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SEC Disgorgement: Who Gets the Money?

March 11, 2020

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Liu v. SEC, No. 18-15-1, argued before the Court last week, is potentially one of the most important cases to be heard by the Supreme Court on SEC Enforcement. The question under consideration is whether the Securities and Exchange Commission can request a federal court to award what the agency calls disgorgement – essentially the gross amount of money obtained through wrongful conduct.

Petitioners, Charles Liu and his wife, claim that the SEC version of disgorgement is not authorized by the federal securities laws. The SEC claims that its long-used remedy is not just essential to its Congressionally assigned task of protecting investors and markets but has been authorized by statute and a long line of cases. While the Court did not dispute the right of the agency to seek disgorgement during oral argument, the Justices seemed to have a very different notion of what constitutes that form of equitable relief from that of the SEC.

Background

Liu is based on an EB-5 offering. Approximately $27 million was raised from investors for a construction program. The investors were Chinese citizens recruited for the program based on the promise of U.S. citizenship in return for an investment that will create a specified number of jobs in this country. Portions of the investor funds were used for the construction. Other portions were mishandled and/or misappropriated, according to the SEC. Suit was filed, followed by the entry of a freeze order and the appointment of a receiver.

In resolving the case the SEC demanded in disgorgement in the amount of $27 million. Defendants claimed any disgorgement should be limited to the amounts they received – about $6.7 million by Charles and $1.5 million by his wife, Xin Wang.

The district court entered an order in favor of the Commission, awarding disgorgement in the amount of $27 million. In making the award the court rejected defense claims that any disgorgement should be limited to the amounts received less business expenses. The Ninth Circuit Court of Appeals, applying existing precedent, affirmed.

Briefing before the Supreme Court

Petitioner: Petitioners contend that the SEC has no authority to seek an award of disgorgement in a federal district court action. In the federal securities laws Congress created a “comprehensive scheme for enforcement . . . the authority to seek extensive relief in federal court, including through defined tiers of civil monetary penalties . . .” That scheme does not include any specific authority to request or obtain disgorgement in federal court actions.  While Congress did give the SEC the power to seek an “accounting and disgorgement” in administrative proceedings in the Remedies Act of 1990, and the CFTC the authority to seek “disgorgement” in “any action” in the Dodd-Frank Act of 2010, such authority was not conferred on the SEC. Under these circumstances, the Court has long recognized a presumption that Congress acted intentionally in omitting language authorizing the agency to seek such a remedy.

The SEC’s contention that the federal courts have the authority to order disgorgement under their equitable powers is also contrary to the Court’s decision in Kokesh v. SEC. There the Court carefully analyzed the concept of disgorgement as used by the SEC and concluded that it is a penalty. It is black letter law that where, as here, the remedy goes far beyond the profits obtained by the wrong doer, it is a penalty. This is particularly true when the funds are not returned to those harmed but rather are given to the U.S. Treasury as is often the case in SEC enforcement actions. The simple fact is that penalties such as the SEC disgorgement remedy cannot be awarded in equity.

While the Kokesh penalty conclusion was fashioned in the context of construing a federal statute of limitations, its rationale and reasoning are directly applicable here. That is particularly true here since the remedy is used in a punitive fashion, often seeking more that the claimed wrong doer obtained as in this case.

Likewise, SEC disgorgement cannot be viewed as an “accounting,” another traditional equitable remedy. This is because such relief is predicated on a breach of a fiduciary relationship that runs between the parties. That is not the case here.

Finally, the SEC’s claim that the remedy was implicitly authorized by Congress in a series of court decisions preceding the addition of Exchange Act Section 21(d)(5) in the 2002 Sarbanes Oxley Act is simply incorrect. While that provision does authorize federal courts to award relief in the interest of investors, it does not permit the imposition of a punitive remedy such as the kind of “disgorgement” claim sought here. Nor is there any reason to believe that somehow Congress intended to codify prior court cases on SEC disgorgement which at times took disparate views on how the requested award should be fashioned.

