Disgorgement

US Supreme Court Disgorgement Ruling Leaves Open Questions

August 18, 2020 | Steve Parker

Earlier this summer, the US Supreme Court handed down a highly anticipated decision clarifying the powers of the Securities and Exchanges Commission in civil enforcement proceedings. The court ruled by a margin of 8 to 1 that the SEC can obtain disgorgement from a defendant because disgorgement is a form of equitable relief. As such, the remedy is based on district courts’ inherent powers to enter remedies based on fairness and equity. But we anticipate that the lower courts will still have difficulty in answering questions relating to the equitable remedy with uniformity, most likely resulting in those questions eventually coming back to the high court for resolution.

The case, Liu v. SEC, involved a lower court’s order that a married couple must pay $27 million in disgorgement as a result of the husband’s raising that amount from Chinese investors in a fraudulent EB-5 offering. The funds were ostensibly raised to fund a new cancer clinic, but ultimately the funds were misused. The husband funneled some of the money to the wife and some to other related companies. Both husband and wife were paid millions of dollars in salaries alone. The disgorgement award held both husband and wife jointly and severally liable for the full amount.

The trial court ordered the couple to disgorge the full amount raised in the fraudulent scheme as “ill-gotten gains.” The defendants challenged the amount of disgorgement imposed on several grounds, including that the amount should be offset by legitimate expenses incurred by the defendants. A disgorgement award that was not limited to net profits, they argued, constituted a penalty and therefore, could not be imposed consistent with other limitations on awards of civil penalties. Continue reading ›

Supreme Court and Congress Weigh-in on Future of SEC Disgorgement

November 25, 2019 | Parker MacIntyre

Recent developments within two of the three branches of the federal government portend significant potential changes in the SEC’s ability to obtain disgorgement of ill-gotten gains in civil actions brought by its enforcement arm. Early in November, the U.S. Supreme Court decided to hear an appeal of a Ninth Circuit case, SEC v. Liu, involving the issue of whether the SEC has statutory authority to obtain disgorgement at all. Then, not three weeks later, the U.S. House of Representatives responded by passing H.R. 4344, a bill explicitly codifying the SEC’s authority to obtain disgorgement. While the ultimate decision of the high court remains months away, and the House’s action has no legal significance until a companion bill in the Senate is acted upon and the two bills are passed by both chambers, these developments are of great significance to securities litigators and SEC-watchers alike.

Disgorgement has long been a powerful arrow in the SEC’s enforcement quiver, allowing it to obtain, on behalf of aggrieved investors, reimbursement of ill-gotten gains. However, despite it having obtained billions of dollars in disgorgement in civil actions over the last few decades, no statute explicitly confers the SEC with authority to seek this remedy. Rather, lacking any express authority, federal judges have implied it in scores of decisions dating back to the 1970s. Now, that entire foundation has come into question, prompted first by the Supreme Court’s 2017 decision in Kokesh v. SEC, and now by the high court’s acceptance of the Liu appeal.

SEC Announces $37.9 Million Settlement with Two RIAs over Conflicts of Interest Violations

October 8, 2019 | Parker MacIntyre

The SEC has just concluded settlement negotiations with two large RIA subsidiaries of the Bank of Montreal, resulting in a total settlement of almost $38 million—with $25 million of that in disgorgement. The SEC’s announcement and administrative order resolves enforcement proceedings against BMO Harris Financial Advisors, Inc. (“BMO Harris”) and BMO Asset Management Corp. (“BMO Asset”)(together, the “BMO Advisers”) involving conflicts of interest violations under the Advisers Act antifraud provisions.

The SEC’s administrative settlement with the BMO Advisers marks yet another significant action by the Commission against RIAs for failing to disclose material conflicts of interest. As fiduciaries, RIAs must seek to avoid conflicts of interest with clients, and, at a minimum, must fully disclosure all material conflicts. The SEC enforces violations of this requirement pursuant to Advisers Act Section 206(2), which prohibits RIAs from engaging in “any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client.”

