The Securities and Exchange Commission (SEC) can initiate enforcement actions both in administrative hearings and in federal court, seeking civil penalties as well as injunctions and other equitable relief. And the SEC also prosecutes violations of its orders and rules, often obtaining million-dollar penalties from private parties. One type of equitable relief that the SEC may seek from a wrongdoer is “disgorgement.” This is essentially a modern-day form of restitution. And the Supreme Court has held that disgorgement orders must be constrained by common-law principles of restitution. Specifically, the Supreme Court held in Liu v. SEC (2020) that disgorgement orders cannot exceed a wrongdoer’s ill-gotten gains and must be used to compensate victims.

Now a new issue has arisen. Under these principles, may the SEC impose a disgorgement order to compensate someone who suffered no pecuniary harm? The Ninth Circuit Court of Appeals held that it may, affirming a disgorgement order despite a lack of pecuniary harm. Now the Supreme Court has agreed to review that decision, and Cato has filed a brief supporting the defendant (with thanks to Hunter Bruton, John Gibbons, and Noel Hudson of Smith Anderson for drafting the brief).

In our brief, we make two key points for why the Ninth Circuit was wrong. First, interpreting “disgorgement” broadly would unlawfully delegate legislative power to executive officials. Interpreting “disgorgement” broadly would effectively allow the SEC to determine the scope of its own power to seek disgorgement. The term “disgorgement” provides a limiting principle on the SEC’s power only if it incorporates traditional equitable imitations.

Second, principles of due process require that potential defendants be given fair notice of the penalties that the state may impose. To provide fair notice, statutes must precisely identify the possible consequences of violating securities law. But if disgorgement is as amorphous as the SEC wants it to be, there is substantial risk that it would fail this due-process requirement. And concerns about politically motivated targeting by government officials make this principle particularly important. Studies have found that partisan affiliation influences the severity of enforcement. The SEC’s powers, like those of any other agency, should be narrowly construed to avoid handing fallible people the opportunity for arbitrary enforcement.

The Supreme Court should reverse the Ninth Circuit and hold that disgorgement is limited by the extent of pecuniary harm suffered by the victim of wrongdoing.