Supreme Court to Decide Whether Disgorgement is Penalty or Equitable Relief

November 4, 2019

In 2016, the SEC sued Defendants Liu and Wang for their roles in an alleged EB-5 scheme whereby at least 50 Chinese investors were purportedly defrauded out of some $27 million. As the case made its way through the federal courts, the SEC prevailed via injunctive relief, civil penalties, and disgorgement. On appeal to the Supreme Court, the Defendants argued that the lower courts were not empowered to order disgorgement in the amount set. The Supreme Court granted certiorari and may subsequently determine whether court-ordered disgorgement is an impermissible "penalty" or a permitted form of "equitable relief."

2016 SEC Complaint

https://www.sec.gov/litigation/complaints/2016/comp-pr2016-105.pdf
As alleged under the "Summary" section:

3. This case involves an ongoing fraudulent scheme perpetrated by defendant Charles C. Liu ("Liu") and his wife, defendant Xin Wang, a/k/a Lisa Wang ("Wang"), to defraud Chinese investors in the federal "EB-5 Immigrant Investor Program," which is administered by the United States Citizenship and Immigration Service ("USCIS"). To date, the defendants have defrauded at least 50 Chinese investors of almost $27 million by falsely claiming that their monies would be invested in a program that met the requirements of the EB-5 program, and would be used to build and operate a proton therapy cancer treatment center in Southern California. 

4. The EB-5 Immigrant Investor Program was created to stimulate the U.S. economy with capital investment from foreign investors. Under the program, foreign investors can receive a permanent visa to live and work in the U.S. if they make a capital investment that satisfies certain conditions over a two-year period, including the creation of jobs. Under the program's regulations, the foreign investors must put "the required amount of capital at risk for the purpose of generating a return." 

5. From at least October 2014 to the present, the defendants have offered and sold, and continue to offer, EB-5 investments to Chinese investors, allegedly to fund the development and operation of the cancer treatment center. The investors made their investment in two parts: a $500,000 "Capital Contribution," which was to be escrowed for use in developing and operating the center, and a $45,000 "Administrative Fee." 

6. Rather than invest the investors' Capital Contributions as promised- and as required for the investors to meet the EB-5 program requirements-the defendants misappropriated or diverted approximately $17.4 million from the accounts where the contributions were deposited. Liu misappropriated at least $6,285,000 for himself, and his wife and co-defendant, Wang, misappropriated at least $1,400,000. Liu also transferred over $11,845,000 to three marketing firms in China, including $3,500,000 to a firm of which Wang is CEO and chairman of the board. Liu also allowed most of the Administrative Fees to be used for undisclosed purposes. As a result, the EB-5 eligible cancer treatment center that the defendants represented would be constructed with investor funds has not been built. Liu and Wang have carried out this fraud through a number of entities, three of which are named as defendants. 

7. The defendants' fraud is still ongoing. The majority of the funds dissipated by the defendants were transferred as recently as February and March 2016, shortly after the SEC subpoenaed Liu for investigative testimony. Also, the website primarily used to offer the EB-5 investments to Chinese investors remains active, and continues to market and promote the investments in a materially misleading manner. 

8. By engaging in this conduct, the defendants have violated, and continue to violate, the antifraud provisions of Sections 17(a) of the Securities Act, 15 U.S.C. § 77q(a), and Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and Rules 10b5(a) and (c) thereunder, 17 C.F.R. 240.10b-5(a) & 240.10b-5(c), and Liu and the corporate defendants have violated, and continue to violate Exchange Act Rule 10b-5(b), 17 C.F.R. § 240.10b-5(b). Liu is also violating Section 10(b) and Rule 10b-5 as a control person of each of the corporate defendant.

