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Client Alert: Supreme Court to review SEC’s power to obtain disgorgement

Financial, Executive and Professional Risks (FINEX)
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By John M. Orr | November 21, 2019

The United States Supreme Court agreed to review whether a district court, in a civil enforcement action brought by the Securities and Exchange Commission, may order disgorgement of money acquired through fraud.

On November 1, 2019, the United States Supreme Court agreed to review the question of whether a district court, in a civil enforcement action brought by the Securities and Exchange Commission (SEC), may order disgorgement of money acquired through fraud. The Court’s ruling, expected before the end of its current term in June 2020, will have an impact on the reach of the SEC’s enforcement powers, as well as potential coverage under corporate directors and officers (D&O) liability insurance policies.

The case at issue is Liu v. SEC, No. 17-55849 (9th Cir. 2018) (Liu). In Liu, the defendants had raised approximately $27M from Chinese investors under a federal immigration program designed to allow foreign citizens to obtain visas in exchange for U.S. investments. The SEC alleged, however, that defendants had acquired the money through fraud and had misappropriated the funds. The district court found the defendants liable under Section 17(a)(2) of the Securities Act of 1933, which prohibits “obtain[ing] money or property by means of any untrue statement of a material fact” in the offer or sale of securities. It further ordered the defendants to, among other things, disgorge gains associated with their purported wrongdoing. The U.S. Court of Appeals affirmed the district court’s order.

The defendants’ current appeal stems from the Supreme Court’s 2017 decision in Kokesh v. SEC, 137 S. Ct. 1635 (2017). There, the Court determined that disgorgement was a penalty within the meaning of federal law for purposes of applying a five-year statute of limitations. The defendants now challenge the authority of the SEC to obtain disgorgement as an equitable remedy, principally asserting that sums paid as disgorgement cannot be both punitive and remedial. Kokesh did not resolve the issue. Instead, it stated in a footnote that it was not addressing “whether courts have properly applied disgorgement principles in this context” or “whether courts possess authority to order disgorgement in SEC enforcement proceedings.” The Liu appeal now appears to emerge from these open questions.

The SEC’s reliance on disgorgement as a remedial tool is long-standing, having had the decades-long effect of compensating victims of fraud to the tune of billions of dollars. Of course, whether the Court ultimately rules the agency no longer has the authority to continue this practice and, if not, whether there are possible legislative workarounds in a challenging congressional environment, remains to be seen. Regardless, the decision is likely to have lasting significance.

Subject to their terms and conditions, D&O insurance policies generally cover corporate directors and officers in SEC enforcement proceedings; however, coverage for civil fines and penalties, whether punitive or remedial, can be challenging, taking into account policy language, underlying facts and public policy considerations. As a result, depending on the scope of the Court’s order, the outcome in Liu is likely to have a bearing on breadth of coverage and an insured’s abilities to advocate for policy recovery going forward.

We will closely monitor Liu and advise on substantive developments as the case progresses through the high court. In the interim, we encourage you to reach out to a Willis Towers Watson FINEX professional if you have questions or feedback.

Willis Towers Watson hopes you found the general information provided in this publication informative and helpful. The information contained herein is not intended to constitute legal or other professional advice and should not be relied upon in lieu of consultation with your own legal advisors. In the event you would like more information regarding your insurance coverage, please do not hesitate to reach out to us. In North America, Willis Towers Watson offers insurance products through licensed subsidiaries of Willis North America Inc., including Willis Towers Watson Northeast, Inc. (in the United States) and Willis of Canada, Inc.

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