How Will Courts Determine Business Expense Legitimacy Under SEC's New Disgorgement Authority?

Over the past four years, Congress and the Supreme Court have reshaped the SEC's authority to obtain disgorgement of ill-gotten gains. The Supreme Court's decision in Kokesh v. SEC, 137 S. Ct. 1635 (2017) — which addressed the statute of limitations for the SEC's ability to obtain disgorgement — left open the question of whether the SEC even had authority to seek disgorgement. The Supreme Court took up that issue when, in 2019, it granted review in Liu v. SEC, 140 S. Ct. 1936, 1940 (2020). The Supreme Court's decision in June 2020 ultimately upheld the SEC's authority to obtain disgorgement but also narrowed the circumstances in which the SEC can seek it. And earlier this year in the National Defense Authorization Act, Congress passed legislation expressly reaffirming the SEC's ability to obtain disgorgement.

Of these developments, Liu's decision that the SEC can seek disgorgement only of "net profits" has been the thorniest for practitioners and the courts to apply. In limiting disgorgement to "net profits," the Supreme Court held that courts must deduct "legitimate expenses" from any disgorgement amount. At the same time, the court noted that "expenses" may be "wrongful gains under another name." This distinction has opened a battleground over what expenses courts should and should not consider legitimate.