2017 CDCA Judgment 

In pertinent part, the CDCA Judgment states:

This matter came before the Court on Plaintiff Securities and Exchange Commission ("SEC" or "Commission")'s motion for summary judgment as to Defendants Charles C. Liu and Xin Wang. (Dkt. 199.) On April 7, 2017, the Court issued an Order granting the SEC's motion. In accordance with the Court's Order, IT IS HEREBY ORDERED that judgment is entered in favor of the SEC. Defendants Liu and Wang are jointly and severally liable for disgorgement of $26,733,018.81 and prejudgment interest thereon in the amount of $89,110.06. Defendant Liu is further liable for a civil penalty of $6,714,580 and Defendant Wang is further liable for a civil penalty of $1,538,000. 

http://brokeandbroker.com/PDF/LiuCDCAJudg170420.pdf  

2018 9Cir Memorandum

Defendants appealed the CDCA  Judgment to the United States Court of Appeals for the Ninth Circuit ("9Cir"), which, in part found that:

Finally, the Appellants contend that the district court's order that they disgorge $26,733,018.81 - the total amount they raised from their investors ($26,967,918) less the amount left over and available to be returned ($234,899.19) - was erroneous. The court reviews a district court's imposition of equitable remedies, including injunctive relief, disgorgement, and penalties, for abuse of discretion. SEC v. Goldfield Deep Mines Co., 758 F.2d 459, 465 (9th Cir. 1985); SEC v. JT Wallenbrock & Assocs., 440 F.3d 1109, 1113 (9th Cir. 2006). Relying on Kokesh v. SEC, 137 S.Ct. 1635 (2017), the Appellants argue that the district court lacked the power to order disgorgement in this amount. But Kokesh expressly refused to reach this issue, id. at 1642 n.3, so that case is not "clearly irreconcilable" with our longstanding precedent on this subject. Miller v. Gammie, 335 F.3d 889, 900 (9th Cir. 2003) (en banc). They also contend that, in setting the amount to be disgorged, the district court did not give them credit for amounts they characterize as legitimate business expenses, such as rent payments and deposits paid to equipment manufacturers. But the proper amount of disgorgement in a scheme such as this one is the entire amount raised less the money paid back to the investors. JT Wallenbrock & Assocs., 440 F.3d at 1114 (stating that it would be "unjust to permit the defendants to offset against the investor dollars they received the expenses of running the very business they created to defraud those investors into giving the defendants the money in the first place").4
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Footnote 4: To justify setting this disgorgement amount, the district court noted that the contracts with the overseas marketers and a significant portion of Liu's compensation - both of which would necessarily require tapping into the funds set aside for construction and operation of the cancer center - were set at the inception of the project; the district court described this as "extensive evidence of a thorough, long-standing scheme to defraud investors." 


Petition to Supreme Court for Writ of Certiorari

In Charles C. Liu and Zin Wang a/k/a Lisa Wang, Petitioners, v. Securities and Exchange Commission, Respondent (Petition for a Writ of Certiorari, United States Supreme Court, May 31, 2019) http://brokeandbroker.com/PDF/LiuPetCert190531.pdf, the "Questions Presented" as set forth as:

Whether the Securities and Exchange Commission may seek and obtain disgorgement from a court as "equitable relief" for a securities law violation even though this Court has determined that such disgorgement is a penalty.

Under the heading "Introduction" the Petitioners assert as follows:

This case presents an open and frequently litigated question about the authority of the Securities and Exchange Commission ("SEC") to seek and obtain disgorgement in federal court as a penalty for securities law violations. 

The SEC sued petitioners in federal district court for violating the securities laws. By statute, the SEC may obtain only injunctive relief, equitable relief, or civil monetary penalties in such cases. See 15 U.S.C. §§ 77t(b), (d), 78u(d)(1), (3), (5). The SEC nevertheless asked the district court to order disgorgement to the agency of all the funds petitioners raised from investors. See Proposed Final Judgment at 3, SEC v. Liu, No. SACV 16-00974-CJC, ECF #220-2 (C.D. Cal. Feb. 8, 2017) ("Liu Proposed Final Judgment"). The district court ordered that relief, in addition to an injunction and the maximum statutory civil monetary penalty. A Ninth Circuit panel affirmed. Its decision makes clear that it did so because it believed itself bound by circuit precedent that pre-dated this Court's holding in Kokesh v. SEC, 137 S. Ct. 1635 (2017), that disgorgement to the SEC is a penalty. 

