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5th Circuit Interprets “Awarded For Victims” Language From Supreme Court’s Liu Decision

Judicial Decision

As highlighted in this prior post, in June 2020 the Supreme Court concluded in Liu v. SEC  that “a disgorgement award that does not exceed a wrongdoer’s net profits and is awarded for victims is equitable relief permissible” under 78u(d)(5) (a statutory provision  which states in pertinent part that “in any action or proceeding brought or instituted by the [SEC] under any provision of the securities laws … any Federal court may grant .. any equitable relief that may be appropriate or necessary for the benefit of investors.”

As often happens, the Supreme Court provided a general framework for lower courts to analyze an issue without specifically defining what the key terms of the framework actually means.

Recently the Fifth Circuit addressed what the term “awarded for victims” means – becoming the first court of appeals to do so since Liu was decided.

In the underlying action, various individual defendants were charged by the SEC with selling unregistered securities and misleading investors during their operation of a penny stock company. At the trial court level, the defendants were found liable on several of the SEC’s claims at the summary judgment stage and the trial court ordered disgorgement of the defendant’s  fraud proceeds. One issue on appeal was whether the disgorgement award was “for the benefit of investors.”

The 5th Circuit stated:

“The Exchange Act authorizes the SEC to seek “equitable relief” that “may be appropriate or necessary for the benefit of investors.” 15 U.S.C. § 78u(d)(5). The Supreme Court recently addressed whether this statute supports the longstanding practice of ordering disgorgement in securities cases. Liu, 140 S. Ct. at 1940. The Court answered yes, noting that “equity practice long authorized courts to strip wrongdoers of their ill-gotten gains.” Id. at 1942. Two things keep such a remedy aimed at unjust enrichment from becoming punitive: Disgorgement cannot exceed the defendants’ “net profits” and must “be awarded for victims.” Id.

The district court’s disgorgement order satisfies those requirements. First, the disgorgement amounts are the profits defendants received from their securities fraud: $1,512,059.96 for Blackburn, $108,291.05 for Mulshine, and $772,434.90 for Gwyn. As those figures show, the district court did not impose joint-and-several liability but individually assessed each defendant’s gain. See id. at 1945, 1949 (raising concerns about joint-and-several disgorgement awards).

Second, the district court concluded that the SEC has identified the victims and created a process for the return of disgorged funds. Under the district court’s supervision, any funds recovered will go to the SEC, acting as a de facto trustee. The SEC will then disburse those funds to victims but only after district court approval.

The disgorgement thus is being “awarded for victims.” 140 S. Ct. at 1942. In contrast to a crime like insider trading—which injures the market as a whole rather than individual market participants —defendants’ fraud harmed identifiable investors. Because the SEC has already identified the defrauded Treaty investors, it is certainly feasible—more than that, it is the plan—that money the defendants return will go to the harmed investors.

This case therefore does not involve the issue Liu left open: whether disgorgement is “awarded for victims” when the money is put into a Treasury fund that helps “pay whistleblowers reporting securities fraud and to fund the activities of the Inspector General.” Id. at 1947. That issue arises when it is “infeasible to distribute the collected funds to investors.” Id. at 1948. Here it is not only feasible to identify the victims to whom the funds will be distributed, that work has already been done.

The district court’s order—requiring disbursements to already identified victims with court supervision to ensure compliance with that edict—easily satisfies Liu. We do not hold that this scheme is the only way to satisfy Liu as other cases may present greater challenges for ensuring that disgorgement benefits victims. Whatever the floor may be for Liu compliance, the remedy here rises well above it.”

In a footnote, the 5th Circuit stated:

“A few months after the Supreme Court decided Liu, Congress amended the Exchange Act to add a statutory subsection specifically authorizing disgorgement without the “for the benefit of investors” language. See 15 U.S.C. § 78u(d)(7) (“In any action or proceeding brought by the Commission under any provision of the securities laws, the Commission may seek, and any Federal court may order, disgorgement.”); see also 15 U.S.C. § 78u(d)(3)(A)(ii). The SEC argues in the alternative that the amended law applies to this case that was pending when it was enacted and gives district courts broader authority to order disgorgement than the general “equitable relief” provision of section 78u(d)(5) that Liu interpreted. But we need not address this argument. As we discuss, the scheme set up by the district court is sufficient under the “equitable relief” provision the district court applied.”

The referenced statutory provision (contained deep in the annual defense budget – the National Defense Authorization Act) was discussed in this guest post by Gibson Dunn attorney Barry Goldsmith (among others).

Reacting to the Fifth Circuit’s recent ruling, Goldsmith stated:

“The Fifth Circuit noted in a footnote in its decision that the SEC argued that the amended disgorgement law in the NDAA  “gives district courts broader authority to order disgorgement than the general ‘equitable relief’ provision of section 78u(d)(5) that Liu interpreted.”  However, it is significant that the Court declined to address this argument because it found the disgorgement award in this case satisfied the “equitable relief” disgorgement standard.  It remains to be seen whether Courts will view the “for the benefit of investors” limitation and other equitable limitations as applying only to equitable disgorgement or inherently to all disgorgement, even if expressly statutorily authorized.”

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