The case doesn’t directly affect the SEC’s ability to seek disgorgement through administrative proceedings.
The SEC says it won administrative and court disgorgement orders totaling $3.2 billion in fiscal 2019, compared with $1.1 billion in other types of penalties.
The case, which the court will decide by late June, could also raise questions about the Federal Trade Commission’s power to seek disgorgement.
President Trump’s administration and the SEC are defending the power, saying it comes from federal courts’ inherent authority and three statutes passed by Congress. Those include the 2002 Sarbanes-Oxley Act, which U.S. Solicitor General Noel Francisco said in court papers “plainly encompasses disgorgement.”
The Sarbanes-Oxley law doesn’t explicitly mention disgorgement but says judges hearing SEC enforcement actions can award “any equitable relief” they deem appropriate to protect investors. Courts have traditionally viewed disgorgement as an “equitable” measure, which means judges make awards based on fairness rather than strict legal rules.
The justices will hear an appeal by Charles Liu and Xin Wang, a California couple fighting a $27 million disgorgement order upheld by a federal appeals court. They were found to have defrauded people seeking to take advantage of a visa program for foreigners who make large U.S. investments. Liu and Wang were accused of falsely telling investors their money would be used for a cancer treatment center.
Liu and Wang’s attorneys say the SEC has sought so much money through disgorgement that it’s become a punitive measure, much like a penalty. They say the order in their case went well beyond the $8 million the trial judge found they had gained from their scheme.
“This court, other courts, and commentators have understood for centuries that equity does not authorize punishment,” they argued.
Liu and Wang point to a 2017 Supreme Court decision that said disgorgement is covered by a five-year statute of limitations that applies to penalties. That ruling declined to say whether the SEC has the power to seek disgorgement in the first place.
The SEC says it tries to return disgorged funds to injured investors when possible. The agency says it collected $1.5 billion in disgorgements and penalties in 2019 and paid out $1.2 billion to investors that year.
Attorneys at the SEC are increasingly concerned the agency is in danger of losing the case, according to people familiar with the matter. That outcome could damage its enforcement efforts in the near term, said the people, who asked not to be identified so they could discuss internal matters.
If the court rules against the SEC, the agency may need to press Congress to pass a fix or shift its strategy to try to recoup ill-gotten gains outside of federal court.
Some outsiders say the court could trim the SEC’s disgorgement power without rejecting it altogether. Oak Management Corp., a venture capital firm that says it was defrauded out of tens of millions of dollars by a former partner, told the justices they can bar the SEC from using disgorgement as a penalty while leaving the commission with the power to seek restitution for victims.
A group of law professors led by Douglas Laycock of the University of Virginia School of Law filed a brief urging the court to allow disgorgement but only up to the level of the wrongdoer’s net profits.
“Each party’s position seriously overreaches,” Laycock wrote. “The measure of disgorgement has always been the wrongdoer’s net profits.”