U.S. Supreme Court Cites Restitution Third
In Liu v. Securities and Exchange Commission, No. 18-1501 (June 22, 2020), the U.S. Supreme Court held, in an enforcement action by the Securities and Exchange Commission (SEC), that a disgorgement order that did not exceed a wrongdoer’s net profits and was awarded for victims constituted “equitable relief” that was permissible under the Securities Exchange Act of 1934, 15 U.S.C. § 78u(d)(5), rather than punitive sanctions, which were historically excluded from the definition of “equitable relief” under the Act.
The SEC filed a civil enforcement action against petitioners Charles Liu and Xin Wang, who had “solicited nearly $27 million from foreign investors under the EB–5 Immigrant Investor Program,” alleging that the petitioners violated the terms of the offering documents by spending far more than permitted on “ostensible marketing expenses and salaries” and by diverting “a sizeable portion of . . . funds to personal accounts and to a company under Wang’s control.” The district court found in favor of the SEC and ordered the petitioners jointly and severally liable for, among other things, disgorgement equal to the full amount that the petitioners raised from investors, less the amounts remaining in the corporate accounts for the project. The U.S. Court of Appeals for the Ninth Circuit rejected the petitioners’ argument that the disgorgement award failed to account for their business expenses, and affirmed, explaining that, according to Ninth Circuit precedent, “the ‘proper amount of disgorgement in a scheme such as this one [was] the entire amount raised less the money paid back to the investors.”’
The U.S. Supreme Court vacated and remanded for the lower courts to ensure that the disgorgement was limited to the petitioners’ net profits, that it was awarded for the benefit of victims, and that it did not otherwise exceed the bounds of traditional equity practice. Associate Justice Sonia Sotomayor, writing for the majority, explained that the SEC was permitted to seek civil penalties and equitable relief in civil actions under the Act, and, while the Act did not define what fell under the umbrella of “equitable relief,” “[e]quity courts [had] routinely deprived wrongdoers of their net profits from unlawful activity, even though that remedy may have gone by different names.” The Court pointed out that, according to Restatement of the Law Third, Restitution and Unjust Enrichment § 51, Comment a, “[r]estitution measured by the defendant’s wrongful gain [was] frequently called ‘disgorgement,’” and that, “[n]o matter the label, this ‘profit-based measure of unjust enrichment’” reflected the “foundational principle” that it would be inequitable for a wrongdoer to profit from his or her own wrong.
Justice Sotomayor explained that courts were required to deduct legitimate expenses before ordering disgorgement under the Act, and left it for the lower courts to examine on remand whether the petitioners’ expenses were legitimate or whether they were merely wrongful gains under another name, such that they could not be deducted. The Court additionally observed that it was for the lower courts to determine whether the disgorgement was “for the benefit of investors,” as required by the Act.
In a dissenting opinion, Associate Justice Clarence Thomas argued that disgorgement was not “equitable relief” within the meaning of the Act, noting that disgorgement was not a traditional equitable remedy included in the Restatement of the Law, Restitution, adopted in 1936, and that the remedy did not appear until Restatement of the Law Third, Restitution and Unjust Enrichment § 51, adopted in 2010.
Read the full opinion here.
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