Where, as here, there is a comprehensive statutory scheme there is no reason to fashion the kind of disgorgement remedy sought by the agency. The SEC has more than sufficient enforcement authority under the statutory scheme fashioned by Congress.

Respondent: The Commission argued that Congress has authorized the disgorgement remedy it has long employed. Three key points support this contention and delimit the scope of review required in this case. First, disgorgement is the remedy of requiring a “conscious wrongdoer to pay over the profits attributable to the underlying wrong, according to the restatement (Third) of Restitution. Prior to 2002 the statutes provided that the Commission could obtain an injunction, an equitable remedy. The courts repeatedly held that the Commission could recover disgorgement.

Second, in 2002 Congress added Section 21(d)(5) to the Exchange Act as part of Sarbanes-Oxley. That section states in part that a district court can award “any equitable relief that may be appropriate or necessary for the benefit of investors” in a case initiated by the Commission. The phrase “any equitable relief” in the section plainly includes disgorgement – there is no predicate for reaching the opposite conclusion. The history of equitable relief confirms this reading of the statute. It is a fundamental equitable principle that no person can profit from his or her own fraud. Disgorgement of those profits is thus a basic equitable remedy.

Third, the context of the statute – other statutes passed during the period -- confirms this reading of the provision. Those statutes are The Insider Trading Sanctions Act, The Remedies Act, the PSLRA and SOX.  Each refers to the authority of the Commission to secure disgorgement. Essentially, those statutes, as well as Section 21(d)(5), confirm the long standing view of the courts, tracing to the 1960s and 1970s, that disgorgement is an equitable remedy designed to preclude the wrongdoer from profiting as a result of engaging in prohibited conduct. That remedy was available to the SEC under the statutes prior to Sarbanes-Oxley. Section 21(d)(5) and later the Dodd-Frank, which authorized disgorgement for SEC administrative proceedings as well as two other federal agencies, confirmed the point.

Petitioners’ fail to present any convincing response to the points raised above. Their claims, based on historical equity practice traced to the days of the split bench, fail to consider the current equity position of the courts and that of Congress in 2002 when drafting Section 21(d)(5).

Finally, Kokesh does not preclude the Commission from obtaining disgorgement. The fact that SEC disgorgement does not always go to the victim does not preclude the use of the remedy. The focus of SEC disgorgement is to deprive the wrongdoer of the profits of illegal conduct which is precisely what it does. In the end, the task here is to properly interpret that Section. On its face, and viewed in context, it authorizes the SEC to obtain disgorgement as defined today. Other issues regarding the mechanics of disgorgement need not be considered.

Reply: The SEC’s claim that Congress ratified the views of certain courts in SOX in 2002 misses the mark. The decisions cited diverge in their views and are not uniform. The fact is, equity has never recognized the view adopted by the SEC which takes a historical remedy and converts it to a penalty, something not recognized by equity. The notion that Dodd-Frank somehow ratified SEC disgorgement by providing for the use of the remedy in administrative actions and to other federal agencies is a supposition that has never been addressed let alone passed by Congress. In the end, the SEC seeks to evade a ruling on the question of disgorgement because there is no historical precedent for its position.

Argument

Petitioners: Counsel for Petitioners began by claiming that there is no statutory authority for the disgorgement remedy used by the SEC. Three points are key: 1) There is no statutory text for the remedy; 2) the SEC has statutory penalties so it does not need the remedy; and 3) the SOX amendments do not support its position.

First, there is no statutory text for the remedy. Nowhere in the federal securities laws is there text specifically stating that the SEC can seek disgorgement in a civil injunctive action. Perhaps more importantly, to the extend the agency claims the remedy can be crafted from the district court’s equitable jurisdiction, Kokesh made it clear that SEC disgorgement is in fact a penalty. While that decision was made in the context of deciding a question regarding the statute of limitations, the same analysis applies here. Indeed, the funds often do not go back to the investors but to the U.S. Treasury.

