SEC v. Govil - Re-Thinking Disgorgement On the First Anniversary of Govil
SEC V. Govil: The Battle Over Disgorgement
On October 31, 2023, the Second Circuit decided the landmark case of SEC v. Govil, 86 F.4th 89 (2d Cir. 2023), which dramatically reduced the Securities and Exchange Commission’s ability to obtain disgorgement in securities fraud matters. Specifically, the Second Circuit, building on the Supreme Court’s earlier decision in Liu v. SEC, 591 U.S. —- (2020), held that disgorgement under the Exchange Act must be limited by equitable principles. This meant, according to the Court, that any disgorgement must be both “ill-gotten gains” and be awarded to victims. A defrauded investor, the Court ruled, is not a “victim” unless he has suffered “pecuniary harm.” As a result, disgorgement, which cannot exceed a perpetrator’s net profits from the fraud, can only be awarded if a court finds that victims of the harm suffered pecuniary harm. Put differently, in Govil, the Circuit observed that “[t]he Supreme Court's opinion in Liu did not explain straightforwardly what a ‘victim’ was for the purpose of awarding ‘equitable relief’ ” and that the term must be limited to individuals who had suffered pecuniary harm. Otherwise, according to the Govil court, those who had not suffered pecuniary harm would receive a windfall. Thus, disgorgement is inappropriate when the only injuries suffered are non-economic—disgorgement is not appropriate where a defendant does not cause economic damage to a victim.
This is an important decision for one primary reason - previously, the SEC (and courts) took the position that a person could be forced to disgorge all net profits derived from fraud (so called “ill-gotten” gains). This was because disgorgement was designed to prevent unjust enrichment. Now, the Second Circuit held that in addition to demonstrating unjust enrichment, the SEC had to show that any disgorged monies would need to go to victims who suffered pecuniary harm. This was an important switch that imposes a high barrier for the SEC in certain types of cases. For example, in an insider trading case, the SEC could easily show that the perpetrator was unjustly enriched from insider trading, but it is difficult to show that disgorgement is appropriate because victims have not suffered pecuniary harm from this insider trading. Since then, the SEC has attempted to distinguish Govil on the grounds that it is incorrect because Liu held that “disgorgement prevents ‘unjust enrichment’ and restores the violator to the ‘status quo’ by taking ‘money out of the wrongdoer's hands.’” That argument, however, runs counter to Liu itself. As Liu stressed, “depriving a wrongdoer of ill-gotten gains” alone is insufficient, as it would “simply benefit the public at large.” Rather, Liu clearly held that disgorgement must run to the benefit of victims, at least when they can be identified and where it is feasible to do so.
The Second Circuit's Decision in Govil
The Second Circuit’s decision in Govil is informed significantly by prior legal precedent.
First, in Liu v. SEC, the Supreme Court held that a disgorgement award in an SEC civil enforcement action cannot exceed a "wrongdoer's net profits" and is "awarded for victims ... as equitable relief under the Securities Exchange Act."[1] Six month after Liu, Congress enacted 15 U.S.C. § 78u(d)(7) (National Defense Authorization Act, NDAA), which prescribed' the SEC’s authority to "seek" and federal court's authority to order "disgorgement" in enforcement proceedings.[2] GIven this statutory enactment, in SEC v. Ahmed, 72 F.4th 379, 396 (2d Cir. 2023), the Second Circuit addressed whether the newly amended 15 U.S.C. § 78u(d)(7) was limited to Liu's equitable limitations on disgorgement (like § 78u(d)(5)), or, whether this statutory enactment restored disgorgement to its “pre-Liu” setting, whereby disgorgement could be authorized in a “legal-not equitable-sense” meaning that disgorgement was not limited to equitable principles. Ahmed answered this question in the affirmative, holding that disgorgement under both 15 U.S.C. § 78u(d)(5) and (7) must comport with Lui, including the traditional equitable limitations.[3] Notably, the Ahmed holding disagreed with the 5th Circuit’s holding in SEC v. Hallam, 42 F.4th 316, 334-35 (5th Cirt. 2022), which held that the NDAA modifications restored disgorgement to its pre-Liu setting, creating a Circuit split.
