Supreme Court Hears Arguments on Potential Limits on SEC’s Use of Disgorgement

Last week the Supreme Court held oral arguments in Sripetch v. SEC, a case that presented the question of whether the U.S. Securities and Exchange Commission (SEC) may seek equitable disgorgement without a showing that investors suffered pecuniary harm. The Court’s questions suggested that several justices are skeptical of petitioner’s arguments that disgorgement should be so limited, but that SEC’s powers will remain subject to the Court’s careful scrutiny in the future.

Disgorgement as an SEC Tool

Disgorgement, a remedy through which defendants are “deprive[d]” of “the gains of wrongful conduct,” has been a tool used by SEC in civil enforcement cases for decades. It is a “profit-based measure of unjust enrichment” based on the equitable principle that a wrongdoer should not profit from misdeeds. But it was not until a 2021 amendment to the Exchange Act that Congress made explicit that “[i]n any action or proceeding brought by the Commission under any provision of the securities laws, the Commission may seek, and any Federal court may order, disgorgement.” And the Supreme Court has previously limited SEC’s ability to use disgorgement as a remedy, for instance holding that it is subject to a five year statute of limitations and that it should “not exceed a wrongdoer’s net profits” and be “awarded for victims.” Relying on these previous rulings, the petitioner in Sripetch argued that SEC may not seek disgorgement without a showing that investors suffered pecuniary harm.

The Sripetch Matter

SEC brought a civil enforcement action against Sripetch and 14 other defendants in 2020, alleging that they had “engage[d] in numerous fraudulent schemes and other violations of the federal securities laws, involving at least 20 penny stock companies” and “obtained at least $6 million in illicit sale proceeds from this illegal conduct.” It charged six counts of securities fraud and one count of selling unregistered securities and sought disgorgement, among other remedies. Sripetch consented to the entry of judgment against him, but opposed SEC’s motion for disgorgement, arguing that a showing of pecuniary harm to investors was required. The district court ordered disgorgement, assuming without deciding that such a showing was necessary but that SEC had made the requisite showing. 

On appeal, the U.S. Court of Appeals for the Ninth Circuit noted the existence of a circuit split as to whether a finding of pecuniary harm is necessary for an award of disgorgement under the Exchange Act. The U.S. Court of Appeals for the Second Circuit in SEC v. Govil had concluded that it is, while the U.S. Court of Appeals for the First Circuit in SEC v. Navellier had reached the opposite conclusion. Though the Ninth Circuit agreed with the Second Circuit that disgorgement requires a victim, it faulted that court for taking too narrow a view of what constitutes a victim, noting that at common law a victim need only show an actionable interference with its interests to obtain disgorgement, not a specific loss. It also emphasized the “fundamental distinction between compensatory damages, which are designed to compensate the victim for her losses, and restitution, which is designed to deprive the wrongdoer of his ill-gotten gains.” And it rejected the Second Circuit’s comparison of SEC disgorgement to private securities actions, noting that the economic loss requirement in the latter derived from a concern about “abusive litigation by private parties” that would not apply to SEC. Accordingly, the court adopted the First Circuit’s view that pecuniary harm is not required.

Before the Supreme Court

During oral arguments on April 20, several Supreme Court justices appeared skeptical about limiting disgorgement to situations where pecuniary harm could be demonstrated. Justice Ketanji Brown Jackson commented that she “didn’t see any case [under traditional equitable principles] that suggests that pecuniary harm was a requirement” for disgorgement. Similarly, Justice Sonia Sotomayor, suggested that Sripetch was essentially arguing that a “slew of common law cases … where lost profits were [a] measure … were all wrong,” and Justice Brett Kavanaugh referenced an amicus brief suggesting petitioner was “really quite wrong about the first principles.” Justice Amy Coney Barrett appeared to reject Sripetch’s argument that, absent a pecuniary harm, disgorgement would be transformed into a penalty, asking why that would be the case when “all you’re taking away is the ill-gotten gains.” Even Justice Clarence Thomas, who had previously stated in dissent that disgorgement was “not a traditional equitable remedy” and should not be available to SEC, stated that “the world has changed in this area” since the amendment of the Exchange Act. 

At the same time, Justice Thomas questioned whether disgorgement “look[s] a lot less like an equitable remedy” if SEC keeps the proceeds rather than returning them to investors. And Justice Neil Gorsuch suggested that, if the disgorgement was not passed along to investors, the Seventh Amendment right to a jury trial might be triggered. Although Justice Gorsuch appeared to recognize that questions about the jury right could be reserved for a future case, he characterized the issue as “pretty perilous” and stated that “if you want the equitable remedy… you’ve got to behave.”

Conclusion

Though oral arguments before the Supreme Court are not always predictive of the outcome of cases, the questions asked by the justices in Sripetch suggested that there is some skepticism about limiting SEC’s ability to seek disgorgement to cases where pecuniary harm can be demonstrated. It was also clear, however, that the court will continue to scrutinize the scope of SEC’s powers, so public companies and their investors alike should continue to watch for securities law developments from the high court.