Early in the argument, Justice Alito asked a question which seemed to echo throughout the argument: Could an accounting be done, net profits determined and later give to the victims? When there was debate regarding the difficulty of applying the proposition began, Chief Justice Roberts stepped in noting essentially how hard can this be? Indeed, Justice Gorsuch noted that in class actions a procedure is routinely used to identify the victims and distribute the funds to them.

Petitioners, however, rejected the proposal of Justice Alito. That approach would essentially create a new regime to defend a remedy that has no statutory basis and is contrary to the traditional equitable principles cited by the statutes and the courts which have permitted the SEC to obtain disgorgement. Disgorgement as used by the SEC is a penalty as Kokesh held and thus not within the meaning of the language incorporated into the statutes. Despite this contention Justice Ginsburg repeatedly questions the application of Kokesh in this case.

Respondent: Counsel for the Commission focused on two key points. First, Kokesh was decided, as Justice Ginsberg noted, in a specific context. It does not apply here.

Second, the general rule applicable should be that the Commission can recover net profits. In those instances, the agency tries to return the funds to the investors. There are, however, instances in which that is not possible. For example, in FCPA cases the profits obtained from a contract secured by a bribe cannot be returned to an injured victim.

In returning the funds there should be deductions that would create a net profits kind of calculation. While the agency tries to follow this approach, it may not always be possible. Deductions should be permitted, but that does not included the costs of operating the fraud.

Discussion

The positions of the parties radically diverge – no disgorgement per the Petitioners and disgorgement of the funds a defendant obtains per the SEC. The Justices also seems to have a uniform view: Disgorgement is permitted– but what is it. During the argument there was little discussion or reference to the statutory text by the Justices. There was also no reference to legislative history of the sections involved or discussions about what Congress intended to create in terms of remedies for the SEC.

Rather, the oral argument seemed to be premised on the idea that the SEC can in fact recover disgorgement. The real question is, “What is disgorgement?” Yet Petitioners continued to focus much of their effort on the claim that the SEC is not entitled to disgorgement because it is not mentioned in the statutory text. Stated differently SEC disgorgement does not exist. The Court seemed unconvinced.

The SEC faired little better. The Commission spent a good deal of time trying to convince the Court that its remedy was not really as awful as it looked in Kokesh - another penalty were huge sums of money are demanded and frequently obtained for the U.S. Treasury before the statutory penalties get added on. Rather, the remedy precluded wrong doers from profiting from prohibited conduct. Again the Court seemed unconvinced.

Justice Alito appeared to strike the right cord for the other Justices early on by noting that disgorgement should be a net profits kind of remedy where the money is returned to the victims. While Petitioners pushed back on this, and the Commission claimed that is what it tries to do but cannot always, the Court may well have coalesced around the remark of Chief Justice Roberts stating essentially how hard can that be?

The Chief Justice is clearly right. In many cases the SEC states how much money the defendants raised or obtained in its complaint as well as what is left. Surely whatever reasonable, appropriate expenses were incurred can be estimated and deducted. While the issue can appear difficult in matters such as insider trading actions in fact it is not. There the corporate insider who breaches his or her duty to the company to obtain the trading profits; the company and its shareholders should receive the profits. If the trading is based on a misappropriation theory, then the profits can go to the owner of the information.

It is always hazardous to project the outcome of a Supreme Court action based on oral argument. In this case, however, the Court seemed to be searching for a practical way to extract the ill-gotten gains from the wrongdoer while fashioning a way to return the funds to those wronged. In Liu the question should be straight forward – the investors who contributed the money through the EB-5 program should be awarded the funds after appropriate deductions. The decision is due by June 30, 2020.

