Practice Areas

Distribution Of Disgorgement Funds To Investors

7.01  Nature of Disgorgement

As a part of its equitable powers, the court in a SEC enforcement action may order a wrongdoer to disgorge all gains from the illegal activity. SEC v. Fischbach Corporation, 133 F.3d 170, 175 (2d Cir. 1997); SEC v. First Jersey Securities, Inc., 101 F.3d 1450, 1474 (2d Cir. 1996); SEC v. Certain Unknown Purchasers of the Common Stock of and Call Options for the Common Stock of Santa Fe International Corporation, 817 F.2d 1018, 1020 (2d Cir. 1987); see also SEC v. Lund, 570 F.Supp. 1397, 1404 (C.D.Cal. 1983).   Disgorgement of “ill-gotten gains” may be ordered against one who has violated federal securities laws, despite the defendant’s own huge loss in the investment scheme.  J.T. Wallenbrock & Assoc., 440 F.3d 1109, 1117 (9th Cir. 2006).

The purpose of disgorgement is to prevent the wrongdoer from profiting from his illegal acts, not to reimburse those who have been injured by his conduct; and there is no requirement that disgorged funds be used for investor restitution.  SEC v. Commonwealth Chemical Securities, Inc., 574 F.2d 90, 102 (2d Cir. 1978)  (“. . . the primary purpose of disgorgement is not to compensate investors. . . . it is a method of forcing a defendant to give up the amount by which he was unjustly enriched . . . .”).  This principle from Commonwealth was reaffirmed by the Second Circuit in both SEC v. Wang, 944 F.2d 80, 85, 88 (2d Cir. 1991), and Fischbach, 133 F.3d at 175-76 (“The primary purpose of disgorgement orders is to deter violations of the securities laws by depriving violators of their ill-gotten gains. *** “The effective enforcement of the federal securities laws requires that the SEC be able to make violations unprofitable ***Although disgorged funds may often go to compensate securities fraud victims for their losses, such compensation is a distinctly secondary goal. ***and a district court may order disgorgement regardless of whether the disgorged funds will be paid to such investors as restitution.”).  See also SEC v. Huffman, 996 F.2d 800, 802 (5th Cir. 1993) (“. . . disgorgement is not precisely restitution.  Disgorgement wrests ill-gotten gains from the hands of a wrongdoer.  It is an equitable remedy meant to prevent the wrongdoer from enriching himself by his wrongs.  Disgorgement does not aim to compensate the victims of the wrongful acts, as restitution does.” [citations omitted])

In Fishbach, 133 F.3d 175-176, where it would have been impractical to identify those investors damaged by the fraudulent conduct, the disgorged funds were instead paid to the United States Treasury.  Id.  See also SEC v. Blavin, 769 F.2d 706, 710, 712-714 (6th Cir. 1985), where disgorged profits in excess of the losses of injured investors would revert to the United States Treasury.

It is still the policy of the Securities & Exchange Commission to recommend that disgorgements be distributed for the benefit of those injured by the illegal activities.  See Fishbach, 133 F.3d at 174.

As to competing jurisdiction over assets between the receivership court and a competing parallel action, see 3.01, supra.

7.02 Distribution Plans

Any plan of distribution may be adopted that is reasonable.  Wang, 944 F.2d at 83-84.  See also SEC v. Basic Energy & Affiliated Resources, Inc., 273 F.3d 657, 668, 670-71 (6th Cir. 2001) (“Similarly, in the present case the district court carefully considered the Escrow Investors’ arguments, the position of the other BEAR investors, and the facts of the case, and accordingly fashioned a distribution plan that was fair and equitable.  Thus, we cannot conclude that the district court has abused its discretion.”); SEC v. Forex Asset Management LLC, 242 F.3d 325, 331 (5th Cir. 2001) (“’ . . . [i]n shaping equity decrees the trial court is vested with broad discretionary power . . . .”); SEC v. Elliott, 953 F.2d 1560, 1566-67 (11th Cir. 1992)  (“The district court has broad powers and wide discretion to determine relief in an equity receivership.”);  SEC v. Hardy, 803 F.2d 1034, 1037-39 (9th Cir. 1986) (“’[I]t is a recognized principle of law that the district court has broad power and wide discretion to determine the appropriate relief in an equity receivership.’”); Lund, 570 F.Supp. 404 (“The receiver or trustee, in addition to handling other duties if necessary, is given the task of locating those members of the public who were injured by the illegal activity and to pay each injured party an amount determined by the trustee to be fair and equitable.”)  See also Norwest Bank v. Malachi Corp., 2007 WL 2302167 (6th Cir. August 13, 2008).

