The Division of Enforcement, by any measure, had a successful year despite facing significant headwinds, according to its FY 2019 Annual Report. Success stems from a variety of factors, not just the number of cases or the amounts of money ordered in actions. Factors discussed in the Report include:

Main street investors: The main street investor is a key focus of the Division. That focus is reflected in the Share Class Selection Disclosure Initiative which resulted in 95 investment advisory firms voluntarily self-reporting and returning over $135 million to impacted mutual fund investors. It is also reflected in the Retail Strategy Task Force which brought a number of cases utilizing in part data analytics which might more typically be seen in insider trading cases.

Financial institutions and issuers: Activity by these key players in the capital markets can be difficult to detect, according to the Report. Nevertheless, the Division filed a series of significant actions involving companies such as a large social media firm, key players in the automotive industry and others. A series of actions centered on abuses involving ADRs while one involved the Options Clearing Corporation and its operations.

Individuals: A key focus for the Division was bringing actions which held individuals accountable. A review of the case load for last year (a table in the appendix of the Report lists those cases) demonstrates that individuals in leadership position at large and small issuers were named as defendants along with their firms in a number of actions.

Digital assets: The Division brought a series of actions against digital asset firms, frequently alleging fraud and registration violations. A case was also brought against two celebrities who touted digital assets for an issuer without disclosing that they were being paid. This group of actions “sent the clear message that, if a product is a security, regardless of the label attached to it, those who issue, promote, or provide a platform for buying and selling that security must comply with the investor protection requirements of the federal securities laws,” according to the Report.

Cybersecurity: Two years ago the Division created a Cyber Unit to focus on cyber-related treats. This unit has brought a number of significant actions and continues to work with other staff Divisions. Included in those actions are two based on violations of Regulation Systems Compliance and Integrity or Reg SCI. Another action centered on exchange listed options against the Options Clearing Corporation.

Accelerating investigations: To maximize the impact of its cases the Division is focusing on accelerating investigations. In Fiscal Year 2019 the average case took under 24 months from opening to closing. This reflects a “slight improvement” compared to prior years. As the Report notes, however, many cases take longer than the 24 month average.

Leveraging technology: Effectively using technology to enhance the limited resources available to the Division has also been a key focus. The impact of these efforts is evident in, for example, the detailed analysis done in the suspicious trading cases and other large international insider trading actions.

Statistics: The Report details the usual statistics. Those include the number of cases brought in FY 2019 compared to prior years. Last year 526 standalone enforcement actions were brought compared to 490 in FY 2018, 446 in FY 2017, 548 in FY 2016 and 508 in FY 2015. The table does not note that in FY 2019 a series of cases were brought as part of the Share Class cooperation initiative, a point noted in earlier reports.

The types of cases brought last year reflect the focus of the Division. In FY 2019 the largest number of cases were brought against investment advisers and investment companies. The second largest group of cases centered on securities offerings while cases involving issuer reporting and audit and accounting were third. In FY 2018 securities offering actions represented the largest group of cases following by those involving investment advisers and investment companies. While there is little doubt that the share class cooperation initiative impacted these results, they are consistent with trends that have been developing for a number of years.

Finally, in FY 2019 total money ordered in enforcement cases was $3,248 million which is composed of $1,101 million in penalties and $3,248 million in disgorgement. Those results compare to the FY 2018 results of $3,945 million ($1,439 in penalties and $2,506 in disgorgement) and in FY 2017 $3,789 ($832 in penalties and $2,957 in disgorgement).

Challenges: Finally, the Report notes that the decision in Kokesh continues to present an on-going challenge. That decision has resulted in the Commission foregoing an estimated $1.1 billion in disgorgement. While the Division has had some improvement in this area, the decision will continue to present issues. Not discussed in the Report is the potential impact of Lui which the Court just agreed to hear later this term. That decision raises the question of whether the Commission can seek disgorgement in its enforcement actions since neither the Securities nor the Exchange Act have a specific statutory provision authorizing such relief. Both cases are likely to present difficulty for the Enforcement Division during fiscal 2020.

Print Friendly, PDF & Email
Tagged with: ,

The Supreme Court granted certiorari in a case that may well have a very significant impact on the remedies available in Commission enforcement actions: Liu v. Securities and Exchange Commission, No. 18-1501 (Cert. granted Nov. 1, 2019). The question the Court agreed to resolve is: “Whether the Securities and Exchange Commission may seek and obtain disgorgement from a court as ‘equitable relief’ for a securities law violation even though this Court has determined that such disgorgement is a penalty.” The case will be heard later this term.

Background

The Commission’s complaint centers on an EB-5 project. Petitioners (defendants below) Charles C. Liu and Xin Wang, operated a regional center. The program offers a path to citizenship for foreign nationals who invest either $500,000 or $1 million, depending on the location, in U.S. projects that create specified numbers of U.S. jobs.

The investment funds in this case were pooled and supposedly would be utilized to build a cancer treatment center. Construction began in 2015 but latter stalled. The Commission filed suit in the Central District of California alleging violations of Securities Act Section 17(a) and Exchange Act Section 10(b) centered on the use of the investor funds.

The District Court granted summary judgment in favor of the Commission, concluding there were violations of Securities Act Section 17(a)(2). The Court entered a permanent injunction as to each Defendant. The Court also imposed a fine of $6,714,580 and ordered the payment of disgorgement of $26,440,304 along with prejudgment interest. The Court refused to reduce that amount by the cost of construction. No fair fund was requested by the SEC. The Ninth Circuit Court of Appeals affirmed.

