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The Equity Facade Of SEC Disgorgement

A guest post today by Russ Ryan, a former Assistant Director of the SEC’s Division of Enforcement, who has spent the last ten years as a partner in the Washington, DC office of King & Spalding where he represents clients in FCPA and other SEC investigations.


This post concerns my article “The Equity Facade of SEC Disgorgement” (a title I readily admit was inspired and partially borrowed from Professor Koehler’s article “The Facade of FCPA Enforcement“) recently published in the online edition of the Harvard Business Law Review.

As most FCPA practitioners know, it is now common for the SEC to demand disgorgement of tainted profits in FCPA enforcement actions (for instance, as noted in this FCPA Professor post, 86% of SEC FCPA settlement amounts in 2012 consisted of disgorgement and prejudgment interest).  In parallel SEC and DOJ resolutions involving issuer defendants, it is often the case that disgorgement is ordered in the civil SEC case while any fines and penalties are paid in the DOJ criminal case.  Of course, the SEC also seeks disgorgement in many kinds of other cases involving tainted profits, not just FCPA cases, and the prevailing truism is that this is a remedy in equity.  My article suggests this truism is actually a fallacy in many SEC cases, particularly those where the defendant does not, for whatever reason, still actually possess or control the tainted profits when the court orders them disgorged.

The issue is most likely to arise in cases against individuals rather than companies, but it could arise in either.  For instance, in the FCPA context, a potential scenario could include some or all of the following:  foreign subsidiary in X country realizes profits from a tainted transaction, parent sells the subsidiary to another company which temporarily benefits from the tainted contract(s), but the subsidiary is ultimately shut down because it eventually starts losing money overall, and whatever profits were once realized have long since been redeployed elsewhere within both the prior owner and current owner.

In the individual context, a common non-FCPA scenario is insider trading cases against “tippers” who are ordered to disgorge not only their own profits (if any) but also those of their direct and indirect tippees.  Another is the classic case of the defendant who quickly spends or squanders his ill-gotten gains from a violation before getting caught by the SEC.  In the FCPA context, for example, suppose an issuer’s agent makes a big payday from a transaction tainted by his own bribery, but then promptly squanders all his loot on an unrelated deal that fails miserably before the bribes are discovered and prosecuted.

In all these cases, the named defendant holds none of the tainted profits when the government comes along, and thus is hardly in a position to “disgorge” anything.  The SEC and the courts typically ignore this fact and order disgorgement anyway, but that renders the whole notion of disgorgement a misnomer, and in any event the remedy is simply not a remedy in equity.  It is quintessentially a remedy at law – a personal obligation to pay a sum of money to a plaintiff based on a violation of law.

Anyone who doubts this should read Justice Scalia’s majority opinion in Great-West Life & Annuity Insurance Co. v. Knudson, 534 U.S. 204 (2002), an ERISA case I confess I was not even aware of until a few years ago when first considering the issue that led to my article.  The Great-West case dealt with restitution, but clearly distinguished between restitution in equity (where the defendant actually still possesses the funds ordered returned to the plaintiff) and restitution at law (where, as in Great-West, the defendant no longer possesses the funds and the court is simply ordering the defendant to pay a sum of money as a substitute for the actual tainted profits).

So what’s the big deal?

Plenty.  The securities laws don’t authorize the SEC to seek, or courts to order, money damages or any other similar remedies at law, although of course the statutes do provide separately for punitive relief in the form of civil penalties.  The only two sources of legal authority for disgorgement are that (1) it is included among the ancillary equitable remedies inherently available to the court once its equitable powers are invoked by the SEC’s request for an injunction and (2) it is authorized by a provision in the Sarbanes-Oxley Act – codified at Exchange Act section 21(d)(5)  – saying the SEC can obtain any “equitable relief.”  In either case, however, so-called “disgorgement” is authorized only if it is truly a form of equitable relief rather than legal relief.  Removing the façade of equity from many SEC cases could also affect whether the putative disgorgement claim was subject to any statute of limitations or entitled the defendant to a jury trial (both of which protections are now typically denied to defendants facing SEC disgorgement claims).

If you are an SEC expert and thinking “but wait, can’t the SEC also order disgorgement in administrative proceedings without going to court at all?,” go to the head of the class.

You’re right, the SEC can indeed do so, because Congress has said so in the parts of the securities laws dealing with administrative proceedings.  But think about it:  If Congress can bestow this power to order disgorgement upon an independent Executive Branch administrative agency acting in its law enforcement role, without the involvement of an Article III court, doesn’t that undermine – if not completely negate – any premise that the remedy is inherently an equitable one, i.e., something typically ordered by an Article III court exercising its core judicial powers in equity?

If you’re still reading at this point, I encourage you to check out my entire article and see what you think.

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