courthouseThree years ago, the Supreme Court issued its decision in Kokesh v. U.S. Securities and Exchange Commission, 581 U.S. ___ (2017), holding that the remedy of disgorgement in SEC civil enforcement proceedings constitutes a penalty for statute of limitations purposes. Kokesh was issued alongside the decision in Honeycutt v. United States, 581 U.S. ___ (2017), which dealt with criminal forfeiture and held that the remedy could only be applied to the recipient of ill-gotten gains and not jointly and severally.

Although these cases dealt with different types of proceedings, this author and another posited at the time that Kokesh and Honeycutt should be read together and foretold that the Court would continue to curtail the SEC’s remedies in enforcement cases.  https://www.law360.com/articles/939021/demise-of-disgorgement-kokesh-and-honeycutt-in-tandem?copied=1.

Today’s decision in Liu v. SEC –authored by Justice Sotomayor for a nearly unanimous court – confirms this prior prediction by addressing an issued explicitly reserved in Kokesh: Whether the SEC properly can obtain disgorgement. Although many headlines on the Liu decision imply a win for the SEC by reporting that the Court upheld disgorgement as a permissible equitable remedy, a closer reading of the majority opinion reveals the Court, like in Kokesh, continues to restrict the SEC’s powers by narrowly defining the scope of permissible disgorgement.

In Liu, Justice Sotomayor canvasses 200 years of jurisprudence to hold that courts long have recognized some form of equitable remedy of “disgorgement” that requires the return of ill-gotten profits to victims. The statute permitting the SEC to seek “equitable” remedies for violations of the securities laws, 15 U.S.C. §78u(d)(5), was adopted against this background and thus, according to the Court, incorporated the remedy of disgorgement of ill-gotten profits.

Relying on this legal framework, Justice Sotomayor explained that in order for a disgorgement remedy to be equitable and thus permissible under §78u(d)(5), it had to satisfy three criteria: (1) it must be made for the benefit of the victims; (ii) it had to be based on the ill-gotten net profits, meaning any legitimate expenses had to be excluded; and (iii) it could only be imposed as to those net profits that actually accrued to an individual, meaning that it could not be awarded on a joint-and-several liability basis. Although the Court declined to rule on the specifics of the disgorgement order before it in Liu, noting that the issues had not been fully briefed, it did opine on all three criteria vis-à-vis that order.

First, the Court expressed skepticism of any disgorgement award that failed to try to distribute the disgorged funds to the victims. This includes the order before it, which directed the disgorged funds to be placed into the Treasury Fund that had been created for such purposes. The Court made clear that the SEC had to make reasonable efforts to identify and return funds to victims before placing them in the Treasury Fund in order for the disgorgement not to be an impermissible penalty.

Second, the Court emphasized that disgorgement could not be imposed jointly and severally against multiple defendants; rather, disgorgement has to be imposed against a defendant based on his or her individual liability. The exception to the rule is if two partners were “engaged in concerted wrongdoing.” Thus, in the case of the petitioners, the Court noted that although they were married and appeared to act together equally in the fraud, the lower court on remand still had to determine if disgorgement could be awarded against both of them together consistent with these equitable principles.

Third, the Court made clear that “legitimate expenses” cannot be part of disgorgement, unless the “‘entire profit of a business or undertaking’ results from wrongdoing.” In the instant case, the Court noted there was some evidence that – despite the widespread fraud in petitioners’ business – some expenses of the scheme were for items that could have value independent of the fraud. If that were the case, the Court remarked, the lower court would have to exclude those expenses from disgorgement, which it did not do in the original order.

Liu, like Kokesh, narrows the scope of remedies available to the SEC in civil enforcement cases by further restricting disgorgement to the specific net profits obtained by a defendant as a result of the violation of the securities laws. As the SEC previously had sought and obtained broad orders of disgorgement premised on a defendant’s gains without accounting for expenses and imposing joint and several liability on multiple defendants despite their complicity or receipt of gains, Liu drastically reduces the exposure for many defendants in SEC civil enforcement proceedings. In so doing, Liu hopefully will reduce the inordinate leverage previously wielded by the SEC in such cases.

