What Remains of Kokesh After Liu?
By Andrew N. Vollmer
Senior Affiliated Scholar, Mercatus Center at George Mason University. Former Professor of Law, General Faculty, University of Virginia School of Law; former Deputy General Counsel of the Securities and Exchange Commission; and former partner in the securities enforcement practice of Wilmer Cutler Pickering Hale and Dorr LLP.
In Liu v. SEC, 2020 WL 3405845 (U.S.), the Supreme Court decided that federal courts have the authority to enter an order obliging a defendant in an SEC enforcement case to disgorge wrongful profits but only if the disgorgement order stays within the bounds of three traditional principles of equity. Equity was a system of law developed in England and imported into the American colonies that supplemented the courts of common law. First, equity and part of the language of the relevant statute demand that generally a disgorgement order must require the return of “a defendant’s gains to wronged investors for their benefit.” Id. at *9; see also id. at *7. Second, an order should not impose joint liability obliging one defendant to pay profits that another person received. Id. at *7, *10–11. Third, an order must not exceed net profits from wrongdoing after deducting legitimate expenses. Id. at *7–8, *11–12.
The majority, Justice Thomas in dissent, and commentators already observed that the Liu opinion left open a variety of important issues. What happens if the SEC and the court are not able to distribute disgorged funds to victims, which regularly occurs in insider trading and corrupt payment cases? When are the finances of two separate persons so commingled that an order may require a defendant to disgorge wrongful profits received by the other person? When are expenses not legitimate and eligible for deduction from gross receipts of misconduct?
Those are worthy topics to explore, but two slightly different questions emerging from Liu attracted my attention. The first concerns the status of a disgorgement order that fails to satisfy the Court’s equitable limitations. The second concerns the application of the five-year limitations period in 28 U.S.C. § 2462 to a disgorgement order complying with the Liu requirements.
A reaction to Liu was that courts could issue two different types of disgorgement orders. One type would comply with the equitable limitations listed in Liu. The other would not. What would be the status of an order that does not comply with the Liu restrictions? My view is that such an order is not possible because courts do not have power to issue a disgorgement order in an SEC case unless the terms of the order meet the limitations required in the Liu opinion. An order not meeting those limitations would not be valid.
The Court said the question in Liu was whether federal courts have “authority” to order disgorgement in SEC enforcement proceedings. 2020 WL 3405845, at *4. To have the necessary authority to enter a particular form of relief in an SEC case, courts need a statute to grant them the power. Id. at *3, *5. The statute the Liu Court considered was section 21(d)(5) of the Exchange Act, which gives federal courts the power to order “equitable relief” for the benefit of investors in an SEC enforcement case.
The Court therefore examined whether disgorgement was equitable relief and found that it was. Equity courts routinely deprived wrongdoers of their net profits from unlawful activity. Id. at *5–6.
Not every order labelled disgorgement qualified as equitable, however. The Court determined that equity courts circumscribed profit-based remedies in several ways to prevent them from transforming into a penalty outside the power of equity. Id. at *7. The Court then identified three limitations from traditional equitable principles: payment to victims, payment of net profits not gross receipts, and payment of only the specific defendant’s profits. The limitations were essential to the equitable character of relief ordering a defendant to pay profits from misconduct, and a disgorgement order needed to meet those limitations to be equitable relief under section 21(d)(5). Id. at *8.
That meant that the statute authorized only those disgorgement orders within the boundaries. The Court said section 21(d)(5) incorporated the “longstanding equitable principles.” Id. An award complying with the limitations in Liu was “equitable relief permissible under” section 21(d)(5). Id. at *2. An award that did not comply was not permissible because it was not equitable relief and lacked statutory authorization. A court therefore has no power to issue a disgorgement order in an SEC enforcement case that does not conform to the restrictions discussed in Liu, accepting that the scope and meaning of the restrictions have not been definitively established.
A second question of interest is about the relationship between Liu and Kokesh v. SEC, 137 S. Ct. 1635 (2017), where the Court held that disgorgement in an SEC enforcement case imposed a penalty for purposes of applying the limitations period in 28 U.S.C. § 2462. Section 2462 provides that a claim for a fine, penalty, or forfeiture must be commenced within five years from the time the claim first accrued.
