Disgorgement: Punitive Demands and Remedial Offers
Posted: 6 Aug 2008
Date Written: February 29, 2008
With the post-Enron, post-Sarbanes-Oxley Act emphasis on holding corporate executives involved in securities fraud individually accountable, the US Securities and Exchange Commission (SEC) has had renewed impetus to force such executives to disgorge "ill-gotten gains" of the fraud. The remedy of disgorgement is available to the SEC as ancillary equitable relief in injunctive actions filed in federal district court. Disgorgement is also expressly authorized in certain federal securities law statutes that grant courts or the SEC in certain situations the power to impose a disgorgement order. Whether pursuant to a court's general equitable authority or pursuant to specific statutory authorization, the SEC may seek to recover from individuals the fruits of securities fraud, such as profits from unlawful trading or incentive-based compensation and bonuses that are artificially increased by puffed-up corporate performance.
In this article from The Business Lawyer, NERA Senior Vice Presidents Dr. Elaine Buckberg and Dr. Frederick Dunbar address the proper measurement of disgorgement from legal and economic perspectives. Both the courts and economic principles support the calculation of disgorgement as the net economic gain stemming from officer misconduct. The net gain approach is firmly underpinned by the concept of offsetting or "netting" and the presumption of market efficiency, both of which have been accepted by the courts in the context of disgorgement and, more broadly, in securities litigation. After discussing the judicial application of the net gain approach, the authors present an economic methodology for the calculation of a defendant's net economic gain. Dr. Buckberg and Dr. Dunbar argue that in settled SEC enforcement actions, where parties disgorge funds as a result of a negotiated settlement between the SEC and the party charged, the SEC has often exceeded the limits of established jurisprudence and economic reasoning in calculating the amount to be disgorged. Because of the risks and costs of litigation, especially for white collar defendants in the post-Enron environment, the SEC may be able to extract settlements that are punitive rather than remedial, thereby overreaching the well-settled boundaries of the remedy of disgorgement. Indeed, in litigated matters, courts strictly limit the exposure of these corporate defendants to the gains that were causally related to the fraud. This means that courts limit disgorgement of trading profits to the gains made prior to corrective disclosure (and thereby acknowledge the efficient capital market hypothesis) and offset the gains from the fraud by the losses necessarily incurred from the same fraud. This article presents the broad judicial and scholarly support for the net economic gain calculation of disgorgement, including the use of event studies.
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