Price GougingFederal and state authorities are creatively using the Defense Production Act (“DPA”), state anti-price gouging and consumer protection statutes, and antitrust laws to go after alleged price gougers and hoarders. This article, the final in our series on anti-hoarding and price gouging enforcement efforts, takes a look at various ways businesses can avoid liability.

The Laws Are Unconstitutionally Vague

Generally, laws may be declared unconstitutionally vague for two reasons. First, because they fail to provide people of ordinary intelligence with a reasonable opportunity to understand what conduct is proscribed. Second, because they lack explicit standards, thereby inviting arbitrary or discriminatory enforcement.

Many anti-hoarding and price gouging laws contain unclear and ambiguous terms such as excessive and exorbitant. The DPA, for example, bars the resale of scarce or threatened items “in excess of prevailing market prices,” yet it provides no definitions, instruction or other guidance for determining the meaning of that phrase.

While the intentions of lawmakers may have been clear when enacting these laws, the language used to draft them is not and several federal and state anti-hoarding and price gouging laws around the county may satisfy both tests for unconstitutional vagueness.

Good Faith Price Increases Caused By Rising Costs

Several articles have been written on the on the impact of COVID-19 to supply chains in various industries. The pandemic has led to increased procurement and production costs for many companies.

Quite often, anti-price gouging laws provide safe harbor provisions for sales price spikes tied to a rise in production costs. For example, Ohio’s proposed anti-price gouging legislation, Senate Bill 301, would provide affirmative defenses for price increases “related to any reasonable but unforeseen circumstances” including, but not limited to, supply chain cost increases, government actions, or an “intentional effort” by a business to add “objective value” to its products or services.

Antitrust and Consumer Protection Laws Don’t Apply  

While some authorities have tried to use antitrust laws as enforcement mechanisms, actions brought solely under the Sherman Act and state law equivalents will fail unless the price gouging is a conspiracy amongst competitors, which is not something that is typically alleged in these types of prosecutions.

Actions brought solely under consumer protection acts would have similar problems because those statutes typically only protect consumers. For instance, the Ohio Consumer Sales Practice Act (“OCSPA”) applies only to transactions between suppliers and individuals for the purchase of personal, family, or household goods or services. As such, a company could avoid liability for price gouging by showing that the transaction at issue involved another business or non-consumer. Moreover, “good faith errors” made notwithstanding compliance with procedures adopted to adhere to the OCSPA are exempted from liability.

Federal and state authorities are under immense pressure to investigate COVID-19-related wrongdoing. Still, in seeking harsh civil and criminal penalties, these agencies should be mindful of ensnaring legitimate and lawful commercial conduct. Moreover, these agencies should not twist or manipulate otherwise inapplicable or constitutionally infirm statutes in order to pursue perceived wrongdoers.

If you or your business becomes the target of a hoarding or price gouging investigation, the lawyers of Thompson Hine LLP’s white collar criminal defense practice group can help you navigate the wide array of legal options available to avoid liability.

As the COVID-19 pandemic worsens, public pressure has led to increased efforts to investigate and punish those engaging in hoarding and price gouging of essential items across the country.

The Authorities and Civil Plaintiffs Have Relied on Creative Means to Target Perceived Price Gouging

On March 24, 2020, United States Attorney General William P. Barr announced the creation of the COVID-19 Hoarding and Price Gouging Task Force. Since then, federal prosecutors in New York have filed the first ever cases charging defendants under the 1950 Defense Production Act (“DPA”) which makes it a federal crime to resell scarce essential items, as declared by the President, in excess of prevailing market prices.

In Tennessee and Ohio, the state Attorneys General brought civil claims against would be entrepreneurs trying to make a quick buck by reselling cleaning and medical supplies at excessive markups on the internet. Both cases resulted in quick settlements.

