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On June 22, in an 8-1 ruling, the U.S. Supreme Court vacated the U.S. Court of Appeals for the Ninth Circuit’s judgment in Liu v. SEC, holding that the SEC may continue to collect disgorgement in civil proceedings in federal court as long as the award does not exceed a wrongdoer’s net profits, and that such awards for victims of the wrongdoing are equitable relief permissible under §78u(d)(5). The ruling impacts petitioners who were ordered by a California federal court to disgorge $26.7 million in money collected from investors for a cancer treatment center that was never built, with the related SEC investigation finding that more than $20 million was spent on ostensible marketing expenses and salaries, far in excess of what the offering memorandum permitted. As previously covered by InfoBytes, the Court examined whether the SEC’s statutory authority to seek “equitable relief” permits it to seek and obtain disgorgement orders in federal court. The petitioners asked the Court to bar the SEC from seeking court-ordered disgorgement (covered by InfoBytes here), arguing that Congress never authorized the SEC to seek disgorgement in civil suits for federal securities fraud as a form of equitable relief or otherwise. The petitioners pointed to the Court’s 2017 decision in Kokesh v. SEC, in which the Court reversed the ruling of the U.S. Court of Appeals for the Tenth Circuit when it unanimously held that disgorgement operates as a penalty under 28 U. S. C. §2462, which establishes a 5-year limitations period for “an action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture.”
The Court rejected the petitioners’ argument, noting that equity practice has “long authorized courts to strip wrongdoers of their ill-gotten gains,” although “to avoid transforming an equitable remedy into a punitive sanction, courts restricted the remedy to an individual wrongdoer’s net profits to be awarded for victims.” As such, the Court determined that the SEC’s disgorgement remedy must be limited in various ways. The Court discussed three limits: (i) the “profits remedy” must return the defendant’s wrongful gains to those harmed by the defendant’s actions, as opposed to depositing them in the Treasury; (ii) disgorgement under the statute requires a factual determination of whether petitioners can, consistent with equitable principles, be found liable for profits as partners in wrongdoing or whether individual liability is required; and (iii) disgorgement must be limited to “net profits” and therefore “courts must deduct legitimate expenses before ordering disgorgement” under the statute. The Court vacated the judgment against the petitioners and remanded to the lower court to examine the disgorgement amount in light of its opinion.
Justice Clarence Thomas dissented, however, stating that he would have barred the SEC from seeking disgorgement in federal court under the statute rather than limiting the remedy, because while 15 U. S. C. §78u(d)(5) allows the SEC to seek equitable relief that may be appropriate or necessary for the benefit of investors, “disgorgement is not a traditional equitable remedy.”
4th Circuit: Disgorgement calculation lacks necessary casual connection between profits and violations
On April 27, the U.S. Court of Appeals for the Fourth Circuit held that a district court’s disgorgement calculation for a banker found in contempt of a consent order rested on “an erroneous legal interpretation of the terms of the underlying consent order” and “lacked the necessary causal connection” between profits and a violation. As previously covered by InfoBytes, the banker settled RESPA and state law allegations with the CFPB and the Maryland Attorney General concerning his participation in a mortgage-kickback scheme. The 2015 final judgment order banned the defendant from participating in the mortgage industry for two years but did not prohibit him “from acting solely as a personnel or human-resources manager for a mortgage business operated by a FDIC-insured banking institution. . . .” In 2018, the banker was held in civil contempt for violating the final judgment order, and the district court ordered the disgorgement of over half-a-million dollars of his contemptuous earnings. The banker appealed the contempt finding and disgorgement.