 

Firm Highlights

Insights

EPA Limits Title V Re-Litigation of NSR Permits

Overview On September 25, 2026, the U.S. Environmental Protection Agency (“EPA”) published a final rule that significantly limits the ability of third parties to use the Clean Air Act (“CAA”) Title V permitting process to revisit New Source Review (“NSR”) permitting decisions years after those decisions were made. The rule establishes that NSR permitting determinations generally must be challenged during the original permitting proceeding, thereby providing regulated sources with greater permitting certainty and finality for major capital projects. Published in the Federal Register titled Clarifying the Scope of “Applicable Requirements” Under State Operating Permit Programs and the Federal Operating Permit Program (Docket ID No. EPA-HQ-OAR-2023-0401), the rule amends 40 C.F.R. Parts 70 and 71 to codify EPA’s interpretation regarding when requirements established under other CAA programs may be reviewed, modified, or implemented through the Title V operating permit program. The rule becomes effective 30 days after publication. The rule addresses two principal issues: (1) the relationship between NSR preconstruction permitting and Title V operating permits, and (2) the treatment of the General Duty Clause under CAA section 112(r)(1). Most significantly, the rule provides greater certainty for sources navigating the NSR permitting process. EPA’s amendments are intended to ensure that NSR permitting decisions made through an approved public process are generally not revisited later through Title V permit proceedings. The rule responds to a circuit split between the U.S. Courts of Appeals for the Fifth and Tenth Circuits. In Environmental Integrity Project v. EPA, 969 F.3d 529 (5th Cir. 2020), the Fifth Circuit upheld EPA’s interpretation, concluding that it was consistent with the text, structure, and purpose of Title V. In contrast, the Tenth Circuit reached the opposite conclusion in Sierra Club v. EPA, 964 F.3d 882 (10th Cir. 2020), finding that the then-existing regulatory definition of “applicable requirement” did not support EPA’s position. By amending the regulatory language on which the Tenth Circuit relied and codifying the interpretation approved by the Fifth Circuit, EPA has established a nationwide framework governing the interaction between NSR and Title V. NSR and Title V: EPA Establishes a Uniform Nationwide Framework At the core of the rule is EPA’s effort to define the respective roles of NSR and Title V. The rule codifies the approach EPA has applied since 2017: once a source obtains an NSR permit under an EPA-approved permitting program, and that permit was issued following public notice with an opportunity for comment and judicial review, the permit establishes the NSR-related “applicable requirements” of the State Implementation Plan (“SIP”) or Federal Implementation Plan (“FIP”) for Title V purposes. Under this framework, Title V is not a vehicle for re-examining underlying NSR permitting decisions. EPA does not intend to use the Title V process to revisit applicability determinations, emissions calculations, control technology determinations, permit conditions, or other issues resolved through the NSR permitting process. This principle applies regardless of the stage of the Title V proceeding; whether the NSR permit was issued pursuant to a SIP or FIP; the type of NSR issue involved; or whether the NSR permit is incorporated into Title V sequentially or concurrently. Limited Exceptions EPA recognizes several circumstances in which NSR issues may still be reviewed through the Title V program: No NSR permit was issued at all; The permit was issued without public notice and an opportunity for comment and judicial review; or The issue involves substantive overlap between Title V and NSR requirements, such as the adequacy of monitoring provisions. As a result, the rule does not insulate unpermitted projects or foreclose review of matters that independently arise under Title V. Key Regulatory Amendments The rule revises the definition of “applicable requirement” in 40 C.F.R. §§ 70.2 and 71.2. Paragraph (1): Where an NSR permit is issued with public notice and an opportunity for comment and judicial review, the permit establishes and defines the applicable SIP or FIP requirements for Title V purposes. Paragraph (2): All NSR permit terms, including terms contained in minor NSR permits, constitute applicable requirements