It is under this prior framework that the Second Circuit considered the issue presented in Govil, including whether the disgorgement ordered by the lower court was authorized in the absence of the requisite showing of “victim” harm.[4] The Second Circuit held that the as-ordered disgorgement was unauthorized under Liu (and Ahmed) because: (1) disgorgement under the Exchange Act is equitable relief; (2) equitable relief cannot exceed a “wrongdoer’s net profits” and “is awarded for victims;” and (3) a “victim” for the purposes of 15 U.S.C. § 78u(d)(5) “is one who suffers pecuniary harm from the securities fraud.”[5] While the first and second points were predicated under Ahmed’s application of Liu, the Supreme Court did not “straightforwardly” explain “what a ‘victim’ [was] for the purpose of awarding ‘equitable relief.’”[6] As such, the Second Circuit applied the following “guiding principles” provided by the Supreme Court in Lui to reach its holding in Govil. These principles include that:
1: while “disgorgement was a ‘limited form of penalty’ insofar as it takes money out of the wrongdoer's hands, the Court nevertheless compared disgorgement to restitution that simply ‘restores the status quo,’ thus situating the remedy squarely within the heartland of equity[]” and does not allow “a windfall on those who received the benefit of the bargain;”[7]
2: the equity based “profits remedy often imposed a constructive trust …. convert[ing] the wrongdoer, who in many cases was an infringer, into a trustee” of the profits for which he “infringed;”[8] and
3: an “accounting” is “an equitable remedy requiring disgorgement of ill-gotten profits” that is “for the violation of strictly legal primary rights.”[9]
In sum, Govil held that in the securities fraud context, disgorgement is an equitable remedy predicated on returning funds to victims who suffered “pecuniary harm,” which requires “economic loss”. The recipient of disgorgement must suffer economic harm to qualify. Moreover, under these same principles, the Govil court also held that “a defendant need not return more than the amount by which he was unjustly enriched” in calculating the amount of disgorgement, and that “each payment in satisfaction of disgorgement,” or from the “unjust gains,” “offsets the overall disgorgement amount.”[11] For purposes of calculating “unjust gains” or enrichment, Govil concluded that “a wrongdoer returns ‘value; for the purpose of disgorgement whenever he returns property that holds value in his own hands. That is consistent with our repeated statement that ‘[d]isgorgement serves to remedy securities law
The Aftermath of Govil
The purpose of this blog post is to examine what has happened in the year since Govil. A number of principles have become clear. First, Govil has been faithfully applied in the Second Circuit, and has resulted in a significant change in how district courts have fixed disgorgement. Second, Govil has not gained much traction outside of the Second Circuit.
District courts in the Second Circuit
Most recently, the Southern District of New York in SEC v. Ripple, 2024 WL 3730403 (SDNY Aug. 7, 2024) the district court examined whether Govil barred disgorgement of RIpple’s profits from Institutional Sales, where people did not suffer true pecuniary harm.
First, the district court set forth the governing law:
Disgorgement is an equitable remedy, permissible only where it “does not exceed a wrongdoer's net profits and is awarded for victims.” Liu v. SEC, 591 U.S. 71, 75 (2020). Following Liu, the Second Circuit clarified the meaning of “victims” in SEC v. Govil, 86 F.4th 89 (2d Cir. 2023). There, the defendant caused his company “to engage in three fraudulent securities offerings,” representing to investors that the company “would use the proceeds from the transactions to satisfy outstanding debts and for general corporate purposes.” Id. at 93. “Instead, he diverted over $7.3 million of the offering proceeds to his own private accounts.” Id. The district court determined that disgorgement was warranted, reasoning that the defrauded investors were victims of the defendant's conduct because they were lied to, even if they “may not have been financially harmed” as a result of the lie. Id. at 97. he Second Circuit reversed, holding that “a ‘victim’ for purposes of § 78u(d)(5) is one who suffers pecuniary harm from the securities fraud.” Id. at 102. The Circuit explained that an equitable remedy is meant to “restore[ ] the status quo”—in the context of disgorgement, by “returning the funds to victims.” Id. at 103 (quoting Liu, 591 U.S. at 80, 88) (cleaned up). Allowing “defrauded investors who suffered no pecuniary harm ... to receive the proceeds of disgorgement,” the Circuit reasoned, would “confer[ ] a windfall on those who received the benefit of the bargain.” Id. at 103. Therefore, for purposes of ordering disgorgement, it is not enough that investors are lied to and “thus denied the right to make an informed decision when considering whether to make [an] investment.” Id. at 105. “[O]ffending that right” does not result in pecuniary harm.” Id. (citing Ciminelli v. United States, 598 U.S. 306, 315 (2023)).
