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At issue are three terms, equitable relief, disgorgement, and penalty. If one were to not burden oneself with defining terms and their context, the U.S. Supreme Court decided to allow the Securities and Exchange Commission (SEC) to seek disgorgement as a remedy in their civil actions under an equitable relief construct. However, the calculation of that disgorgement must factor in and exclude legitimate business expenses when determining the amount of disgorgement.

Liu et al. v. Securities and Exchange Commission

The case before the high court was entitled Liu et al. v. Securities and Exchange Commission (Liu) – (click here). According to the initial SEC complaint a married Chinese couple Charles Liu and his wife Xin (Lisa) Wang, solicited nearly $27 million from foreign investors under the EB–5 Immigrant Investor Program (EB–5 Program). The EB-5 program is administered by the U. S. Citizenship and Immigration Services. From the perspective of investing in an EB-5 program federal securities laws apply.

The SEC alleged that most proceeds of the funds raised by Liu and Wang were diverted and not used for the stated purpose. Thus, the couples action violated the terms of the offering documents by misappropriating millions of dollars.

The SEC prevailed in the District Court obtaining of an Order of $26 million in disgorgement and approximately $8 million in civil monetary penalties. The Ninth Circuit Court affirmed upon appeal. The Petitioners Liu et. al. then filed with the U.S. Supreme Court arguing in part that disgorgement was not equitable relief.

The balancing act

When seeking damages based on equity the Court referenced Marshall v. Vicksburg, 15 Wall. 146, 149 (1873) pointing out that equity never “lends its aid to enforce a forfeiture or penalty.” Some of the issues addressed were the meaning of the word disgorgement and is disgorgement equitable relief.

In a Supreme Court ruling in the 2017 Kokesh v. SEC (Kokesh) matter the Court ruled that disgorgement qualified as a penalty for purposes of the applicable statute of limitations. However, the Kokesh ruling did not address the calculation of disgorgement, only the applicability in terms of statute of limitations. Apparently, the $26 million of disgorgement in the Liu did not consider expenses spent on leases and cancer-treatment equipment related to the investment. Liu provided clarity on the calculation of disgorgement.

The Court expressed concern about the SEC’s determination of disgorgement by stating, “The SEC’s disgorgement remedy in such incarnations is in considerable tension with equity practices.” The Government, for its part, contends that the SEC’s interpretation of the equitable disgorgement remedy has Congress’ tacit support, even if it exceeds the bounds of equity practice.

The crux of the argument before the Supreme Court in Liu was whether “legitimate business expenses” were to be considered in calculating the amount to be disgorged. The Court held, “A disgorgement award that does not exceed a wrongdoer’s net profits and is awarded for victims is equitable relief permissible under §78u(d)(5).” N.B. §78u(d)(5) Equitable Relief states the following: “In any action or proceeding brought or instituted by the Commission under any provision of the securities laws, the Commission may seek, and any Federal court may grant, any equitable relief that may be appropriate or necessary for the benefit of investors.”

“The Government maintains, however, that the primary function of depriving wrongdoers of profits is to deny them the fruits of their ill-gotten gains, not to return the funds to victims as a kind of restitution.” “Under the Government’s theory, the very fact that it conducted an enforcement action satisfies the requirement that it is “appropriate or necessary for the benefit of investors.”

Since long ago it was ruled that equity never “lends its aid to enforce a forfeiture or penalty” how is it that disgorgement that was determined to be a penalty under Kokesh can be imposed under a regulation that claims to be authorized under the concept of equitable relief?

Back to the definition issue. Justice Thomas disagrees that disgorgement, however calculated constitutes equitable relief – (it) “represents a “‘novel extension’” of equity”. There is a considerable amount of text devoted to the genesis of the word disgorgement. Thomas gets to the heart of the matter, in my view. The convention of equitable relief refers to forms of equitable relief available in the English Court of Chancery at the time of the founding. Disgorgement was not a concept dating at that time. Disgorgement is a “20th Century construct.

What this means for compliance professionals

There is an established carve-out related to the deduction of business expenses as it pertains to disgorgement, “It is true that when the “entire profit of a business or undertaking” results from the wrongdoing, a defendant may be denied “inequitable deductions” such as for personal services. Root, 105 U. S., at 203.”, as is most likely the case here. Establishing the delineation between “inequitable deductions” and legitimate business expense, in some cases is going to be difficult.

There is most likely to be considerable confusion in applying this standard of disgorgement from an illegal activity of a legitimate business concern whether disgorgement is defined as a penalty or equitable relief. For example, say a bank is found to have violated Bank Secrecy Act/AML requirements. The challenge, if disgorgement is sought by a regulator is going to be determination and separation of legitimate business expenses related to the illegitimate business activity.


Justice Thomas in his dissent stated “The majority’s treatment of disgorgement as an equitable remedy threatens great mischief. The term disgorgement itself invites abuse because it is a word with no fixed meaning.” He is correct.

Although the agency could just call it what it was, a penalty not an equitable relief as the money was never going back to the people who lost it in the first place.


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