What About All Those Tainted SEC Disgorgement Awards?

Welcome to "On SECond Thought...," an endeavor to provide short doses of my unconventional thinking about securities enforcement on a more regular monthly schedule. Feedback and comments are encouraged, especially if you think I’m either really onto something or completely off-base, and please consider clicking “Subscribe” so you'll be automatically notified when each month's new post appears. This month's essay asks a critical question in the aftermath of the Supreme Court's recent decision in Liu v. SEC, which severely curtailed the SEC's ability to obtain "disgorgement" of illicit gains: What should happen to all those other tainted disgorgement orders the SEC has been awarded over the past five decades?

In its recent decision in Liu v. SEC, which overturned a disgorgement award the SEC had won in the lower courts, the Supreme Court made clear that certain types of SEC disgorgement awards do not constitute “equitable relief” and thus that federal courts lack lawful power to order them. As explained in Liu, SEC disgorgement awards are not equitable relief, and are thus impermissible, if they exceed a defendant’s net personal profits, if they impose joint and several liability against a defendant for profits realized by unrelated co-defendants, or if the disgorged funds are simply deposited with the U.S. Treasury instead of being awarded for the benefit of victimized investors.

The Liu decision also planted a big, leafy money tree for securities lawyers by expressly declining to answer a number of related questions and sending them all back down to the lower courts to figure out over the course of many more years of litigation. Oddly enough, however, the Court didn’t mention perhaps the thorniest unanswered question of all: What about the scores of other illegal disgorgement awards the SEC has obtained over the past five decades?

Billions at Stake

As I’ve previously detailed, the SEC has been seeking and winning disgorgement awards since the late 1960s. And until Liu came along, lower federal courts had been exceedingly generous with the SEC whenever it sought disgorgement, essentially bending over backwards in the SEC’s favor on nearly every contested legal issue that ever arose. As a result, the agency has been awarded nearly $15 billion in disgorgement in just the past five years – about three times the total civil penalties it has obtained over the same period. 

Yet many of those disgorgement awards – and perhaps most of them – suffered from some combination of the infirmities called out by the Supreme Court in Liu. That is, they (1) impermissibly exceeded the wrongdoer’s own actual personal gain; (2) impermissibly imposed joint and several liability against unrelated co-defendants; and/or (3) impermissibly made no effort to return the disgorged funds to victimized investors and instead merely deposited the funds into the U.S. Treasury.

Now that the Supreme Court has ruled that disgorgement awards plagued by these infirmities are impermissible under applicable law, does the federal government just get to keep all those billions of dollars that were unlawfully confiscated in past cases from private citizens and businesses?

In a system based on limited government and the rule of law, you might assume the answer is not just “no,” but “hell no.” But as is often the case, it’s not that simple.

Finality vs. Fairness

To begin with, courts typically accord great sanctity to the finality of their judgments, and they don't lightly disturb them even if they later turn out to have been based on an error of law or fact. Courts understandably don’t want to open the floodgates to relitigation of long-ago closed cases every time the losing party can claim the court got something wrong (that’s what appeals are for), and there’s also the societal benefit of repose when the results of cases that were fairly litigated and resolved through either settlement or adjudication remain undisturbed.

But those interests come into play only after a case is finally closed – after judgment is entered and all available appeals have been exhausted. Thus, the SEC will now be forced to relitigate not only the Liu case but many others that are still pending at some level within the federal court system. Indeed, shortly after deciding Liu, the Supreme Court summarily vacated and remanded at least two other cases that were pending on its certiorari docket as a direct result of Liu, and several appellate courts have taken similar approaches.

(This impending mess for the SEC is reminiscent of the fallout from the Supreme Court’s 2018 ruling in Lucia v. SEC that SEC administrative law judges were unconstitutionally appointed, which had the domino effect of requiring the SEC to relitigate – or, as it turned out in most cases, to settle on the cheap – dozens of other proceedings then pending on the Commission’s administrative docket. The lesson, which the SEC seems to be learning the hard way, is that tethering critical elements of its enforcement program to risky and objectively indefensible legal theories can have dire negative consequences for the overall program when courts inevitably reject those theories.)

But even if still-pending cases are destined for substantial relitigation, what about closed cases where all appeals have already been either exhausted (through litigation) or waived (through typical SEC settlement terms), perhaps many years ago? [Full disclosure here: I have current and former clients in both categories, so I admittedly have a horse or two in this race.]

Who's Interested?

For overall context, keep in mind that in the world of SEC enforcement, there are high correlation rates between and among: (1) disgorgement awards obtained through contested litigation rather than through settlement; (2) disgorgement awards in which the defendant either was held jointly and severally liable for other people's gains or otherwise was ordered to pay more than his or her own net personal profits; (3) disgorgement awards where the SEC made no effort to distribute disgorged funds to harmed investors; and (4) disgorgement awards that remain unpaid. 

The reasons are fairly straightforward. Those who settle with the SEC typically either have the money to disgorge and are willing and able to pay it promptly upon entry of judgment, or they are impecunious and negotiate a payment plan or financial-distress waiver with the SEC. When a deep-pocketed defendant settles and promptly pays a large disgorgement sum, the SEC has at least some incentive to go through the laborious effort of identifying investor victims and distributing the funds to them. 

On the other hand, those who litigate against the SEC and are ordered to pay more than their own personal net profits – sometimes outlandishly more – typically lack the means to pay their disgorgement obligation and have little incentive to stop resisting payment even if they do have the money. The SEC knows this, so it rarely anticipates distributing any funds to harmed investors in such cases.