On appeal, the 4th Circuit first held that the district court properly found the banker in violation of the consent order, determining among other things that, while the final judgment order did not broadly prohibit his participation in the mortgage industry, there was sufficient evidence that he “continued to communicate impermissibly with third-party businesses engaged in settlement services” and that he failed to follow various reporting requirements, such as uploading the consent order to a national registry and notifying regulators of a change in residence and business activity. However, the 4th Circuit found that the district court erred in its approach to calculating disgorgement because it assumed that “managing the business was improper and set out identifying [the banker’s] profits from his business because any such profit was contemptuous income.” (Emphasis in the original.) Holding that the district court’s view relied on an overbroad interpretation of the consent order and lacked the causal connection between the banker’s profits and a violation, the 4th Circuit vacated the disgorgement order and remanded the case to the district court to reassess the disgorgement calculation based on the banker’s more limited conduct that did not comply with the order.
Maryland Court of Appeals reverses trial court approval of settlement for interfering with CPD action
On March 3, the Maryland Court of Appeals reversed a trial court’s approval of a proposed settlement in a class action based on fraudulently induced assignments of annuity payments. The class members were recipients of structured settlement annuities from lead paint exposure claims who responded to ads by a structured settlement factoring company (company). The class members then transferred the rights to their settlement annuity contracts to the company, which paid the class members lump sums for the rights at a discount. The class filed a lawsuit against the company in 2016, alleging that it had engaged in fraud in procuring the annuity contract transfers. Around the same time, the Consumer Protection Division of the Maryland AG’s Office (CPD) had filed suit against the company alleging violations of the State Consumer Protection Act. Several months after both actions were filed, the CFPB filed a similar suit against the company based on the same alleged misconduct. All three actions sought similar kids of relief with respect to the same individuals, though the bases for seeking relief and the nature and amount of relief sought differed among the actions.
The class and the company proceeded towards a negotiated settlement, to which the trial court signed a proposed final order, certifying the class and approving the settlement, despite CPD’s opposition to both issues. Following the court’s approval, the company moved for summary judgment in its case against the CPD, which the court granted because it held CPD’s claim for restitution for the same individuals was barred by res judicata; CPD’s claim for injunctive relief and civil penalties is still currently awaiting trial.
Following an appeal, the Court of Appeals granted the company’s petition to consider whether “class members [may] lawfully release and assign to others their right to receive money or property sought for their benefit by [CPD] or [CFPB] through those agencies’ separate enforcement actions” under state and federal consumer protection laws, respectively.
The Court of Appeals held that the lower court erred in approving the settlement, stating that consumers “have no authority, through a private settlement, whether or not approved by a court, to preclude CPD from pursuing its own remedies against those who violate . . . [Maryland’s] Consumer Protection Act, including a general request for disgorgement/restitution.” In particular, the Court of Appeals held that the parties cannot preclude CPD from pursuing the remedies of disgorgement and restitution, as that would directly contravene CPD’s statutory authority to sanction the company for wrongful conduct. For this reason, the Court of Appeals concluded that the trial court’s approval of the settlement must be reversed and remanded the case for further proceedings.
On March 3, the U.S. Supreme Court heard oral arguments in Liu v. SEC. As previously covered by InfoBytes, the principal question at issue in this case is whether the SEC’s authority to seek “equitable relief” permits it to seek and obtain disgorgement orders in federal court. Petitioners—a couple found to have defrauded investors and ordered to disgorge $26.7 million by a California federal court—argued that disgorgement is not a form of “equitable relief” available to the SEC. Respondent SEC contended that Congress enacted several statutes that anticipated the SEC’s use of disgorgement, including the Securities Exchange Act and the Sarbanes-Oxley Act, and that historically, disgorgement has been used as an equitable remedy to deny wrongdoers of their ill-gotten gains.
