Summary: The U.S. Court of Appeals for the Second Circuit recently issued a decision which could have important implications for the SEC when seeking disgorgement. In Securities and Exchange Commission v. Govil, No. 22-1658, 86 F.4th 89 (2d Cir. 2023), the Second Circuit held that disgorgement is an equitable remedy and is only available where defrauded investors have suffered pecuniary harm. The Govil decision arrives in the wake of Liu v. SEC, 140 S. Ct. 1936 (2020), in which the U.S. Supreme Court held the SEC could seek disgorgement as an equitable remedy under 15 U.S.C. § 78u(d)(5) if the disgorgement award “does not exceed a wrongdoer’s net profits and is awarded for victims[.]” (emphasis added).

Facts: The Govil case involved claims against Aron Govil, the founder and CEO of Cemtrex, Inc. for allegedly fraudulently misrepresenting to investors he would use proceeds from three securities offerings to satisfy outstanding debts and for various corporate purposes, when he instead diverted over $7.3 million from the offerings to his own private accounts. After entering into a settlement agreement with Cemtrex in which Govil agreed to surrender his Cemtrex securities to the company and pay the company $1.5 million in the form of a promissory note, Govil entered into a Consent Agreement with the SEC, which included the entry of judgment against Govil for securities fraud and left to the district court a determination of additional monetary remedies. After securing a partial judgment against Govil, the SEC moved for additional disgorgement from Govil of approximately $7.3 million. Over Govil’s opposition, the district court credited the $1.5 million due under the promissory note, but disregarded the securities surrendered by Govil and awarded the SEC disgorgement of approximately $5.8 million. Govil appealed the disgorgement rulingon the grounds that the allegedly defrauded investors were not “victims” under Liu and because the district court failed to credit the value of the securities he surrendered against the disgorgement award.

Decision: In its decision, the Second Circuit vacated the order by the district court and remanded the case for further fact finding. The Court concluded that under Liu, the disgorgement remedy is only available if it can be awarded to “victims,” which it defined as investors who had suffered pecuniary harm. In so holding, the court reversed the district court’s determination that to qualify as a “victim,” “it was sufficient that the investors were told a ‘lie’” because “[t]he investors were thus denied the right to make an informed decision when considering whether to make the investment.” The Second Circuit rejected this reasoning, explaining that a determination as to whether investors suffered pecuniary harm requires the court to consider “the type of securities held, the terms of those securities, and when those securities were sold.” The Court also noted that in private securities fraud actions, an investor must prove an economic loss and recognized that “[w]ere we to call those investors [who could not pursue individual fraud claims] ‘victims’ without a similar showing, we would allow the SEC to forward proceeds of disgorgement to such investors and circumvent the limitations on private claims under § 10(b) [of the Securities Exchange Act] and the common law.”

Key Takeaway: The Govil decision is significant, as going forward, at least in the Second Circuit, the SEC’s ability to seek disgorgement will be more limited. Although the holding in Govil does not entirely preclude the SEC from seeking disgorgement as a remedy, it will require a fact-intensive inquiry into whether the allegedly defrauded investors suffered any pecuniary harm.