The discretion of the Commission in developing a plan is particularly strong when the disgorgement, and Commission authority to propose a plan for its distribution, is provided for in a consent decree.  See Wang, 944 F.2d at 83-85; SEC v. Levine, 881 F.2d 1165, 1181-183 (2d Cir. 1989).

A reasonable plan should be upheld by an appellate court even though the reviewing court might have chosen a different plan.  Wang, 944 F.2d at 88.

A distribution plan may also provide for reimbursement to certain claimants, while excluding others.  Levine, 881 F.2d at 1173, 1183, cited with approval in Wang, 944 F.2d at 84; see also Santa Fe, 817 F.2d at 1020-21; Basic Energy, 273 F.3d at 660-661. The plan may also provide different treatment for different classes of investors.  Wang, 944 F.2d at 85-88; see also Basic Energy, 273 F.3d at 660-661; Norwest Bank, 2007 WL 2302167 at *6. Providing such differing treatment is particularly applicable when the aggregate losses suffered due to the scheme cannot be fully compensated by available proceeds.  Wang, 944 F.2d at 86, 87; Santa Fe, 817 F.2d at 1021.

For a case limiting participation in distributions to those who have suffered actual out-of-pocket losses, see  Santa Fe, 817 F.2d at 1020-21.

In some instances, responsibility for developing the distribution plan may be given by a consent decree to the SEC, CFTB or FTC, or even the Receiver.  In such instances, it has been held that “…unless the consent decree specifically provides otherwise once the district court satisfies itself that the distribution of proceeds in a proposed SEC disgorgement plan is fair and reasonable, its review is at an end.”  Wang, 944 F.2d at 85.  Insofar as the drawing of distinctions between different classes of investors, the court also observed “This kind of line-drawing—which inevitably leaves out some potential claimants—is, unless commanded otherwise by the terms of a consent decree, appropriately left to the experience and expertise of the SEC in the first instance. . . . The district court’s task is to decide whether, in the aggregate, the plan is equitable and reasonable.”  Id., at 88.

Disqualifying defendants and their related parties, as well as those who participated in the development, implementation or marketing of the scheme, from participation in distributions has been upheld as reasonable, since it permits the disgorgement proceeds to be distributed to those who are most innocent.  See Basic Energy, 273 F.3d at 660-661 (6th Cir. 2001), where defendants were excluded from participation in disgorgement proceeds and marketers of the scheme were reimbursed for a smaller fraction of their losses than were non-marketers.

Providing for a reasonable “Claims Bar Date” has also been sustained by the courts.  Hardy, 803 F.2d at 1038-1040.

Reduction in administrative costs is a consideration that may also be taken into account in developing a plan of distribution.  Wang, 944 F.2d at 86-87, 87-88; see also Fischbach, 133 F.3d at 175; Elliott, 953 F.2d at 1566; Wencke, 783 F.2d at 837.

In the context of an SEC receivership distribution plan, due process requirements generally include giving investors that opportunity to have a fair hearing, present evidence and appeal adverse rulings.

The broad discretion granted the Court in developing a plan of distribution is particularly important in addressing Ponzi-Pyramid Marketing Schemes, with their multiple investment programs, numerous investors, and non-defendants who may still have some truth of culpability.  Thus in the Basic Energy receivership, the Receiver recommended (and the Court adopted) a plan which created a single pool of assets for all investors, rather than tracking claims of investors in each of the multiple programs to the investors in that particular program.  However, investors were classified as to whether thy were “non-marketers” (claim full value), “substantial marketers” (claim reduced by 90%), “insubstantial marketers” (claim reduced by 10%), or defendants (claims reduced to zero).  The Court also developed guidelines concerning the treatment of affiliates of defendants and marketers, various aspects of this plan were implicitly affirmed in the Sixth Circuit’s Basic Energy opinion included in the Selected Legal Authorities.