Counsel for the petitioners made three primary arguments before the Court: (i) the SEC is only authorized to use the powers conferred upon it by Congress and disgorgement is not one of them; (ii) though the statute allows the SEC to seek equitable relief, disgorgement as the SEC has used it is akin to a penalty and “penalties are not equitable relief.”; and (iii) “Congressional silence…does not give an agency any authority to act, much less the authority to punish” in a manner that exceeds its existing statutory authority
Petitioners’ counsel fielded questions from Justices Ginsburg, Alito, and others that probed the limits of the petitioners’ position. The justices asked, among other things, whether disgorgement could ever be ordered by the SEC; whether it could be ordered if the profits are paid out to injured parties; and whether the Court’s holding in Kokesh v SEC, that disgorgement as a penalty should be controlling only when determining the applicable statute of limitations, which was the issue presented in that case. Petitioner’s counsel stated that “the rule should be, if you’re giving the money back to the investors, then [the SEC] can take it and not otherwise, because…then it’s just a punishment.”
Respondent’s counsel argued that the Court’s ruling in Kokesh was limited to determining the applicability of the statute of limitations. He also urged that “courts should continue to order disgorgement but compute it in accordance with traditional general equitable rules, not in accordance with any SEC-specific formula.” In response to a question from Justice Sotomayor regarding the proper recipient of disgorged funds, respondent’s counsel said that if the defrauded investors can be located, the SEC’s practice it to return disgorgement amounts to them. However, he noted that sometimes, such as in FCPA actions, there are no obvious victims to whom the money could be returned. Justice Kavanaugh asked if it would be proper for the Court to insist that the amounts received from a disgorgement order be returned to defrauded investors if at all possible. Respondent’s counsel conceded this would be within the Court’s authority, but added that the “core purposes of disgorgement are to prevent the wrongdoer from profiting from its own wrong and to deter future violations, and disgorgement can serve those traditional purposes, regardless of where the money ends up.”
On rebuttal, petitioner’s counsel asserted that “the scope of disgorgement has grown over time in part because it is not grounded in statutory text.” He contended that “there is no precedent for using an accounting to compel funds to be paid to the Treasury.” Justice Ginsburg pressed petitioner’s counsel regarding statutes that appear to be predicated on disgorgement being available. Petitioner’s counsel suggested those statutes might show that Congress was aware that courts were ordering disgorgement, but that was “not an authorization, and authorization is what’s needed…to inflict a penalty.” He closed by asking the Court to reverse the case, saying that the petitioners were already responsible to pay their entire gains from the fraud, and “anything more would go beyond the equitable principle that no individual should be permitted to profit from his or her own wrong.”
On January 30, the CFPB announced that it filed suit in the U.S. District Court for the District of Rhode Island against a national bank (defendant) based upon alleged violations of the Truth in Lending Act (TILA) and its implementing Regulation Z, the Fair Credit Billing Act (FCBA), and the Credit Card Accountability Responsibility and Disclosure Act (CARD Act). The CFPB claims that among other things, when servicing credit card accounts, the defendant did not properly manage consumer billing disputes for unauthorized card use and billing errors, and did not properly credit refunds to consumer accounts resulting from such disputes. Specifically, the complaint alleges that violations included the defendant’s (i) “practice of automatically denying billing error claims or claims of unauthorized use for failure of the consumers to provide Fraud Affidavits, including agreeing to testify as witnesses”; (ii) “failure to refund related finance charges and fees when it resolved billing error notices or claims of unauthorized use in consumers’ favor”; (iii) failure “to provide written notices of acknowledgement or denial in response to billing error notices”; and (iv) failure “to provide credit counseling referrals.” The CFPB is seeking injunctive relief, monetary relief, disgorgement of defendant’s ill-gotten gains, civil money penalties, and costs of the action.
The defendant issued a response to the suit on January 31, stating that it self-identified the issues to the Bureau five years ago while simultaneously correcting any flawed processes. According to the defendant’s statement, “the CFPB’s action is misguided” and “well beyond the expiration of the statute of limitations. The defendant vows to “vigorously challenge” the suit.