Did Liu alter the application of the statute of limitations to disgorgement orders or have no effect? The way I read the opinion, Liu overruled Kokesh as a practical matter, allowing the SEC to seek and a court to order disgorgement in a case commenced more than five years after the enforcement claim first accrued, but others might disagree with that reading. No doubt this question will become the subject of further litigation.
My understanding of the reasoning in Liu follows. We have already discussed that a disgorgement order needed to be equitable to be authorized by statute as a form of relief available in an SEC enforcement case in federal court. Liu concluded that a disgorgement order qualifies as equitable relief only when it has certain features established by longstanding principles of equity.
To understand that Liu overrode Kokesh, we need only add that Liu found equitable relief to be incompatible with a penalty. Liu made the point in several ways. The Court observed that the power to award equitable relief under section 21(d)(5) was historically one that excluded punitive sanctions, 2020 WL 3405845, at *2, and that equity never lends its aid to enforce a forfeiture or penalty, id. at *4. When describing the conditions a disgorgement order needed to meet to constitute equitable relief, the Court several times said those limitations were necessary to prevent the remedy from becoming a penalty: “to avoid transforming an equitable remedy into a punitive sanction, courts restricted the remedy to an individual wrongdoer’s net profits to be awarded for victims.” Id. at *5; see also id. at *7 (limitations on disgorgement were “to avoid transforming it into a penalty outside [the courts’] equitable powers”), *11.
Liu said that a properly limited disgorgement award is equitable relief and that equity does not enforce a penalty. The five-year statute of limitations in section 2462 applies only to claims for a fine, penalty, or forfeiture. It therefore does not govern a disgorgement order that conforms to the equitable principles in Liu.
If that logic holds, can Liu and Kokesh be read together harmoniously or does Liu imperil Kokesh? Did Liu offer a way to distinguish Kokesh, where the Court had determined that SEC disgorgement was a penalty? Yes, but not with the clarity and directness that the matter deserved. The Liu Court said that disgorgement relief in past SEC cases had been in considerable tension with equity practices but that Kokesh had not ruled that all types of disgorgement were not available in equity. The version of the disgorgement remedy evaluated in Kokesh seemed to exceed the bounds of traditional equitable principles. Thus, Kokesh “has no bearing on the SEC’s ability to conform future requests for a defendant’s profits to the limits outlined in common-law cases awarding a wrongdoer’s net gains.” Id. at *8.
The final sentence and the phrase “has no bearing” are not entirely clear. They could mean that Kokesh and Liu have nothing to do with each other and that Kokesh remains alive to impose the five-year limitation on SEC cases for disgorgement. The better reading, however, is that Liu was distinguishing between a disgorgement order complying with the restrictions Liu found necessary to make the order equitable, that is, an order in the future that satisfied the limits on awarding wrongdoer net profits, and a disgorgement order from past SEC cases with features the Court found to cross the bounds of traditional equity practice. Disgorgement qualifying as equitable relief was not a penalty and not subject to the five-year statute of limitations. Disgorgement relief from the bad old days did not always qualify as equitable relief and, when it did not, functioned as a penalty subject to the limitations period.
After Liu, of course, a disgorgement order that does not stay within the limitations of longstanding equitable principles is not authorized by statute and is legally invalid. No disgorgement that is permissible under Liu should have occasion to trigger the statute of limitations in section 2462.
This is what I believe to be the better reading of the Court’s treatment of Kokesh in Liu, but it is not the preferred policy outcome. The legal system works better when limitations periods bar claims. Statutes of limitation have been a feature of the law since Roman times because they serve powerful social interests. They promote accuracy in litigation by reducing the use of stale evidence. They promote repose in human affairs. By cutting off the time for bringing claims, they permit wounds to heal and personal redemption to occur. Statutes of limitation are vital to the welfare of society. See Rotella v. Wood, 528 U.S. 549, 555 (2000); Wilson v. Garcia, 471 U.S. 261, 271 (1985); Wood v. Carpenter, 101 U.S. 135, 139 (1879).
Congress should act to set a limitations period for SEC disgorgement claims. Indeed, the statute of limitations should govern the commencement of all SEC enforcement proceedings and the enforcement proceedings of other federal agencies no matter what type of relief is sought.