that must be incorporated into Title V permits. Paragraph (4): CAA section 112(r)(1) (the General Duty Clause) is expressly excluded from the definition of “applicable requirement,” while section 112(r)(7) Risk Management Program requirements remain included. EPA also amended 40 C.F.R. §§ 70.8 and 70.12 to clarify that alleged defects in requirements established outside the Title V process generally do not provide a basis for EPA objection to a Title V permit or for a Title V citizen petition. General Duty Clause Exclusion The rule also codifies EPA’s longstanding position that the General Duty Clause in CAA section 112(r)(1) is not an “applicable requirement” for Title V purposes. EPA points to several considerations supporting that conclusion, including the distinction between the General Duty Clause and Title V permit terms, the provision’s origins in the Occupational Safety and Health Act’s general duty clause, and the different enforcement structures applicable to the General Duty Clause and Title V permit requirements. Importantly, excluding section 112(r)(1) from the definition of “applicable requirement” does not eliminate EPA’s authority to enforce the General Duty Clause independently of the Title V program. The final rule instead clarifies that the General Duty Clause need not—and should not—be incorporated into Title V permits as an applicable requirement. Practical Implications for Regulated Sources Greater Finality for NSR Permits  For projects requiring PSD, nonattainment NSR, or minor NSR permits, the permitting process becomes the primary forum for resolving disputes regarding applicability determinations, emissions calculations, control technology requirements, offsets, and permit conditions. Once an NSR permit is issued through a qualifying public process, regulated sources should face substantially reduced risk that those same issues will be challenged years later through Title V permit proceedings. Reduced Risk of Collateral Permit Challenges Stakeholders have sometimes sought to use Title V permit issuance, renewal, revision, or citizen-petition proceedings to challenge underlying NSR determinations. The final rule makes clear that Title V is not the appropriate vehicle for challenging whether an applicable requirement was correctly established in the first instance. This should reduce the risk of permit delays and uncertainty associated with collateral challenges to previously issued NSR permits. The rule does not, however, eliminate all Title V challenges relating to an NSR permit. Challenges concerning the Title V permit itself—including whether it appropriately incorporates applicable requirements or contains adequate compliance provisions—remain possible. Increased Importance of the Initial NSR Proceeding Because Title V generally will not provide a second opportunity to challenge the substantive validity of an NSR determination, the administrative record developed during the NSR process becomes increasingly important. Permit applicants should ensure that applicability analyses, emissions calculations, control technology evaluations, modeling demonstrations, and supporting technical documentation are thoroughly developed during the original permitting proceeding. For significant projects, applicants may therefore have an additional incentive to identify and resolve potential permitting issues before the NSR permit is issued rather than assuming that unresolved issues can be addressed during a subsequent Title V proceeding. Potential Incentive for Broader Public Participation EPA also notes that permitting authorities may choose to provide public notice and an opportunity for comment for a broader range of NSR permits because permits issued through a qualifying public process receive the benefit of the finality framework established by the rule. Some permitting authorities may conclude that greater public participation at the NSR stage is preferable to uncertainty during subsequent Title V proceedings. Conclusion The final rule is principally a permitting-certainty measure. For sources that obtain NSR permits through a public process, EPA has substantially limited the ability of third parties to revisit underlying NSR determinations through the Title V program. As a result, regulated entities should benefit from greater finality regarding key permitting decisions, reduced risk of collateral permit challenges, and increased certainty when planning and implementing capital projects.