Given these realities, those defendants who are most likely to challenge a past disgorgement award, and in the best position to do so, are those who did not settle and have not been able to pay their disgorgement obligation because it exceeded their own net personal gains or because they were held jointly and severally liable for gains received by unrelated others. Better still if they specifically opposed disgorgement on grounds similar to those now vindicated by Liu, so there'd be no plausible argument of waived defenses.

In this best-case scenario, not only was the disgorgement award invalid when ordered, but the government still must take further affirmative steps to collect the invalid award. It's hard to believe any court would affirmatively facilitate further collection activity under such circumstances in light of Liu. (Indeed, it might be suggested that the government should proactively review all uncollected disgorgement awards and unilaterally abandon efforts to collect those that plainly don't conform to the criteria for "equitable relief" set forth in Liu.)

On the other hand, those who settled with the SEC and have already paid their disgorgement obligation (or were excused from paying due to financial distress) have generally moved on with their lives, with far less incentive to exhume the bones of what was probably one of the most dreadful experiences of their lives. Besides, on top of the above-referenced sanctity generally accorded to the finality of judgments, those based on voluntary settlements (with all of the waivers embedded therein) are typically accorded even greater sanctity. Defendants who settled also might reasonably fear that if they tried to undo their disgorgement obligation now, the SEC might convince the court to undo the entire settlement and return the case to its active litigation docket, which is the last thing most settling defendants want.

But even defendants who previously settled and/or paid their disgorgement obligations are not necessarily precluded from mounting a challenge if so inclined. Under our constitutional system, federal agencies and courts have only the powers granted to them by Congress. The Supreme Court in Liu made clear that the SEC has no lawful power to seek disgorgement, and courts have no lawful power to order it, unless it constitutes “equitable relief” within the meaning of section 21(d)(5) of the Securities Exchange Act of 1934. The Court further made clear that unless a disgorgement award is, among other things, limited to a defendant’s own net personal profits and awarded for the benefit of victimized investors, it does not constitute “equitable relief” – and thus the SEC has no lawful power to seek it and federal courts have no lawful power to order it.

Disgorgement awards infected by the infirmities flagged by the Court in Liu, therefore, were not simply based on run-of-the-mill errors of law or fact. Those awards were arguably legal nullities, because the courts that imposed them lacked any legitimate power to do so. In that sense, it shouldn’t really matter whether a defendant settled or litigated, or whether the disgorgement obligation has already been paid. If the court lacked any lawful power to enter a disgorgement award because it didn't qualify as "equitable relief" under Liu, even a settlement agreement between the SEC and the defendant couldn't magically bestow that power. Only Congress can create that power through legislation. (A settlement agreement, however, might nevertheless be enforceable as a matter of contract law even if the court's judgment was invalid.)

The Path Forward

So how would somebody challenge an invalid disgorgement award from years past? The cleanest path appears to be Rule 60(b) of the Federal Rules of Civil Procedure.

Rule 60(b) allows courts to “relieve” a party from a final judgment if, among other reasons, the judgment is “void,” or “applying it prospectively is no longer equitable,” or for “any other reason that justifies relief.” All three reasons seem applicable if a defendant was ordered by a federal court to pay a disgorgement obligation that the court lacked any lawful power to impose. (A motion based on these reasons must be made “within a reasonable time,” which for our purposes here would presumably mean within a reasonable time after the Supreme Court’s Liu decision.)

In the context of Rule 60(b), a judgment is “void” if the rendering court was “powerless to enter it” or “proceeded beyond the powers granted to it by law.” Check and check. And if the defendant has not yet paid the invalid disgorgement obligation, and if the government is still trying to collect it, it seems self-evident that applying the judgment prospectively is “no longer equitable.” You really don’t even need to get to the catchall “any other reason that justifies relief.” 

Years ago I successfully invoked Rule 60(b) as successor counsel on behalf of a client who had already been penalized for aiding and abetting a company’s violation of the Investment Advisers Act. Against all conventional wisdom and assumptions, I argued that the then-prevailing text of the relevant statute didn't authorize the SEC to seek, or federal courts to impose, monetary penalties against people charged only with aiding and abetting violations of the Act rather than with committing those violations themselves. Over the inexplicably haughty protestations of SEC counsel – who absurdly suggested that I be personally sanctioned for having the temerity to even raise the issue – the court agreed with me and vacated the penalty. And there wasn’t even a Supreme Court case establishing the underlying legal point. (Don’t bother trying to duplicate this victory now; Congress subsequently caught wind of the decision and inserted section 929N into the Dodd-Frank Act to plug the statutory gap in the Investment Advisers Act that had allowed my client to escape the penalty.)  

It will be interesting to see whether SEC defendants similarly seek to exhume and challenge SEC disgorgement awards that were unlawfully entered against them in years past. But if courts adhere faithfully to the rule of law and principles of limited government, the SEC could have a much bigger problem on its hands than just the questionable disgorgement awards at issue in cases still pending.

Russell G. Ryan, a partner with the law firm King & Spalding LLP, previously served as assistant director of enforcement at the SEC and deputy chief of enforcement at the Financial Industry Regulatory Authority (FINRA).

The opinions expressed by this author are his alone and do not necessarily reflect the views of his law firm, his partners, or his clients. His articles and postings are solely for general information purposes and are not intended to be, and should not be, read or interpreted as legal advice.