The remedy is subject to significant discourse among judges, litigants, legal commentators and policy analysts because disgorged funds rarely—if ever—find their way back into the hands of harmed investors. The SEC's Enforcement Division reported that, for fiscal year 2019, of the $4.3 billion in disgorgement and penalties awarded, only $1.2 billion was returned to harmed investors. That figure reflects the continuing practice of courts to award disgorgement while placing little to no restrictions on the SEC's use of the funds. As a result, the SEC has been able to transform disgorgement into a de facto revenue-raising scheme.

The Supreme Court had flagged the question of disgorgement's continued viability back in 2017, in its now-infamous footnote 3 of Kokesh v. SEC, a decision in which the court held that disgorgement "bears all the hallmarks of a penalty" and is thus subject to the five-year statute of limitations in 28 U.S.C. Section 2462. 137 S. Ct. 1635, 1642 n.3 (2017). The immediate and direct holding of Kokesh was that the SEC could no longer seek disgorgement of ill-gotten gains older than five years. But the decision also had far broader import. As then-Judge Brett Kavanaugh stated, Kokesh "overturned a line of cases from [the D.C. Circuit] that had concluded that disgorgement was remedial and not punitive." See Saad v. SEC, 873 F.3d 297, 305 (D.C. Cir. 2017) (Kavanaugh, J., concurring).

The court's conclusion that disgorgement was punitive in nature set the table for a far broader question—one that Kokesh left for another day—"whether courts possess authority to order disgorgement in SEC enforcement proceedings or whether courts have properly applied disgorgement principles in this context." In other words, the court was questioning—and inviting defendants to challenge—the SEC's long-held belief that it had an unfettered right to seek disgorgement. Oral argument in Kokesh gave litigants a clear preview as to which way the court was leaning on that question. No fewer than five justices questioned the SEC's authority to seek disgorgement, with Chief Justice Roberts observing credulously, "the SEC devised this remedy or relied on this remedy without any support from Congress." Counsel for the SEC in Kokesh could not cite any such source.

The legal challenge presented in Liu arises directly out of the question posed by footnote 3 of Kokesh. Petitioners Charles C. Liu and Xin Wang operated an "Immigrant Investor Program" to procure visas under 8 U.S.C. Section 1153(b)(5)(A), a statute that allows immigrants to enter the United States "for the purpose of engaging in a new commercial enterprise." Investors seeking a visa under this statute often send money to centers such as Liu and Wang's that aggregate investment funds into qualifying commercial enterprises. The government treats such investments as "securities" subject to federal securities laws. The SEC eventually brought suit against Liu and Wang, accusing them of misappropriating investor funds to overseas companies and to pay themselves salaries. The district court in Liu granted summary judgment in the SEC's favor and also ordered Liu and Wang to pay not only civil penalties under 15 U.S.C. Section 77t(d) and Section 78u(d)(3)(B), but also ordered disgorgement pursuant to its "equitable powers." As is standard in its requests for disgorgement, the SEC did not propose returning the disgorged funds to investors, nor did it suggest that any other restrictions be placed on the use of the funds. This crystallizes the issue, whether such an order of disgorgement is, in fact, equitable, when it looks and functions as a penalty.

Just after the district court entered judgment, the court decided Kokesh. Taking up the invitation from footnote 3, Liu and Wang appealed to the U.S. Court of Appeals for the Ninth Circuit, arguing that the district court lacked statutory authority to impose disgorgement. The Ninth Circuit rejected the argument, explaining that Kokesh actually made no ruling with respect to whether disgorgement remained a viable remedy. Thus, footnote 3 was not "clearly irreconcilable" with the Ninth Circuit's longstanding precedent on the matter. The Supreme Court granted certiorari.

In its briefing in Liu before the court, the SEC abandoned any pretext that there existed any express statutory authority to obtain disgorgement in judicial proceedings. Instead, the SEC's sole legal argument was that disgorgement is an "equitable remedy." According to the SEC, because Congress granted it the authority to "enjoin" statutory violations and otherwise grant "equitable relief" under 15 U.S.C. Sections 77t(b), Congress had implicitly authorized disgorgement as another remedy. The SEC's argument, while novel, runs up against a serious hurdle. Congress has already spoken on the matter several times, and has passed numerous statutes enumerating the manner and form of relief the SEC may seek. Never once has Congress ever suggested that the SEC has, on top of all the various monetary remedies outlined by statute, virtually unbridled authority to obtain disgorgement.

The SEC also proffered a second, similarly creative argument. Recognizing the barrier presented by the conclusion in Kokesh, that disgorgement was a "penalty," the SEC cited Supreme Court precedent characterizing "penal" and "penalty" as words that are "elastic in meaning." The problem for the SEC, however, was that Kokesh explained exactly what it meant by "penalty"—in the case of disgorgement, it constitutes a penalty because courts impose the remedy for violations of securities laws, it is punitive in nature, and has no compensatory purpose. Punitive remedies are inconsistent with the remedial purpose of equity, which is to return victims to the status quo. Nothing requires, however, that the SEC return disgorged funds to injured investors and, as the numbers show for FY 2019, the SEC returned something less than 30% of funds subject to disgorgement.

The SEC thus faced an uphill battle in argument before the Supreme Court in Liu. Several justices made clear that, even in cases involving fraud, and even assuming some basis for disgorgement could be found in notions of equity, there must be limits. One limit in particular that the justices seized upon during argument concerned the SEC's ability to distribute disgorged amounts to the Treasury, rather than returned to harmed investors. Justice Neil Gorsuch asked the SEC whether "the government [would] have any difficulty with a rule that the money should be returned to investors where feasible?"

Justice Kavanaugh honed in on the same limitation, asking, "Would it be appropriate for this court to say that's the rule; namely, that it has to be returned to investors where feasible?" The justices also posed similar questions for the petitioners, asking if there could be a viable form of disgorgement that, consistent with equitable principles, sought to return disgorged funds to investors. When counsel for the petitioners suggested that it would be unworkable to administer disgorgement—and supervise the SEC's efforts—in such a manner, Chief Justice John Roberts expressed sharp skepticism, pointing out that "if the SEC is engaged in a proceeding like this with respect to investments, I would assume that investors should be pretty easy to find if there's money available."

Gorsuch noted, that in the analogous situation of class actions, the fact that courts "do police the efforts of the defendant to find and return money to the investors that he or she's defrauded." In light of the fact that courts routinely administer restitution efforts in the class action context, Gorsuch asked the petitioners, "Why doesn't that supply at least a ready guide and maybe make it impermissible for the government to not make any effort at all?"

If the justices' questioning can be any guide to the court's forthcoming decision, to the extent disgorgement survives as a remedy available to the SEC, it will likely be severely curtailed. Borrowing from class actions and similar contexts, the court may, and quite frankly should, impose a requirement on the SEC to, as Gorsuch put it, "be in the business of returning the money." That, of course, assumes that the court would even conclude that the SEC has an unenumerated, equitable right to seek disgorgement in judicial proceedings in the first place.

Perrie M. Weiner is the partner in charge of the firm's Los Angeles office. He is also the chair of the North America securities litigation group. Aaron Goodman is of counsel in the firm's litigation and government enforcement, global compliance and investigations, and securities litigation groups. Kirby Hsu is an associate in Baker McKenzie's Los Angeles office and a member of the firm's North America litigation and government enforcement practice group. Ben Turner is counsel in the firm's Los Angeles office and is a member of the North American litigation and government enforcement practice group.