Another interesting issue in dealing with asset distribution is the relative treatment of trade creditors vis-à-vis investor claimants.  In view of the Court’s tremendous discretion in equity receiverships, the Court should also have broad latitude in resolving this issue.  See, e.g., Norwest Bank, 2007 WL 2302167 at *6.

Note that a bankruptcy trustee or judge would not have the same latitude if the matter was being handled in a bankruptcy.

7.03  Use of Summary Procedures and Administration of the Estate

The use of summary proceedings to implement the distribution plan and to administer the Estate is customary in federal receiverships and is perfectly permissible under “due process” rules so long as potential claimants are given the opportunity to be heard and to present their claims.  Basic Energy, 273 F.3d at 668-671; Elliott, 953 F.2d at 1566-67, 1570-71 (11th Cir. 1992); Hardy, 803 F.2d at 1040; SEC v. Wencke, 783 F.2d 829, 834-839 (9th Cir. 1986); U.S. v. Arizona Fuels Corporation, 739 F.2d 455,458-460 (9th Cir. 1984).  See also Warfield v. Alaniz, 2006 WL 2190563 (D.Ariz. 2006), **12-13.  Thus, as the Eastern District of New York noted in FDIC v. Bernstein, 786 F.Supp. 170 (E.D.N.Y. 1992):

. . . One common thread keeps emerging out of the cases involving equity receivership—that is, a district court has extremely broad discretion in supervising an equity receivership and in determining the appropriate procedures to be used in its administration.

In keeping with this broad discretion, “the use of summary proceedings in equity receiverships as opposed to plenary proceedings under the Federal Rules [of Civil Procedure], is within the jurisdictional authority of a district court.”   Such procedures “avoid formalities that would slow down the resolution of disputes.  This promotes judicial efficiency and reduces litigation costs to the Receivership,” thereby preserving receivership assets for the benefit of creditors.  786 F.Supp. 170, 177-78, citations omitted. 

See also Hardy, 803 F.2d at 1038 (“A district judge supervising an equity receivership faces a myriad of complicated problems in dealing with the various parties and issues involved in administering the receivership.  Reasonable administrative procedures, crafted to deal with the complex circumstances of each case, will be upheld.  A district judge simply cannot effectively and successfully supervise a receivership and protect the interests of its beneficiaries absent broad discretionary power.”); U.S.A. v. Fairway Capital Corp., 433 F.Supp.2d 226, 241 (D.R.I. 2006). 

For a detailed discussion of due process issues, see Elliott, 953 F.2d at 1566-68, 1570.

A receiver need not separately serve process on the various claimants in a receivership claims procedure so long as the claimants are given adequate notice.  Fairway, 433 F.Supp.2d at 237.  A federal court is not required to abstain from exercising its jurisdiction over claims in a receivership estate simply because of a pending parallel proceeding in state court.  Id., at 238-240.

A receiver may properly deny claims that are not substantiated by the claimant.  Fairway, 433 F.Supp.2d at 246-47. 

A receiver’s findings of fact and conclusion of law made in connection with his acceptance or rejection of creditor claims will be reviewed de novo by the court if objected to.  Fairway, 433 F.Supp.2d at 231-32.

7.04 Appeals

The Circuits are in disagreement as to what constitutes an appealable order where distribution plans are involved.  In SEC v. Capital Consultants, 453 F.3d 1166 (9th Cir. 2006), the Court of Appeals for the Ninth Circuit held that an order finally determining the rights of some, but not all, claimants to a receivership distribution plans was not appealable as a “collateral order,” though the order might be appealed pursuant to Rule 54(b) of the Federal Rules of Civil Procedure if but only if the requirements of that Rule (an express determination by the district court that “no just reason for delay exists” coupled with the entry of judgment) are satisfied.  This was contrary to the holdings of the Sixth Circuit in Basic Energy, 273 F.3d at 665-67 and the Fifth Circuit in SEC v. Forex Asset Mgmt. LLC, 242 F.3d 325, 330-31 (5th Cir. 2001), both of which held that such orders were appealable as “collateral orders.”