Then, the court applied this law to the facts of Ripple, analyzing whether the Institutional Buyers suffered any pecuniary harm from Ripple’s Section 5 violations. Because the court found that such harm was not proven by the SEC, no disgorgement was ordered.
In Connecticut, the district court in SEC v. Findley, which examined whether investors lost money as a result of press releases that contained false information, the court held that “Second Circuit caselaw makes clear that disgorgement under Section 78u(d)(7) must nonetheless continue to ‘comport with traditional equitable limitations as recognized in Liu[]’” including that “disgorgement must be ‘awarded for victims.’”[17] Findley ordered disgorgement while “[b]alancing the interests of preventing unjust enrichment and limiting disgorgement to the harm suffered by victims[.]”[18] Regarding the calculation for the amount of disgorgement, the court focused on linking the actual losses suffered to the alleged bad acts. Findley ruled that not all the funds received during the time period of the wrongdoer’s acts “can automatically be disgorged without determining that there is a causal connection between [the funds] and the defendants’ wrongful conduct.”[19] Ultimately, after finding the SEC met its burden establishing a calculation for disgorgement, the court subtracted the sum of funds defendants established were not connected to the wrongdoer’s acts from the amount of disgorgement.[20]
Ripple and Findley are perhaps the two most “defense friendly” opinions in limiting disgorgement where no pecuniary loss is found. However, there are other opinions which also weigh in on the application of Govil to various legal issues. As an example, in SEC v. Oppenheimer, the court held that a finding in a parallel criminal case, arising out of the same misconduct, that investors suffered pecuniary harm can serve as a basis to comply “with the law as set forth in Govil.” [23] In SEC v. iFresh, the court held that the SEC’s “allegation that iFresh’s stock prices were artificially inflated during the relevant time period” established pecuniary harm to investors for the purposes of Govil, thereby warranting disgorgement. [24]
Outside the Second Circuit
At this stage, Govil has only been cited by one other Court of Appeals—the First Circuit.[25] In SEC v. Navellier, 108 F.4th 19 (1st Cir. 2024), the First Circuit examined whether an investment advisor was required to pay disgorgement for making false statements in marketing materials. The First Circuit agreed that disgorgement was appropriate, and disagreed with Govil to the extent that the defendants argued that a predicate finding of pecuniary harm to investors was required, stating this “mischaracterizes the nature and purpose of disgorgement” and “[n]either Liu nor our case law, however, require investors to suffer pecuniary harm as a precondition to a disgorgement award.”[27] Instead, Navellier held that to warrant disgorgement, the “profits-based remedy must do more than simply benefit the public at large by virtue of depriving a wrongdoer of ill-gotten gains.”[28] In Navellier, this boundary was satisfied because disgorgement would “remedy a direct harm” to investors, who were “induced into paying advisory fees” based on the misrepresentations.[29] Critically, where Govil linked disgorgement to making “victims” whole, Navellier “tether[s] [disgorgement] to a wrongdoer's net unlawful profits.”[30]
Defendants have tried to utilize Govil in numerous district courts nationwide, such as courts in California, Massachusetts, Minnesota, and Utah, to little success.[31]
In Sec. & Exch. Comm'n v. Beck, No. 2:22-CV-00812-FWS-JC, 2024 WL 1626280, at *14 (C.D. Cal. Mar. 26, 2024), the district court agreed with the Govil court, and ruled that “Liu’s equitable limitations apply with equal force to disgorgement under section 78u(d)(7).”[32] However, that meant little for Beck, who was alleged to have committed a pump and dump, because the victims in Beck did suffer pecuniary harm.
In SEC v. Carebourn, a case out of the District of Minnesota, the court rejected Govil’s holding that a “more substantial showing” was needed to satisfy Liu, holding that the “victim-benefit requirement” of Liu was generally satisfied by “demonstrating that it plans to distribute disgorged funds to investors[.]”[37] The court declined to adopt Govil’s requirement that the SEC must “show[] that particular investors suffered ‘pecuniary harm.’”[38] Furthermore, Carebourn held that Congress’ amendment to 15 U.S.C. §§ 78u(d)(7) broadened the reach of disgorgement and provides courts with “even greater flexibility.”[39]
In SEC v. Giguiere, while the court noted that the Ninth Circuit had not ruled on the Govil issue, it held that the victims did suffer pecuniary harm through “artificially inflated” stock prices, and therefore, disgorgement should be measured by a defendant’s net gains as opposed to investor losses.”[41] This is contradictory to the Govil holding.