SEC Case Against Wells Fargo Adviser Highlights Need for Supervision of Account Statements Sent to Clients

March 18, 2019 | Elizabeth Dalziel

On February 19, 2019, the United States District Court for the Southern District of Ohio granted a consent judgment against John Gregory Schmidt, a former Wells Fargo Advisors Financial Network (FINET) advisor. The Securities and Exchange Commission had filed a complaint against Schmidt in September 2018, alleging that Schmidt sold securities that belonged to some of his retail brokerage customers and covertly used the proceeds from those sales to conceal shortfalls in customer accounts. According to the SEC’s complaint, Schmidt sent his customers fake account statements which overstated their account balances in order to cover up his conduct. This case demonstrates the need for broker-dealers and registered investment advisers to adopt and enforce policies that effectively give them the ability to detect the use of such fraudulent statements.

Schmidt worked as a registered representative and the branch manager of a FINET office from about December 2006 through October 2017. By October 2017, he had about 325 retail brokerage customers, many of whom were retirees who were dependent on withdrawals from their accounts to pay living expenses. Continue reading ›

Court Orders Hedge Fund Advisers to Pay $12.9 Million in SEC Fraud Case

August 22, 2017 | Elizabeth Dalziel

On August 2, 2017, a federal court in Connecticut ordered Steven Hicks (“Hicks”), a hedge fund manager, and his hedge fund advisory firms to pay almost $13 million. This payment includes disgorgement and a penalty. In 2010, the Securities and Exchange Commission (“SEC”) filed a complaint against Hicks and his two hedge fund advisers, Southridge Capital Management LLC (“Southridge Capital”) and Southridge Advisors, LLC (“Southridge Advisors”). The complaint alleged that Hicks, Southridge Capital, and Southridge Advisors committed fraud by placing investor money in illiquid securities when investors were told that “at least 75% of their money would be invested in unrestricted, free-trading shares.”

According to the SEC’s complaint, starting in 2003, Hicks started soliciting investors. He told them that 75% of any money they invested in two funds he was starting would be invested in unrestricted, free-trading shares. Free-trading shares are shares that are eligible to be sold. Evidence shows that some potential investors were also told that the funds would invest “in short-term transactions that would take only 10 or 15 days, such as equity line of credit (‘ELC’) deals.” Continue reading ›

Supreme Court Rules that SEC’s Ability to Seek Disgorgement is Subject to a Five-Year Statute of Limitations

June 13, 2017 | Elizabeth Dalziel

On June 5, 2017, the United States Supreme Court, in a unanimous decision, ruled that disgorgement, a remedy that the SEC frequently utilizes to recover so-called “ill-gotten gains” from respondents in enforcement proceedings, is subject to 28 U.S.C. § 2642’s five-year statute of limitations for “an action, suit, or proceeding for the enforcement of any civil fine, penalty, or forfeiture.” As discussed previously, the Supreme Court agreed to hear the underlying case, SEC v. Kokesh (“Kokesh”), after a split in the appellate judicial circuits over whether SEC disgorgement was a “penalty” subject to the five-year statute of limitations.

The Supreme Court’s decision in Kokesh is not the first time that the Supreme Court has placed limitations on the SEC’s enforcement powers. In Gabelli v. SEC, a case from 2013, the Supreme Court ruled that civil monetary penalties were subject to the five-year statute of limitations.

Firm and CEO Settle Charges with SEC for Ponzi-like Plot Relating to Life Settlements

May 23, 2017 | Elizabeth Dalziel

On May 4, 2017, the Securities and Exchange Commission (“SEC”) reached a settlement with Verto Capital Management, LLC (“Verto”), a New Jersey-based life settlement firm, and its CEO, William Schantz III (“Schantz”). Verto and Schantz consented to pay the SEC about $4 million, which includes both disgorgement and a penalty, to settle claims that they used funds from new investors to pay older investors in a Ponzi-type manner. The SEC also alleged that Verto and Schantz diverted investor funds for Schantz’s personal use.

The settlement resulted from a complaint filed by the SEC in the United States District Court for the District of New Jersey alleging that between November 2013 and November 2015 Verto and Schantz issued about $12.5 million worth of nine-month 7% promissory notes to investors. Verto and Schantz claimed that the funds from these promissory notes would be used to purchase “life settlements,” which are life insurance policies that have been sold by their original owners to third-party buyers. The SEC’s complaint alleges that Verto and Schantz made a variety of misrepresentations in the sale of these promissory notes. Continue reading ›

Supreme Court Expected to Rule on Case Involving Potential Restrictions on SEC Disgorgement Remedy

May 11, 2017 | Elizabeth Dalziel

On January 13, 2017, the United States Supreme Court agreed to examine a case involving the Securities and Exchange Commission’s (“SEC’s”) ability to seek disgorgement of ill-gotten gains in fraud cases, including fraud cases involving investment advisers. The case, Kokesh v. SEC, raises the issue of whether claims for disgorgement are subject to a five-year statute of limitations on civil penalties. Oral arguments were heard by the Supreme Court in April.