On January 15, the SEC filed a brief in a pending U.S. Supreme Court action, Liu v. SEC. The question presented to the Court asks whether the SEC, in a civil enforcement action in federal court, is authorized to seek disgorgement of money acquired through fraud. The petitioners were ordered by a California federal court to disgorge the money that they collected from investors for a cancer treatment center that was never built. The SEC charged the petitioners with funneling much of the investor money into their own personal accounts and sending the rest of the funds to marketing companies in China, in violation of the Securities Act’s prohibitions against using omissions or false statements to secure money when selling or offering securities. The district court granted the SEC’s motion for summary judgment, and ordered the petitioners to pay a civil penalty in addition to the $26.7 million the court ordered them to repay to the investors. The petitioners appealed to the Supreme Court and in November, the Court granted certiorari.
The petitioners argued that Congress has never authorized the SEC to seek disgorgement in civil suits for securities fraud. They point to the court’s 2017 decision in Kokesh v. SEC, in which the Court reversed the ruling of the U.S. Court of Appeals for the Tenth Circuit when it unanimously held that disgorgement is a penalty and not an equitable remedy. Under 28 U.S.C. § 2462, this makes disgorgement subject to the same five year statute of limitations as are civil fines, penalties and forfeitures (see previous InfoBytes coverage here). The petitioners also suggested that the SEC has enforcement remedies other than disgorgement, such as injunctive relief and civil money penalties, so loss of disgorgement authority will not hinder the agency’s enforcement efforts.
According to the SEC’s brief, historically, courts have used disgorgement to prevent unjust enrichment as an equitable remedy for depriving a defendant of ill-gotten gains. More recently, five statutes enacted by Congress since 1988 “show that Congress was aware of, relied on, and ratified the preexisting view that disgorgement was a permissible remedy in civil actions brought by the [SEC] to enforce the federal securities laws.” The agency notes that the Court has recognized disgorgement as both an equitable remedy and a penalty, suggesting, however, that “the punitive features of disgorgement do not remove it from the scope of [the Exchange Act’s] Section 21(d)(5).” Regarding the petitioner’s reliance on Kokesh, the brief explains that “the consequence of the Court’s decision was not to preclude or even to place special restrictions on SEC claims for disgorgement, but simply to ensure that such claims—like virtually all claims for retrospective monetary relief—must be brought within a period of time defined by statute.”
In addition to the brief submitted by the SEC, several amicus briefs have been filed in support of the SEC, including a brief from several members of Congress, and a brief from the attorneys general of 23 states and the District of Columbia.
On December 13, the FTC filed a brief in a U.S. Supreme Court action that is currently awaiting the Court’s decision to grant certiorari. The question presented to the Court asks whether the FTC is empowered by Section 13(b) of the FTC Act to demand equitable monetary relief in civil enforcement actions. The petitioners, who include a Kansas-based operation and its owner, filed the petition for a writ of certiorari in October, appealing a December 2018 decision by the U.S. Court of Appeals for the Ninth Circuit (covered by InfoBytes here), which upheld a $1.3 billion judgment against the petitioners for allegedly operating a deceptive payday lending scheme. Among other things, the 9th Circuit rejected the petitioners’ argument that the FTC Act only allows the court to issue injunctions, concluding that a district court may grant any ancillary relief under the FTC Act, including restitution. The 9th Circuit also rejected the petitioners’ request to revisit those precedents in light of the Court’s 2017 holding in Kokesh v. SEC—which limited the SEC’s disgorgement power to a five-year statute of limitations period applicable to penalties and fines under 28 U.S.C. § 2462 (previously covered by InfoBytes here)—concluding that the district court did not abuse its discretion in calculating the award. Additionally, the 9th Circuit referenced the Court’s statement in Kokesh that noted “[n]othing in [its] opinion should be interpreted as an opinion on whether courts possess authority to order disgorgement in SEC enforcement proceedings.”
In response to the petition, the FTC asked the Court to delay reviewing the appeal, stating that the Court should hold the petition pending the disposition in a matter that was recently granted cert “to decide whether district courts may award disgorgement to the [SEC] under analogous provisions of the securities laws.” The FTC acknowledged that while the “relevant statutory schemes are not identical, and the FTC’s and the SEC’s authority to seek monetary relief will not necessarily rise and fall together,” the questions presented in both cases overlap.