In SEC v. Putnam, a case out of the District of Utah, the court determined, in limiting the applicability of Govil, that: (1) “the SEC need not prove the identities of wronged investors before the court orders disgorgement,” only that these “wronged investors” exist; and (2) disgorgement funds “may not merely be deposited in the Treasury” because “Liu disapproved an approach under which the SEC did ‘not always return the entirety of disgorgement proceeds to investors[.]’”[44]
Conclusion
In sum, there are at least two decisions, Ripple and FIndley, which apply Govil favorably for the defense and serve to limit the reach of the SEC’s disgorgement powers. Beyond that, and especially in districts outside the Second Circuit, the reach of Govil has been far more limited.
[1] See Liu v. Sec. & Exch. Comm'n, 591 U.S. 71, 71, 140 S. Ct. 1936, 1937, 207 L. Ed. 2d 401 (2020).
[2] See Govil, 86 F.4th at *100.
[3] See Sec. & Exch. Comm'n v. Ahmed, 72 F.4th 379, 396 (2d Cir. 2023), cert. denied sub nom. Ahmed v. SEC, 144 S. Ct. 2658 (2024), and cert. denied sub nom. Ahmed v. SEC, 144 S. Ct. 2658 (2024). Ahmed also later moves for relief under Fed. R. Civ. P. 60(b)(5) based on Govil, which is denied. See United States Sec. & Exch. Comm'n v. Ahmed, No. 3:15-CV-675 (JAM), 2024 WL 4349066, at *1 (D. Conn. Sept. 30, 2024). Likewise, the Eastern District of New York also held that Fed. R. Civ. P. 60(b)(5) was inapplicable to disgorgement ordered prior to Govil’s decision. See Sec. & Exch. Comm'n v. Curran, No. 12-CV-2937 (RPK) (SIL), 2024 WL 3431953, at *2 (E.D.N.Y. July 15, 2024).
[4] See Govil, 86 F.4th at *98.
[5] See Govil, 86 F.4th at *102.
[6] See Govil, 86 F.4th at *102-03.
[7] See Liu, 591 U.S. at 80 (citing Tull v. United States, 481 U.S. 412, 424, 107 S. Ct. 1831, 1839, 95 L. Ed. 2d 365 (1987) (alteration omitted)).
[8] See Liu, 591 U.S. at 82 (citing Burdell v. Denig, 92 U.S. 716, 720, 23 L.Ed. 764 (1876) (quotations omitted).
[9] See Liu, 591 U.S. at 81 (citing SCA Hygiene Products Aktiebolag v. First Quality Baby Products, LLC, 580 U. S. 328, 137 S.Ct. 954, 964, 197 L.Ed.2d 292 (2017)) and Liu, 591 U.S. at 79 (citing 1 J. Pomeroy, Equity Jurisprudence § 101, p. 112 (4th ed. 1918)).
[10] See Govil, 86 F.4th at *103-04.
[11] See Govil, 86 F.4th at *106.
[12] See Govil, 86 F.4th at *107 (citing S.E.C. v. Contorinis, 743 F.3d 296, 301 (2d Cir. 2014) and S.E.C. v. Razmilovic, 738 F.3d 14, 36 (2d Cir. 2013), as amended (Nov. 26, 2013)).
[13] See Sec. & Exch. Comm'n v. Hallam, 42 F.4th 316, 341 (5th Cir. 2022).
[14] See Hallam, 42 F.4th at 337-41.
[15] See Ahmed, 72 F.4th at *396.
[16] See Govil, 86 F.4th at *98
[17] See United States Sec. & Exch. Comm'n v. Findley, 718 F. Supp. 3d 125, 138–39 (D. Conn. 2024)
[18] See id.
[19] See id. at 140 (citing Sec. & Exch. Comm'n. v. Razmilovic, 738 F.3d 14, 31 (2d Cir. 2013)).