Seeking bigger fish, the Texas Attorney General recently filed a price gouging lawsuit against Cal-Maine Foods, the nation’s largest egg producer. The lawsuit alleges that Cal-Maine illegally sold eggs at more than 300% of their normal cost in violation of Texas’s deceptive trade practices statute. Similarly, a putative class action price gouging lawsuit was recently filed in the Northern District of California against some of the nation’s largest grocers.

This is a Relatively Underdeveloped Area of Law

Because there has not been a nationwide crisis of this scale in recent memory, the law in the area of price gouging is underdeveloped. As a result, recent actions have been brought under a wide variety of novel and untested legal theories, including as violations of state anti-price gouging, consumer sales protection, and even antitrust statutes.

If you find yourself or your company the target of a hoarding or price gouging action, there are ways to fight back. Many of the anti-price gouging statutes have imprecise definitions of key terms such as excessive or exorbitant. Others, like the DPA, have no statutory definition of those terms at all, making them vulnerable to arguments that they are unconstitutionally vague.

Claims under consumer sales protection statutes, on the other hand, generally are expressly limited to transactions between suppliers and consumers for the purchase of personal, family, or household items. So, as an example, it seems to follow that no liability would lie under those statutes for transactions between merchants and non-consumer purchasers, such as healthcare professionals or businesses.

If you or your business becomes the subject of a hoarding or price gouging claim, contact Thompson Hine LLP’s white-collar criminal practice group.

 

We’ve been closely monitoring the legal landscape to see how law enforcement is pursuing companies and individuals for profiteering during the current pandemic. This article is the second in a series of articles exploring the heightened focus on COVID-19-related hoarding and price gouging. So far through the pandemic, federal and state authorities have primarily relied on three tools to go after hoarders and price gougers: the Defense Production Act (“DPA”), state emergency anti-price gouging and consumer protection statutes, and antitrust laws.

Defense Production Act

The DPA is a federal statute that, amongst other things, allows the President to declare certain items as “scarce” or “threatened scarce” during a national emergency. Once an item receives such a declaration, its accumulation in “excess of reasonable demands of business, personal, or home consumption” or “for the purpose of resale of at prices in excess of prevailing market prices” becomes unlawful.

Before the COVID-19 pandemic, criminal charges had never been brought under the DPA. But it has since been invoked by federal prosecutors in three cases as of the date of this publication. Individuals convicted of violating this statute face penalties of up to a year in prison and up to $10,000 in fines.

State Legislation

Several states have anti-price gouging laws and are suing under those laws to combat profiteers. Sometimes these laws are parts of statutes enacted for the express purpose of targeting hoarders and price gougers and sometimes they are included as provisions in consumer protection legislation. Typically, these laws forbid large price spikes in consumer goods and services after an emergency declaration by a governor or other cabinet-level state official. These statutes often carry some combination of fines and imprisonment.

Ohio has not enacted any explicit anti-price gouging legislation, but it is quickly catching up.

Ohio Attorney General Dave Yost announced that he was working with Ohio lawmakers on Ohio Senate Bill 301. The bill would amend Ohio’s Consumer Sales Practices Act to explicitly make the sale of consumer goods or services at “grossly” excessive prices during an emergency an unlawfully unconscionable act.

Antitrust Laws

Ohio’s Valentine Act and federal antitrust law govern and punish anti-competitive behavior. In a civil lawsuit against an alleged Cleveland-area price gouger, AG Yost claimed that the hoarding and reselling of N95 masks amounted to a violation of the Valentine Act. Although the defendant in that case quickly reached an agreed settlement with the state, he could have faced severe penalties if his conduct was found to violate the statute. Criminal violations of the Valentine Act range from second degree misdemeanors all the way up to fourth degree felonies, which carry up to 18 months in prison and fines as much as $5,000. Claimants can also seek treble damages for civil actions under the Valentine act.

The next article in this series will take an in-depth look at some of the ways that liability could be avoided or mitigated should you or your business become the target of a hoarding or price gouging enforcement action.