On December 6, the U.S. Court of Appeals for the Tenth Circuit affirmed a district court’s revised disgorgement order in SEC v. Kokesh. As previously covered by InfoBytes, in 2017, the U.S. Supreme Court handed down a unanimous ruling in Kokesh and rejected the SEC’s position that disgorgement is an equitable remedy and not a penalty. The Court’s decision limited the SEC’s disgorgement power to a five-year statute of limitations period applicable to penalties and fines under 28 U.S.C. § 2462. Following the Court’s ruling, in 2018, the 10th Circuit, on remand, directed the district court to enter an order for a lower disgorgement amount of $5 million (from nearly $35 million), holding that only a portion of the SEC’s claims were not time-barred by 28 U.S.C. § 2462. At the district court, the SEC also argued that prejudgment interest of more than $2.6 million should apply to the disgorgement penalty, as well as nearly $2.3 million in civil penalties, and the district court awarded such amounts, rejecting Kokesh’s argument that “the district court should reject any relief other than an order of disgorgement.” Kokesh again appealed, arguing, among other things, that “§ 2462 is jurisdictional and precludes this action in its entirety,” and that the permanent injunction and civil penalties were invalid.
On appeal, the 10th Circuit refused to address Kokesh’s jurisdictional argument, stating that, among other things, the appellate court had previously found that “each act of misappropriation should be considered separately” and that not all of the SEC’s claims were time-barred. The appellate court further concluded that because it had previously found that some alleged misappropriations happened within the five-year limit, the $5 million disgorgement calculation that the SEC requested was warranted. Moreover, the appellate court noted that Kokesh failed to show any reason that its 2018 decision was “clearly erroneous,” and during remand, “rather than. . .contesting timeliness or the SEC’s calculations, Kokesh conceded the district court should enter the disgorgement order and instead focused on the SEC’s new request for prejudgment interest.” Additionally, the appellate court refused to consider Kokesh’s challenges to the permanent injunction and the civil penalty ordered because they were first raised in Kokesh’s reply brief.
On November 18, the U.S. House passed the Investor Protection and Capital Markets Fairness Act (H.R. 4344) by a vote of 314-95. The bill, which was received in the Senate, would overturn the U.S. Supreme Court’s 2017 decision in Kokesh v. SEC, which limits the SEC’s disgorgement power and subjects the agency to the five-year statute of limitations applicable to penalties and fines. (Previously covered by InfoBytes here.) As discussed in a recent Buckley article, in Kokesh’s wake, H.R. 4344 would amend the Securities Exchange Act of 1934 by specifically authorizing the SEC to seek disgorgement and restitution, putting to rest the threshold question of whether the SEC has the authority to seek disgorgement. Notably, on November 1, the Court granted certiorari in Liu v. SEC to answer this very question. If signed into the law, H.R. 4344 would allow the SEC 14 years to pursue disgorgement in federal court under the statute of limitations.
On August 27, the SEC issued an administrative order settling allegations against a U.S.-based investment management firm, which remained outstanding after the company’s June 4 NPA with the DOJ. The June 4 NPA resolved claims of FCPA violations in Libya and included a criminal penalty of $32.6 million and disgorgement of $31.6 million (see prior FCPA Scorecard coverage here). The SEC order stated that the company’s actions were in violation of the internal accounting controls provision of the Securities Exchange Act of 1934. The SEC settlement did not include a separate penalty beyond the disgorgement already agreed to in June, and pre-judgment interest.
- Hank Asbill to discuss "The federal fraud sentencing guidelines: It's time to stop the madness" at a New York Criminal Bar Association webinar
- Daniel P Stipano to moderate "Digital identity: The next gen of CIP" at the American Bankers Association/American Bar Association Financial Crimes Enforcement Conference