In seeking such disgorgement here, the SEC was following a well-worn path. Since the 1970s, that agency has routinely piggybacked off its authority to ask for injunctions to seek massive disgorgement awards as a form of "equitable relief." Even after Congress authorized the SEC to seek civil monetary penalties in addition to injunctions, the agency continued to insist that courts can and should order defendants both to pay such monetary penalties and to disgorge all funds they have received.

The lower courts have accepted the SEC's assertion that it may obtain "disgorgement" as an equitable remedy. Indeed, as in this case, they have done so even when a disgorgement award exceeds what the defendant unlawfully gained, see, e.g., SEC v. Contorinis, 743 F.3d 296, 306 (2d Cir. 2014); SEC v. Clark, 915 F.2d 439, 454 (9th Cir. 1990), and even when the award is granted to the SEC instead of returned to the alleged victims, see Kokesh, 137 S. Ct. at 1644; SEC v. Fischbach Corp., 133 F.3d 170, 176 (2d Cir. 1997). 

These decisions cannot survive this Court's reasoning in Kokesh. Although this Court had no occasion, and explicitly declined, to consider whether disgorgement could still be available as equitable relief, the identification of disgorgement as a penalty compels the answer. As then-Judge Kavanaugh noted, Kokesh "overturned a line of cases . . . that had concluded that disgorgement was remedial and not punitive." Saad v. SEC, 873 F.3d 297, 305 (D.C. Cir. 2017) (Kavanaugh, J., concurring). Other judges have likewise read Kokesh to spell the end of "equitable" disgorgement. See, e.g., FTC v. AMG Capital Mgmt., LLC, 910 F.3d 417, 429 (9th Cir. 2018) (O'Scannlain, J., specially concurring) (Kokesh "undermines a premise in our reasoning: that restitution under § 13(b) [of the Federal Trade Commission Act] is an 'equitable' remedy at all"); Osborn v. Griffin, 865 F.3d 417, 470 n.1 (6th Cir. 2017) (Merritt, J., dissenting) (suggesting that Kokesh foreclosed "equitable disgorgement"). 

The Court should grant certiorari to address the fundamental and frequently litigated issue that Kokesh raised, but did not reach, and to clarify and harmonize the law as to the availability of agency disgorgement in the absence of statutory authority. 

As to the manner in which the underlying case came to the Supreme Court, the Petition offers the following guidance under the heading "Procedural Background":

On May 26, 2016, the SEC sued petitioners, the EB-5 Fund, and Beverly in the Central District of California for allegedly defrauding investors. The SEC claimed that, despite telling investors their money would fund an enterprise that met the EB-5 program's requirements, petitioners misappropriated millions for personal use and funneled $12.9 million to overseas marketers. The SEC brought claims under Section 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a), Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and SEC Rule 10b-5(a) and (c), 17 C.F.R. § 240.10b-5(a), (c). See Compl. ¶ 8, SEC v. Liu, No. SACV 16-00974-CJC, ECF #1 (C.D. Cal. May 26, 2016) ("Compl."). Liu was also accused of violating SEC Rule 10b-5(b), 17 C.F.R. § 240.10b-5(b). See Compl. ¶ 8. 

On April 20, 2017, the district court granted summary judgment to the SEC, holding that petitioners violated Section 17(a)(2) of the Securities Act.3 App. 9a-61a. The SEC sought a number of remedies. 

First, the agency sought an injunction against petitioners participating in any additional EB-5 investments. The district court granted that relief. App. 34a-40a. 

Second, the SEC sought civil monetary penalties from the steepest tier available under 15 U.S.C. § 77t(d) and § 78u(d)(3)(B). The district court granted that request as well. It imposed a $6,714,580 fine on Liu and a $1,538,000 fine on Wang based on their direct personal gains from the investors. App. 41a42a. 

