In March, in “Will the Supreme Court Save the FTC’s Disgorgement Authority,” I wrote about the oral argument before the Supreme Court in Liu v. SEC, which considered whether the Securities and Exchange Commission possesses disgorgement authority over federal securities law violators, requiring them to cough up their “ill-gotten gains.” The issue is of great interest and relevance to the Federal Trade Commission community because of arguable similarities between the SEC’s and the FTC’s statutory schemes and because a case raising a similar question about the FTC’s disgorgement authority, FTC v. Credit Bureau Center, is also before the Supreme Court on a pending petition for certiorari. What could a decision in Liu potentially mean for the FTC’s own disgorgement powers? I wrote in March that from the oral argument, it was my judgment that both the SEC and the FTC hade more reason to be optimistic about the outcome than the defendants in the two cases.
This week, Liu was decided. Was I right? In boxing terms, the result could be called a split decision. The SEC has definite cause to be happy because the Court, in an 8-1 decision, upheld its disgorgement authority, and, as I explain, the FTC could have reason to breathe easier, too, over the survival of its own authority. But the SEC cannot be happy about the limitations the Court placed on disgorgement, and neither can the FTC given the Court’s reasoning underlying those limitations which could apply to its disgorgement power.
While the two agencies’ statutes have some broad similarity, one difference, which potentially disfavors the FTC on the disgorgement question, is that the SEC statute explicitly provides for “any equitable relief that may be appropriate or necessary for the benefit of investors,” while the FTC statute only explicitly allows for an injunction and make no mention of other equitable relief. While Liu interpreted the scope of express equitable relief in the SEC statute to include disgorgement, the decisionseems to rest less on the fact that the SEC’s equitable authority emanatesfrom statute, and more on a conclusion that disgorgement fits within traditional common law equity principles and practice. The Court’s reasoning in holding disgorgement is compatible with the traditional exercise of equity would seem to apply with equal force whether an enforcement agency is acting under express permission from Congress to seek equitable relief or under a federal court’s historically recognized inherent equitable authority, which the Court majority seemed to reaffirm in its decision (“[u]nless otherwise provided by statute, all . . . inherent equitable powers . . . are available [to the federal courts] for the proper and complete exercise of that jurisdiction.”
To be sure, since the SEC’s statute explicitly provides for equitable relief, the issue of the federal courts’ inherent equitable powers was not squarely at issue in Liu, as it would be in Credit Bureau Center or another case the Court might hear addressing the implications of the lack of explicit equitable relief in the FTC’s statute. Liu therefore by no means forecloses the possibility that the Court could find that the FTC lacks disgorgement authority by virtue of the absence of express equitable relief in its statute. Given the virtually unanimous Court’s passing nod to the federal courts’ inherent equitable powers in Liu, however, which was not necessary to its decision, should the Court take up the FTC’s disgorgement authority, and should it apply the Liu reasoning, then it seems a decent if not sure guess that the absence of explicit equitable relief in the FTC statute should not prove fatal to the survival of its disgorgement power as well.
This is only half the story, though. While the SEC (and, if my guess is right, the FTC) gets to keep its disgorgement authority, Liu promises to place some real reins on its use. This is bad news for the SEC (and likely the FTC) since for years the threat and imposition of disgorgement has been one of their biggest weapons of deterrence and enforcement. While the Court emphasized that its holding is limited to a finding that the SEC possesses disgorgement authority, it signaled in crystal clear terms that its proper exercise is subject to three restrictions: (1) disgorgement limited to “net profits,” allowing for deduction of legitimate business expenses, rather than of all revenue; (2) limitation of a defendant’s disgorgement liability to only its net profits, rather than having “joint and several liability” for the net profits of multiple defendants; and (3) distribution of disgorged net profits to the victims of the wrongdoing, rather than to the federal treasury.
Disgorgement has to be limited to net profits, the Court explained, to ensure that it serves the purpose of equity, which is to restore the status quo and not to punish (“the wrongdoer should not be punished by ‘pay[ing] more than a fair compensation to the person wronged’”). Past decisions in SEC cases, it said, had violated this equity principle by allowing disgorgement of a wrongdoer’s total take, without deduction of legitimate business expenses. Unless the “entire profit of a business or undertaking” results from the wrongful activity, the Court stated, expenses such as salaries, rent, equipment and vendor payments should be deducted in calculating the disgorgement award. In an FTC context, this presumably would include as well advertising, marketing, media, fulfillment, customer service and other expenses not directly tied to the alleged unfair or deceptive business practice. The potential impact of a “net profits” limitation on disgorgement on both the FTC and FTC defendants cannot be overstated. In any give case, it could make a difference of millions or tens of millions in the size of a monetary judgment, or result in no disgorgement at all from a defendant that has no net profits.
The doctrine of joint and several liability does not fit with disgorgement, the Court concluded, because in equity liability is limited to one’s own ill-gotten gains, and does not extend to the illicit net profits of others. To apply it, to make an individual liable for another wrongdoer’s net profits, could transform disgorgement into a prohibited punitive sanction. An exception, however, where collective liability could be appropriate, the Court said, is in the case of “partners…equally culpable codefendants…engaged in concerted wrongdoing.” In an FTC context, this exception could swallow the rule, at least where multiple defendants either directly participated to a substantial degree in the wrongdoing and/or had authority over the conduct.
The Court strongly stressed that to be consistent with the practice in equity that the fruits of wrongdoing go to the victim, the SEC must return disgorged net profits to those harmed by it, unless it can show that their deposit in the U.S. Treasury would somehow be for the “benefit of investors.” Like the SEC, the FTC does not always return disgorged funds to injured consumers but instead passes them to the Treasury. While there is no express statutory command to effect equitable relief “for the benefit of consumers” in the FTC Act, under Liu, the FTC’s future discretion to reward the government rather than victims with disgorged ill-gotten gains would seem to be sharply, if not entirely, circumscribed.
While preserving the SEC’s disgorgement authority, Liu dramatically alters the legal landscape on which it can now be exercised, and tilts the playing field toward defendants, both in settlement negotiations and in litigation. Under its reasoning, the same should hold true for the FTC. Will the Court grant certiorari in Credit Bureau Center, to let the FTC and those it regulates know sooner rather than later if that is the case, or will it let lower courts decide whether, how and to what extent the equity principles laid out in Liu apply to the FTC. That is the next big unanswered question in the unfolding legal drama over the traditionally assumed, but now heavily disputed, power of the FTC to take money from its defendants. Stay tuned….