Reasons for granting the writ

Petitioners offered three key reasons for granting the writ. First, Congress did not authorize what the Petition calls “disgorgement penalties.” When the federal securities laws were enacted, and in subsequent amendments, Congress did not specifically authorize the SEC to seek disgorgement. To the contrary the Commission, in civil cases, was authorized to seek civil monetary penalties, injunctions and “appropriate or necessary” equitable relief (internal cites omitted). “Disgorgement does not fall within any of those categories,” the Petition notes, citing Kokesh v. SEC, 137 S.Ct. 1632 (2017).

Second, it is clear that the SEC remedy of disgorgement is not supported by “any express or implied authority of the federal courts to grant equitable relief.” At oral argument in Kokesh five Justices “noted the lack of any clear statutory authority for disgorgement” – Justices Kennedy, Sotomayor, Alito, Gorsuch and the Chief Justice. That lack of statutory authority makes it clear that Congress “cabined” the SEC’s authority to obtain monetary penalties only – disgorgement was not authorized.

Third, disgorgement as an equitable remedy can be awarded to “restore the status quo after a wrong-doing, not punish, Petitioners argued. In contrast, punishment is the aim of disgorgement in cases such as this one. In Commission cases such as this, disgorgement “does not simply restore the status quo, it leaves the defendant worse off.”

This is precisely the situation here. Petitioners were directed to pay what is called disgorgement of over $26 million. Yet it is clear that a substantial portion of the money raised was expended on the construction. In the end Petitioners will be nearly $16 million in debt, a financial position that is far worse that what it was prior to the project.

Finally, Kokesh concluded that disgorgement in Commission cases is a penalty – the funds frequently are not returned to the investors. Under such circumstances the award is not designed to return the situation to the status quo. To the contrary, it is imposed because of a violation of public laws. Viewed in that context, the aware is ordered to “vindicate the public interest.” Thus, the SEC has sought and obtained millions of dollars in disgorgement not as an equitable remedy but a penalty without statutory authority.

Respondents

Petitioners obtained about $27 million from investors, much of which went to Petitioners, the Commission noted. The lower courts were thus correct in awarding disgorgement here. The decisions of those courts should stand – there is no reason to grant the writ.

First, judicial authority to award disgorgement derives from two sources. One is the statutory authority to “enjoin” violations which includes the power to “order a violator to disgorge profits . . .” (internal citations omitted). That authority is fortified by the Sarbanes-Oxley Act of 2002. There Congress amended Exchange Act Section 21(d) to authorize Courts hearing an enforcement action to order “any equitable relief that may be appropriate or necessary for the benefit of investors. This legislation was passed against an unbroken record of circuit courts permitting the award of disgorgement in Commission enforcement actions, the agency argued, citing cases such as SEC v Texas Gulf Sulphur Co., 446 F. 2d 1301 (2nd Cir. 1971). This interpretation has been repeatedly confirmed by Congress which has over the years passed legislation that cited and/or referenced disgorgement in Commission enforcement actions.

Second, while Petitioners rely on Kokesh to support their claim that disgorgement in SEC enforcement actions is inconsistent with equitable principles, their reliance is misplaced. There the Court concluded that disgorgement in enforcement actions is a penalty in the context of considering a question regarding the statute of limitations. While a remedy might be a penalty in one context, that is not determinative of other situations. That is the situation here.

Third, five decades of circuit court cases support the proposition that disgorgement in SEC enforcement actions is an equitable remedy. Indeed, since the decision of the Second Circuit in Texas Gulf the circuit courts have uniformly recognized that district courts can award disgorgement in Commission enforcement actions. That understanding has continued since Kokesh.

Finally, while Petitioners argue that the disgorgement award here is a penalty because the lower court failed to offset certain expenses, they are incorrect. Here the court concluded that the disgorgement awarded represented a “reasonable approximation of the profits causally connected to . . .” the violation.

Comment

Liu presents a significant issue for the SEC and its enforcement program. As the Commission points out in its papers, there is a virtually unbroken line of cases tracing back to at least Texas Gulf awarding the agency disgorgement. Congress has also repeatedly legislated against the backdrop of those cases, thus implicitly affirming the action of the courts.

Nevertheless, it is difficult to contend that disgorgement, as that term is used today by the SEC, is the traditional equitable remedy of years past. When the SEC requested an award of disgorgement in cases like Texas Gulf the argument was predicated on the traditional equitable power and authority of the federal courts. That remedy focused on restoring the status quo.

SEC disgorgement today seems to have moved far from its traditional roots. The impact of that shift may well have resulted in the passages cited from Kokesh about penalties by Petitioners. While the Commission is correct that the ruling in that case was tied to the dictates of Section 2467, it is also true that the awards sought in its enforcement actions are at least in part penalties.

Ultimately, the resolution of Liu may turn on the lack of statutory authority in the Securities Act and the Exchange Act. Each statute specifies the remedies available. Neither statute specifically authorizes disgorgement. For a Supreme Court which likes to focus on the plain language of the statutory text, those omissions may prove determinative despite years of circuit court decisions to the contrary.

Print Friendly, PDF & Email
Tagged with: ,