How Supreme Court Ruling on Disgorgement Will Affect Advisors

As SEC Chairman Jay Clayton remarked, "[i]nvestment advisers play a vital and trusted role in our markets … Regardless of the scope and duration of the investment advisory services, investment advisers are fiduciaries and, as such, their duties of care and loyalty require them to disclose their conflicts of interest, including financial incentives."

While there are categories of cases, such as Foreign Corrupt Practices Act and insider trading cases, where the SEC may need to justify disgorgement in the absence of any return of ill-gotten gains to injured investors, in the investment adviser context, the court's focus on returning money to victims should be easier to address. Notably, disgorgement awards in share class disclosure cases or in cases involving excessive fees are frequently returned to victims (often funds). Netting out expenses is also much simpler in most investment adviser cases, where fees tend to be set.

For example, disgorgement amounts in Rule 12b-1 cases are easily calculated by determining the fee that the advisers obtained by placing their clients in a 12b-1 fee-paying share class.  Indeed, under its Share Class Selection Disclosure Initiative, the SEC routinely obtained disgorgement of fees collected by advisers and directed disgorged sums to harmed clients, including $135 million paid to victims in Fiscal Year 2019.

To be sure, Liu may still affect certain aspects of SEC cases in the investment adviser space.  For example, the SEC has sought disgorgement under joint-and-several liability theories in certain past investment adviser enforcement actions — a practice the SEC might curtail after Liu found it to be "in considerable tension with equity practices."

Also, the court embraced consideration of a wrongdoer's "legitimate expenses" in calculating appropriate disgorgement awards. And however district courts may interpret Liu, as Justice Clarence Thomas wrote in dissent, "[i]t is unclear whether the majority's new restrictions on disgorgement will apply to [the SEC's administrative] proceedings as well."

In short, we expect the SEC will likely continue to focus on investment advisory cases as an enforcement priority and the Supreme Court's decision in Liu will have a modest impact on the staff's analysis to seek disgorgement in these types of cases, whether litigated or settled. The SEC's ability to pursue disgorgement in such cases will allow the SEC to continue to bring adviser cases as a significant part of its docket in the months and years ahead.

Michael D. Birnbaum, Haimavathi V. Marlier and Jina Choi are partners of Morrison & Foerster LLP and each held previous roles with the Securities Exchange Commission. Gerardo Gomez Galvis is an associate with the firm.