Judicial review of SEC disgorgement orders
🔍 Judicial Review of SEC Disgorgement Orders
I. ⚖️ What Is Disgorgement?
Disgorgement is an equitable remedy used by courts to compel wrongdoers to give up ill-gotten gains resulting from violations of securities laws. The Securities and Exchange Commission (SEC) has historically used disgorgement in civil enforcement actions to deter wrongdoing and restore unlawfully obtained profits.
II. 🧭 Legal Framework and Evolution
Disgorgement is not explicitly authorized by the federal securities laws (e.g., the Securities Exchange Act of 1934), but courts traditionally permitted it under their equitable powers.
Over time, the use of disgorgement by the SEC expanded significantly, especially in administrative proceedings and federal court actions.
Judicial review involves determining whether such orders exceed statutory authority, violate constitutional protections, or are equitable and fair under the circumstances.
III. 🧨 Landmark Case Law: SEC Disgorgement Under Judicial Scrutiny
Below are seven major cases that have shaped the contours of judicial review over SEC disgorgement:
1. SEC v. Texas Gulf Sulphur Co., 446 F.2d 1301 (2d Cir. 1971)
🔹 Facts:
SEC sought disgorgement from insiders who traded based on material nonpublic information.
🔹 Holding:
The Second Circuit upheld the SEC’s right to seek disgorgement, characterizing it as a remedial, equitable measure.
🔹 Impact:
First major federal appellate case to firmly endorse SEC disgorgement as a deterrent and restitutionary device.
Set the stage for expansive SEC use of disgorgement in insider trading cases.
2. SEC v. First Jersey Securities, Inc., 101 F.3d 1450 (2d Cir. 1996)
🔹 Facts:
Broker-dealer was found liable for fraudulent practices; the SEC sought significant disgorgement.
🔹 Holding:
The court upheld a large disgorgement order and emphasized that disgorgement is not a punitive sanction as long as it does not exceed the wrongdoer's unjust enrichment.
🔹 Impact:
Clarified that prejudgment interest may be included in disgorgement orders.
Reinforced that causation and traceability are required between illegal conduct and profits.
3. SEC v. Cavanagh, 445 F.3d 105 (2d Cir. 2006)
🔹 Facts:
SEC sought disgorgement of profits from unregistered stock sales.
🔹 Holding:
The court affirmed disgorgement of gross proceeds, rejecting arguments to deduct legitimate expenses.
🔹 Impact:
Highlighted the principle that "wrongdoers are not entitled to deduct business expenses" from illegally obtained profits.
Underscored court’s broad discretion in calculating disgorgement amounts.
4. Kokesh v. SEC, 581 U.S. 455 (2017)
🔹 Facts:
Kokesh challenged a $34.9 million disgorgement order, arguing it was a penalty and thus time-barred under the 5-year statute of limitations (28 U.S.C. § 2462).
🔹 Holding:
The Supreme Court unanimously held that SEC disgorgement is a penalty, not merely remedial, and therefore subject to the 5-year statute of limitations.
🔹 Impact:
Dramatically curtailed the SEC’s ability to reach back indefinitely to recover profits from older violations.
First major setback to the SEC's broad disgorgement authority.
5. Liu v. SEC, 591 U.S. ___, 140 S. Ct. 1936 (2020)
🔹 Facts:
The petitioners challenged the SEC’s disgorgement order, arguing that disgorgement exceeded the agency's statutory authority under 15 U.S.C. § 78u(d)(5).
🔹 Holding:
The Supreme Court held that disgorgement is permissible as an equitable remedy under certain conditions:
It must not exceed net profits (after legitimate expenses).
It must be awarded for the benefit of victims.
It must be consistent with traditional equity practice.
🔹 Impact:
Limited the SEC’s disgorgement power.
Introduced the requirement that courts must calculate “net profits”, not gross revenue.
Rejected disgorgement when funds go to the U.S. Treasury instead of victims.
6. SEC v. Hallam, 42 F.4th 316 (5th Cir. 2022)
🔹 Facts:
The defendant challenged a disgorgement order arguing that the SEC failed to comply with Liu’s standards, especially regarding net profits and benefit to victims.
🔹 Holding:
The Fifth Circuit vacated part of the disgorgement order because the SEC did not adequately justify the amount and failed to show the money would be returned to victims.
🔹 Impact:
Confirmed that post-Liu, courts must scrutinize disgorgement orders more carefully.
Signaled a trend toward narrower disgorgement in line with equity principles.
7. SEC v. Ahmed, 72 F.4th 379 (2d Cir. 2023)
🔹 Facts:
The SEC sought one of its largest-ever disgorgement awards (over $90 million) after an insider trading scheme.
🔹 Holding:
The Second Circuit affirmed the disgorgement of net profits but reversed parts where the SEC failed to link the amounts directly to illegal gains.
🔹 Impact:
Reinforced Liu's requirement for tracing illegal gains.
Clarified that joint-and-several liability may apply only where co-defendants acted as partners.
IV. 🔍 Key Legal Principles from Case Law
| Legal Principle | Explanation |
|---|---|
| Disgorgement as equitable | Courts may order it to deprive wrongdoers of profits. |
| Statutory authority limits | Disgorgement must fit within powers granted by Congress (Liu). |
| Must reflect net profits | Gross revenues must be reduced by legitimate business expenses (Liu). |
| Benefit to victims | Funds should ideally go to harmed investors, not the Treasury (Liu, Hallam). |
| Subject to statute of limitations | 5-year bar applies (Kokesh). |
| Judicial discretion in calculation | Courts have broad leeway, but decisions must be reasoned and tied to facts. |
V. Judicial Review: Standards and Limits
When reviewing SEC disgorgement orders, courts look at:
Statutory Authority – Does the order exceed what Congress allowed under securities laws?
Due Process – Was the defendant fairly notified of what was required and why?
Equity – Is the disgorgement fair, reasonable, and consistent with equitable traditions?
Evidence – Are the amounts clearly traceable to illegal conduct?
Post-Liu, courts are now more active in examining these elements rather than rubber-stamping SEC requests.
VI. Final Notes: Post-Liu SEC Disgorgement Landscape
The SEC continues to seek disgorgement but must now build stronger evidentiary records.
Disgorgement is now capped at net profits, not revenue.
Courts are more vigilant in reviewing whether victims are actually being compensated.
The power balance between agency discretion and judicial oversight has shifted toward the courts.
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