Late in June, the U.S. Supreme Court docket issued a choice in Liu v. SEC, a intently watched case wherein the Court docket in an 8-1 opinion curtailed the authority of the Securities and Trade Fee (SEC) to hunt disgorgement of income from non-public events in judicial enforcement proceedings. The Court docket articulated restrictions on the SEC’s disgorgement energy, together with (1) limiting disgorgement quantities to the online income from wrongdoing, (2) limiting the SEC’s means to hunt disgorgement of income on a joint and a number of other foundation, and (3) directing the SEC to return disgorged monies to aggrieved traders relatively than depositing them within the U.S. Treasury. Though it doesn’t deal with insurance coverage points instantly, the Court docket’s evaluation of the disgorgement treatment is sure to revive dialogue of the problem of insurability of losses suffered because of settlements or judgments characterised as disgorgement.
The development in latest insurance coverage circumstances has been to carry that, the place insurers have agreed to supply protection for such losses, courts won’t second-guess the events’ contractual preparations merely on the idea of the amorphous idea of “uninsurability,” grounded as it’s in imprecise notions of public coverage. In narrowing the scope of what could correctly be known as “disgorgement” or “restitution,” the Liu resolution additional bolsters these latest traits in favor of protection.
For many years, the SEC has secured disgorgement of “ill-gotten good points” obtained by firms and people alleged to have illegally profited from violations of SEC guidelines, accumulating greater than $4 billion in disgorgement and penalties for the 12 months 2019 alone. In 2017, nevertheless, the Supreme Court docket in Kokesh v. SEC curtailed the SEC’s disgorgement energy by establishing that the Fee’s proper to disgorgement was constrained by a five-year statute of limitations. Extra notably, the Court docket additionally hinted in a footnote that an open query remained as as to if courts “possess authority to order disgorgement in SEC enforcement proceedings,” thus arousing hypothesis that Kokesh could have been signaling the start of the top of SEC disgorgement actions. The Supreme Court docket’s resolution in Liu now places that hypothesis to relaxation, however topic to key limitations on what constitutes disgorgement, of which policyholders ought to take word.
The Supreme Court docket’s Choice in Liu v. SEC
In Liu, a husband and spouse raised $27 million in a personal providing that pledged to dedicate the majority of funds to assemble a cancer-treatment middle. As a substitute, in violation of the phrases of the providing, the couple spent practically $20 million of the funding proceeds on advertising and salaries and diverted funds to private accounts. In an ensuing civil motion introduced by the SEC, a district court docket ordered the husband and spouse to disgorge practically the total quantity of funds raised within the providing, and the Ninth Circuit affirmed.
As a result of the statute at subject solely authorizes the SEC to hunt “equitable reduction,” the Supreme Court docket analyzed disgorgement beneath ideas of fairness. In response to the Court docket, these ideas “lengthy licensed courts to strip wrongdoers of ill-gotten good points,” but additionally sought to “prohibit the treatment to a person wrongdoer’s web income to be awarded to victims” to keep away from remodeling the treatment right into a penalty. The Court docket confirmed the SEC’s authority to disgorge funds beneath these ideas, however articulated key restrictions on prior SEC disgorgement practices that, the Court docket admonished, had been “in appreciable stress with fairness practices.”
First, the Court docket clarified that disgorgement awards could not exceed web income from wrongdoing after deducting reputable bills. Funds utilized to bills equivalent to “lease funds and cancer-treatment gear,” for instance, had worth “impartial of fueling a fraudulent scheme,” and shouldn’t have been ordered disgorged.
Second, the Court docket disapproved the SEC’s prior follow of imposing disgorgement on a joint and a number of other foundation, discovering it “at odds with the common-law rule requiring particular person legal responsibility for wrongful income.” In different phrases, forcing mates, households or purchasers to whom ill-gotten good points flowed to return these good points could be inconsistent with the aim and idea of disgorgement.
Third, the Court docket disapproved the SEC’s frequent follow of depositing disgorgement proceeds within the U.S. Treasury relatively than returning them to “wronged traders for his or her profit.” Because the Court docket defined, beneath ideas of fairness, a disgorgement “should do greater than merely profit the general public at giant.”
The Insurer Disgorgement Uninsurability Argument
The Liu resolution could also be critically necessary to some D&O policyholders. In circumstances involving calls for for restitution or disgorgement of ill-gotten good points, insurers steadily argue that, whatever the language of their insurance policies affording protection for such claims, the losses could also be thought of “uninsurable” beneath purportedly relevant state legislation ideas.
Key Insurance coverage Takeaways
In defining the contours of the equitable treatments of restitution/disgorgement, and limiting the SEC’s means to safe such reduction, Liu undermines the already questionable viability of insurers’ restitution/disgorgement protection.
The Court docket goes to nice pains to make clear that the quantity recoverable as “disgorgement” is proscribed to the particular quantity the defendant truly obtained as income to which it was not legally entitled. That idea dovetails with the “unlawful revenue” exclusion present in most D&O insurance policies, a provision that often excludes solely that portion of “loss” akin to the quantity of private income to which the policyholder was not legally entitled, after which solely after illegality is established by “remaining adjudication” within the underlying litigation.
That side of the ruling is likewise in keeping with the choice of the New York Court docket of Appeals in J.P. Morgan v Vigilant Ins. Co., which held that regardless that a settlement settlement between the SEC and Bear Stearns characterised their $160 million settlement as “disgorgement,” the restitution/disgorgement protection didn’t apply as a result of the beneficiary of Bear Stearns’ improper conduct was not Bear Stearns however relatively sure of its clients (or, as one New York Justice put it at oral argument, a defendant can’t disgorge what it has not gorged.).
With a narrowing of the potential restoration of disgorgement/restitution reduction to that portion of loss constituting unlawful revenue, the Liu resolution ought to restrict the power of carriers to say the protection as a basic bar to protection just because restitution/disgorgement claims could have been asserted. As such, the choice ought to make it tougher to say the protection within the context of a settlement of claims, significantly the place the settlement entails a number of events or a number of claims of which a requirement for disgorgement is however one.
The Court docket’s evaluation additionally makes clear that the quantity of a judgment or settlement that could be characterised as disgorgement or restitution can also be restricted to the quantity paid to the sufferer of the defendant’s acts. Plaintiffs’ attorneys’ charges and damages not truly paid to victims, equivalent to quantities retained by the SEC in an enforcement motion, would fall exterior that definition.
The Supreme Court docket’s ruling in Liu needs to be another nail within the coffin for the “uninsurability” protection as to damages that insurers describe as restitution or disgorgement. Prospectively although, policyholders ought to contemplate tweaking their coverage language to get rid of the problem altogether and so as to add as a lot contract certainty as potential. The unlawful revenue exclusion is enough to deal with insurers’ purported considerations about ethical hazard with out resort to a phantom uninsurability protection, at the same time as courts more and more hesitate to embrace the protection.