Predicting the Supreme Court’s Ruling on SEC’s Disgorgement Authority

Predicting the Supreme Court's Ruling on SEC's Disgorgement Authority
Dante K. Chambers, JD ‘21

 

When the United States Supreme Court issued its opinion in Liu v. Securities and Exchange Commission, No. 18-1501 (June 22, 2020), students in Professor Joe Grundfest’s prediction course had reason to cheer. They had nailed it. They had predicted with almost eerie precision the holding of an 8-1 decision adopting a position that was urged by neither petitioner nor respondent.

The prediction course is a novel exercise in legal pedagogy. As Grundfest explains, “law school is generally a backward-looking enterprise. We study precedent and the historic evolution of statutes and regulations. But in the real world, lawyers and business people are called upon to predict. Is this case a winner or a loser? Should I invest in this project or in that one? This course puts students’ feet to the fire and challenges them to predict the outcomes of Supreme Court cases that have been briefed but not yet decided.”

Joseph A. Grundfest 1
Stanford Law Professor Joe Grundfest

When asked if this focus on prediction changes classroom dynamics, Grundfest responded, “the change is dramatic. Students argue about how and why a pending case should be decided given the law on the books. It’s an entirely different conversation. Students are motivated to read cases differently and to think about the law from a fresh perspective. The ‘prediction method’ fosters a mindset and learning experience that is very different from the traditional ‘case method.’”

Dante Chambers, now a rising 3L, was a student in the course. Here, Dante explains the opinion in Liu, describes the likely next steps in the litigation process, and tells the story of the evolution of the class’s prediction.

What was the question presented in Liu, and why is the question important?

Liu v. Securities and Exchange Commission asks whether the federal securities laws, which authorize the SEC to seek “any equitable relief that may be appropriate or necessary for the benefit of the investors,” include the power to seek disgorgement in federal court. The question had been expressly left open in Kokesh, where the Court recently held that disgorgement is considered a penalty for statute-of-limitation purposes. But a large body of law holds that equitable remedies exclude penalties. So, if disgorgement is a penalty, as the court held in Kokesh, is that remedy ever available to the SEC as a form of equitable relief? The SEC relies extensively on disgorgement. The SEC Enforcement Division’s 2019 annual report documents that the SEC recovered almost $3.25 billion via disgorgement in that fiscal year—compared to ~$1.1 billion in penalties during the same period. In fact, while the SEC’s recoveries from penalties were down more than $300 million from the previous year, disgorgements rose $742m. A holding that disgorgement isn’t available to the SEC in federal court would therefor force the SEC to dramatically change its enforcement strategy. For example, because the statute clearly authorizes the Commission to obtain disgorgement in administrative proceedings, the Commission could respond to a Supreme Court loss by shifting its prosecutions from federal court to its in-house administrative proceedings. But that move would likely be unpopular with many defendants who prefer to litigate in federal court.

How did the court resolve the question? 

Justice Sotomayor’s opinion holds that disgorgement is equitable and can be sought by the Commission only if it: (1) does not exceed the wrongdoer’s net profits, and (2) to the extent practical, returns the “defendant’s gain to the wronged investors for their benefit.” But the Court gave no practical guidance as to the application of these principles. Major battles are yet to be fought over the nature of expenses that defendants can net against the proceeds of a fraud, and about the practicality of returning disgorged funds to harmed investors. The opinion also limited the SEC’s ability to seek disgorgement through joint and several liability and used language that implicitly questions the SEC’s ability to order tippers in insider trading cases  to disgorge tippee profits. So, as is often the case in Supreme Court litigation, the resolution of one case raises many questions that will be litigated for years to come.

How did this decision map onto the Prediction Course’s analysis?

As Justice Sotomayor’s opinion states, the parties heavily briefed the question of whether the SEC may seek disgorgement in federal court at all. On that question, the class predicted that the Ninth Circuit would not be affirmed. Seven of the eight students in the class predicted that the case would come out as it did, including the definition of an intermediate standard that was not urged by either party. That intermediate prediction evolved as a consequence of classroom interaction in which we debated the various approaches the court might take in light of the arguments before it.  The evolution of that prediction reaffirms the research indicating that group interaction often improves the quality of a prediction.

What’s the practical impact of the Liu decision? Can you predict that?

We don’t know what will come next in Liu, but the Court has made clear that the SEC’s current disgorgement practices will have to change in meaningful ways going forward. Thinking with an eye toward prediction, we can map out some potential options. First, lower courts can either permit or prohibit disgorgement in cases where the SEC does not seek to return the funds to harmed investors. Until the question is settled, we can expect the most important SEC disgorgement matters being handled inside of the agency’s adjudicatory process rather than seeking them in federal court. On questions of joint-and-several liability and whether the Commission must reduce the disgorgement awards it seeks by the “legitimate expenses” incurred by wrongdoers, we can expect the practices to continue in the agency while the Commission uses lesser-significant cases to define the contours of disgorgement as an equitable remedy in under Section 78u(d)(5) in federal courts. All told, the SEC’s disgorgement practices are likely to be somewhat curtailed while these questions are clarified.