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 15 USC 78u(d)(5) (a statutory provision which states in pertinent part that “in any action or proceeding brought or instituted by the Commission 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.”).
The previous post mentioned that because most SEC FCPA enforcement actions are resolved administratively – and thus subject to a different statutory provision – that Liu was technically not applicable to most SEC FCPA enforcement actions.
However, the recent FCPA settlement in SEC v. Berko (see here for the prior post) was the first SEC FCPA enforcement action filed in federal court since Liu and thus subject to the Supreme Court’s conclusion that “a disgorgement award that does not exceed a wrongdoer’s net profits and is awarded for victims is equitable relief permissible” under 15 USC 78u(d)(5).
However, as highlighted below, the SEC ignored Liu’s “and is awarded to victims” prong and encouraged the court to require Berko to nevertheless pay disgorgement which the court ordered – seemingly in violation of Liu.
In Berko, the SEC’s motion for a final judgment contained a section titled “Disgorgement of Defendant’s Net Profits – To Be Sent to Treasury” which stated in full:
“The Final Judgment requires Defendant to disgorge an amount that does not exceed the alleged net profits from his violation, orders that the disgorged funds be sent to the Treasury, and includes a finding that this is consistent with equitable principles. The following discussion explains the bases for these provisions.
“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.” Section 21(d)(7) of the Exchange Act, 15 U.S.C. §78u(d)(7);1 see also Liu v. SEC, 140 S. Ct. 1936, 1940 (2020) (“a disgorgement award that does not exceed a wrongdoer’s net profits and is awarded for victims is equitable relief permissible under [15 U.S.C.] §78(d)(5) [Section 21(d)(5) of the Exchange Act]”). Here, the disgorgement amount of $275,000 does not exceed the Defendant’s alleged net profits, with prejudgment interest added to reflect the time benefit of the funds he obtained.
Disgorged funds may be sent to the Treasury consistent with Section 21(d)(7) and Liu when doing so is “consistent with equitable principles.” Liu, 140 S. Ct. at 1949. Liu reasoned that the phrase “for the benefit of investors” in Section 21(d)(5) “restricts” the equitable relief that may be awarded under that provision, but left as an “open question” whether “depositing disgorgement funds with the Treasury may be justified where it is infeasible to distribute the collected funds to investors.” 140 S. Ct. at 1948. Congress’s omission of the “for the benefit of investors” restriction in Section 21(d)(7), combined with its description of disgorgement as a remedy aimed at preventing “unjust enrichment” in Section 21(d)(3)(A)(ii), evinces a congressional intent that courts be able to send disgorged funds to the Treasury where disgorgement is an appropriate equitable remedy for violations of the federal securities laws.
Here, the order in the Final Judgment that the disgorged funds be sent to the Treasury is “consistent with equitable principles.” While the SEC endeavors to distribute disgorged funds to harmed investors when that is feasible and practical, distribution of the disgorged funds to harmed investors is not feasible or practical in this case. Because Defendant’s employer halted its participation in the project to be financed by the alleged bribery scheme before it was constructed, investors in the Holding Company were not harmed by Defendant’s conduct. It is not feasible or practical for the Commission to identify with specificity and then compensate with any specific dollar amounts, the parties who suffered as a result of Defendant’s alleged conduct – the competitors who wanted to construct the Power Plant Project but were foreclosed by the alleged bribery, and the government officials and citizens of Ghana who were harmed by the alleged payment of bribes to Ghanaian government officials. Even if identifying such harmed individuals was possible, there would likely be so many persons involved that the cost of making a distribution would be extraordinarily expensive and might even exceed the amount of disgorgement.
Because distribution to harmed investors is not feasible, the only alternative that is consistent with equitable principles is to send the disgorged funds to the Treasury. Allowing the defendant to retain the funds would be inequitable. The Commission has alleged that Defendant’s conduct was egregious and Defendant acted with a high level of scienter. Allowing him to retain his personal financial gain resulting from the alleged misconduct should not be permitted.
Distribution to the Treasury here serves the “foundational” principle of equity that no person should profit from his own wrong. Liu, 140 S. Ct. at 1943, 1948. Allowing the disgorged funds to remain in the Defendant’s hands would frustrate that basic equitable principle. As between a violator and the Treasury, it is more equitable that collected funds be disbursed to the latter so as not to incentivize fraud. See Kansas v. Nebraska, 574 U.S. 445, 463 (2015) (equity supports ordering disgorgement to “remind [a violating party] of its legal obligations” and to “deter future breaches”); Restatement (First) of Restitution §187 (1937) (discussing the constructive trust remedy that prevented a murderer from inheriting his victims’ estates, and made the murderer the constructive trustee for innocent persons who but for the murder would not have inherited the estate).
Further, equity recognizes that if, as in this case, distribution to a victim is not feasible, disgorged funds may be awarded to the cy pres (i.e., nearest possible) alternative. Pearson v. Target Corp., 968 F.3d 827, 837 (7th Cir. 2020) (applying Liu v. SEC). And, in the securities laws, “Congress made payment to the Treasury the cy pres alternative … to payment to victims of fraud when payment to the victims is infeasible.” SEC v. Custable, 796 F.3d 653, 656 (7th Cir. 2015); see also Kansas, 574 U.S. at 456 (“[W]hen federal law is at issue and the public interest is involved, a federal court’s equitable powers assume an even broader and more flexible character than when only a private controversy is at stake.”).”
In issuing it final judgment in the case, U.S. District Court Judge Frederic Block (E.D.N.Y.) simply stated” the Court finds that sending the disgorged funds to the U.S. Treasury … is consistent with equitable principles.”