Finally, the SEC asked the district court to "[o]rder defendants to disgorge all funds received from their illegal conduct, together with prejudgment interest thereon, and to repatriate any funds or assets they caused to be sent overseas." Compl., Prayer for Relief § V. The SEC notably did not ask that those funds be awarded to the alleged victims of the scheme or represent how it would direct the money. In response to that request, Liu and Wang argued, among other things, that they should not be required to disgorge the nearly $16 million spent on the EB-5 Fund's legitimate business expenses. See Defs.' Mem. of Points & Authorities in Opp. to Pl.'s Suppl. Br. Regarding Civil Penalties at 9-10, SEC v. Liu, No. SACV 16-00974- CJC, ECF #221 (C.D. Cal. Feb. 15, 2017). Offsetting the lease payments, construction costs, equipment manufacturing, marketing fees, and salaries would have reduced the award from $26,440,304 to $10,482,668. However, the district court ordered disgorgement of the full amount, without accounting for those expenses, and, consistent with the SEC's request, included no requirement that any of the money be returned to the alleged victims. See App. 40a-41a, 62a-64a. 

Shortly before Liu and Wang appealed the district court's decision to the Ninth Circuit, this Court decided Kokesh. The Court there unanimously concluded that the statute of limitations in 28 U.S.C. § 2462, which applies to "any civil fine, penalty, or forfeiture," applied to disgorgements sought by the SEC because those qualified as "penalties." 137 S. Ct. at 1643-44. The Court reserved the question whether the SEC could nevertheless continue to seek disgorgement (and whether prior case law on that point was correct): "Nothing in this opinion should be interpreted as an opinion on whether courts possess authority to order disgorgement in SEC enforcement proceedings or on whether courts have properly applied disgorgement principles in this context." Id. at 1642 n.3. 

On appeal to the Ninth Circuit, Liu and Wang argued that the district court "lacked statutory authority to award disgorgement" because, among other problems, this Court had held that it was a penalty, not an equitable remedy. Pet'rs C.A. Br. 48- 49. However, the Ninth Circuit concluded that it was still bound by pre-Kokesh circuit law that had upheld similar disgorgement awards. See App. 6a-7a ("Kokesh expressly refused to reach" whether the district court lacked the power to order the disgorgement award, "so that case is not 'clearly irreconcilable' with our longstanding precedent on this subject") (quoting Miller v. Gammie, 335 F.3d 889, 900 (9th Cir. 2003) (en banc)).
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Footnote 3: Because the district court found that petitioners violated Section 17(a), it did not consider the SEC's remaining claims. App. 34a. 


SEC Brief in Opposition (Cert)

In its September 4, 2019, Brief in Opposition  http://brokeandbroker.com/PDF/LiuSECRepBr190304.pdf, the SEC offers the following "Question Presented":

Whether a district court, in a civil enforcement action brought by the Securities and Exchange Commission, may order disgorgement of money acquired through fraud.

In contrast to Petitioners, the SEC asserts in part in its Brief in Opposition that:

[T]he court of appeals' decision affirming the award of disgorgement was correct and does not conflict with any decision of this Court or any other court of appeals. And this case would be an unsuitable vehicle for reviewing the question presented, because petitioners failed to preserve in the courts below the argument that federal law categorically precludes district courts from awarding disgorgement in SEC enforcement actions. 

Supreme Court Grants Cert

On May 31, 2019, Charles C. Liu and Xin Wang a/k/a Lisa Wang petitioned the United States Supreme Court for a Writ of Certiorari, which was granted on November 1, 2019  https://www.supremecourt.gov/orders/courtorders/110119zr_i42j.pdf

Also READUPDATE: SEC Sustains Saad Sanction Saga (BrokeAndBroker.com Blog /  August 26, 2019)
http://www.brokeandbroker.com/4773/sec-saad/