[20] See id. at 140-41.
[21] See Sec. & Exch. Comm'n v. Ripple Labs, Inc., No. 20 CIV. 10832 (AT), 2024 WL 3730403, at *5-6 (S.D.N.Y. Aug. 7, 2024).
[22] See id. (citing Govil, 86 F.4th at *105 and Ciminelli v. United States, 598 U.S. 306, 315 (2023)).
[23] See Sec. & Exch. Comm'n v. Oppenheimer, No. 15 CIV. 5456 (GBD) (SDA), 2024 WL 3342098, at *4 n.2 (S.D.N.Y. July 8, 2024).
[24] See United States Sec. & Exch. Comm'n v. iFresh, Inc., No. 22CV3200ARRSJB, 2024 WL 416709, at *3 (E.D.N.Y. Feb. 5, 2024) (citing Govil, 86 F.4th at *104).
[25] See Sec. & Exch. Comm'n v. Navellier & Assocs., Inc., 108 F.4th 19 (1st Cir. 2024).
[26] See Navellier, 108 F.4th at *41.
[27] See Navellier, 108 F.4th at *41 n.14.
[28] See id. (citing Liu, 591 U.S. at 74, 89, 140 S.Ct. 1936).
[29] See id.
[30] See Navellier, 108 F.4th at *41 (citing Liu, 591 U.S. at 74, 79-80, 140 S.Ct. 1936).
[31] The District Court of Massachusetts held that Govil’s requirements were met because the SEC demonstrated that the “victims” suffered pecuniary harm. See Sec. & Exch. Comm'n v. Commonwealth Equity Servs., LLC, No. 1:19-CV-11655-IT, 2024 WL 1375970, at *7 (D. Mass. Mar. 29, 2024).
[32] See Sec. & Exch. Comm'n v. Beck, No. 2:22-CV-00812-FWS-JC, 2024 WL 1626280, at *14 (C.D. Cal. Mar. 26, 2024), reconsideration denied, No. 2:22-CV-00812-FWS-JC, 2024 WL 2110034 (C.D. Cal. Apr. 1, 2024).
[33] See id. (citing Govil, 86 F.4th at *102).
[34] See id.
[35] Westlaw states that a New York case distinguished Govil, however, this case was regarding civil penalties, and held that Govil’s holdings for disgorgement were not applicable. See Sec. & Exch. Comm'n v. Honig, No. 18 CIV. 8175 (ER), 2024 WL 3454840, at *5 (S.D.N.Y. July 18, 2024).
[36] See United States Sec. & Exch. Comm'n v. Carebourn Cap., L.P., No. 21-CV-2114 (KMM/JFD), 2024 WL 4249546, at *8, *10-11 (D. Minn. Sept. 20, 2024).
[37] See id. at *8.
[38] See id. at *10 (citing Govil, 86 F.4th at *105).
[39] See id. at *11.
[40] See Sec. & Exch. Comm'n v. Giguiere, No. 18-CV-1530-WQH-JLB, 2024 WL 3550395, at *6-7, n.2 (S.D. Cal. June 11, 2024). Other decisions by District Courts of California also state the “split of out-of-circuit authority” involving Govil need not be resolved because the SEC had demonstrated pecuniary harm. See Sec. & Exch. Comm'n v. Sripetch, No. 20-CV-01864-H-BGS, 2024 WL 1546917, at *5 (S.D. Cal. Apr. 8, 2024).
[41] See Giguiere, 2024 WL 3550395, at *9.
[42] See Sec. & Exch. Comm'n v. Putnam, No. 2:20-CV-00301-DBB-DAO, 2024 WL 4135684, at *15 (D. Utah Sept. 10, 2024)
[43] See id.
[44] See Putnam, 2024 WL 4135684, at *15 (citing Liu, 591 U.S. at 74, 82, 87-90, 140 S.Ct. 1936).
[45] See id.
[46] See SEC v. Xia, No. 22-3137, Dkt. 98 (2d Cir. Dec. 15, 2023).
[47] See Sec. & Exch. Comm'n v. Xia, No. 21-CV-5350 (PKC) (JAM), 2024 WL 3447849, at *3 (E.D.N.Y. July 9, 2024) (citing SEC v. Xia, No. 22-3137, Dkt. 98 (2d Cir. Dec. 15, 2023)).
[48] See id.