The underlying case involves a New Mexico investment adviser named Charles R. Kokesh (“Kokesh”), who acted as an investment adviser to various funds organized as limited partnerships. The SEC filed suit against Kokesh, alleging that from 1995 through 2006, Kokesh ordered the funds’ treasurer to take money from the funds to pay various expenses, including $23.8 million for salaries and bonuses to the funds’ officers, including Kokesh, $5 million for office rent, and $6.1 million characterized as “tax distributions.” According to the Tenth Circuit, the payments violated the funds’ contracts because the contracts did not permit payments for salaries of the funds’ controlling persons, including Kokesh, until 2000. The contracts also did not address bonus payments, and they only permitted payment of tax obligations if certain prerequisites were present. A jury found that Kokesh violated the Investment Advisers Act of 1940, among other statutes, and the District Court ordered Kokesh to pay a $2.4 million civil penalty, plus disgorgement of $35 million based on amounts going back to 1995.

In response, Kokesh appealed to the Tenth Circuit Court of Appeals, arguing that the disgorgement was a penalty subject to a five-year statute of limitations under 28 U.S.C. § 2462. The SEC argued that the disgorgement was remedial and not punitive, and therefore not a penalty subject to the statute of limitations. The Tenth Circuit agreed with the SEC and held that disgorgement was not a penalty.

SEC Settles Charges with Investment Adviser for Failure to Disclose Conflicts of Interest Stemming From Revenue Sharing Arrangement

March 27, 2017 | Elizabeth Dalziel

On March 8, 2017, the Securities and Exchange Commission (“SEC”) issued an Order Instituting Administrative and Cease-and-Desist Proceedings (“Order”) against Voya Financial Advisors, Inc. (“Voya”), an SEC-registered investment adviser. The Order, to which Voya consented, obligates Voya to pay disgorgement of $2,621,324, prejudgment interest of $174,629.78, and a civil money penalty of $300,000.

The SEC’s Order claims that Voya did not inform its clients that it was receiving compensation from a third-party broker-dealer and that these receipts created a conflict of interest. Section 206(2) of the Investment Advisers Act of 1940 (“Advisers Act”) states that investment advisers are forbidden from participating in “any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client.” Section 207 provides that investment advisers are not allowed to “make any untrue statement of a material fact in any registration application or report filed with the Commission, or to omit to state in any such application or report any material fact which is required to be stated therein.” Finally, Rule 206(4)-7 under the Adviser’s Act compels investment advisers to “[a]dopt and implement written policies and procedures, reasonably designed to prevent violation” of the Adviser’s Act and the rules thereunder. Continue reading ›

Asset Management Company and its Owner Charged With Fraud

December 22, 2016 | Elizabeth Dalziel

On December 1, 2016, the Securities and Exchange Commission (“SEC”) announced that it had filed a complaint for injunctive and other relief in the United States District Court for the Southern District of Florida against Onix Capital LLC (“Onix Capital”), an asset management company, and its owner, a Chilean national by the name of Alberto Chang-Rajii (“Chang”). The complaint alleges that Onix Capital and Chang “violated the federal securities laws by fraudulently raising approximately $7.4 million from investors based on material misrepresentations regarding the investments offered, the use of the funds raised, and the background and financial success of Chang himself.”

Onix Capital was not an SEC-registered adviser, nor was Chang registered as an investment adviser or broker-dealer. However, the SEC alleged that Onix Capital and Chang violated the Investment Advisers Act of 1940 (“Advisers Act”). Specifically, the SEC alleged that Chang, “for compensation, engaged in the business of advising… investors… as to the value of securities or as to the advisability of investing in, purchasing, or selling securities,” and therefore met the definition of an “investment adviser” subject to the anti-fraud provisions of the Advisers Act. Continue reading ›