Insights

Energy Law: Month in Review - September 2026

Welcome to Dorsey’s Energy Law: Month in Review. We provide this update to our clients to identify significant developments in the previous month. Please reach out to any of the authors, listed above, to discuss these issues. Regulatory Developments Massachusetts Ratchets Up State and Local Regulation of AI Data Centers In early September, Governor Maura Healey of Massachusetts signed an executive order requiring that artificial intelligence data centers secure the approval of local communities as a precondition to proceeding with a given project. According to the terms of the order, data center developers will need to secure a “community benefits agreement” as a precondition to receiving permits from numerous state agencies, including the Department of Environmental Protection, the Energy Facilities Siting Board, and the Massachusetts Environmental Policy Act Office. Beyond requiring community benefits agreements, the order also mandates that developers mitigate utility costs to consumers, prohibits the use of nondisclosure agreements, and requires various state agencies to develop measures to limit data center impacts on the environment. North Carolina Regulators Decline Approval of Duke Energy Gas Turbine On September 18, 2026, North Carolina Utilities Commission (NCUC) denied Duke Energy’s application for a certificate of public convenience and necessity required to construct a gas-fueled combustion turbine at its Smith Energy Complex in North Carolina. The NCUC objected strongly to the $584 million price tag and noted that Duke appeared to be constructing the facility “based on anticipated data center customer additions.” The NCUC rejected that anticipated growth as “insufficiently reliable for the Commission to act at this point.” In rejecting Duke’s application, the NCUC also noted that Duke had signed the White House Ratepayer Protection Pledge, in which it represented that it would not shift data center costs to consumers. The NCUC observed that the record did not demonstrate how Duke “intends to adhere to its commitments under the Ratepayer Protection Pledge with regard to the Proposed Facility.” Notably, commission staff had actually supported the construction of the turbine, citing concerns about Duke’s reserve margins. The NCUC noted that it “understands the Public Staff’s expressed concerns,” but those concerns were outweighed by the NCUC’s reservations, including questions of demand. Department of Energy Approves Funds for Grid Improvement The U.S. Department of Energy (DOE) recently announced that it would fund 31 grid-improvement projects in 26 states. The funding initiative is part of the DOE’s “SPARK” initiative. The funding will include $1.9 billion in federal funding from DOE and $3.35 billion in recipient cost-sharing funding. The funds will go to projects designed to improve grid reliability and lower electricity costs. Recipients plan to reconductor over 1,500 miles of transmission lines and will deploy grid-enhancing technologies across approximately 21,000 miles. DOE stated that this initiative will make available over 23 additional gigawatts of electricity. Texas Moderates Rules Governing Data Center Interconnection The Texas Public Utility Commission adopted new regulations governing large-load interconnections. The rules impose a flat study fee of $100,000 for all proposed interconnections, which departs from the initial proposal to impose study fees using a tiered system based on project size. Additionally, the final rule eliminates the PUC’s previous proposal to impose a non-refundable interconnection fee of $50,000 per MW of contracted peak demand. The final rule also moderates the initially proposed regulations governing Electric Reliability Council of Texas (ERCOT) notifications for large-load customers’ non-utilized capacity. The proposed rules would have required notifying ERCOT within 30 days of missing a scheduled energization milestone by six months. The final rules, however, do not require informing ERCOT unless a scheduled energization milestone is missed by 24 months. FERC Denies TransAlta 202(c) Cost-Recovery Plan The Federal Energy Regulatory Commission (FERC) recently rejected TransAlta’s plan to recover $19.9 million in expenses stemming from a DOE order in which DOE prohibited TransAlta from retiring its coal-powered Centralia power plant. TransAlta had previously intended to retire the facility at the end of 2025. TransAlta’s cost recovery plan proposed spending an additional $23 million on repairs to continue operating the unit. FERC’s main objection had to do with geographic scope. TransAlta’s recovery plan called for recovering costs from California Independent System Operator (CAISO) and the Southwest Power Pool (SPP), but the DOE’s order requiring operation of the plant was designed to ensure reliability in the Northwest assessment area (Montana, Oregon, Washington, and parts of northern California and northern Idaho). Accordingly, FERC was unwilling to allow cost recovery from CAISO and SPP when the order that precipitated the additional costs only related to the Northwest assessment area. FERC informed TransAlta that it would only approve cost recovery from load-serving entities in the Northwest assessment area. FERC’s decision comes amid a rush of DOE emergency orders requiring the continued operation of coal-fired generating units. Litigation Appeals Court Upholds Washington Hydropower Plant With Caveats In a September 21, 2026, opinion, the Washington Court of Appeals largely upheld a Clean Water Act water quality certification by the Washington Department of Ecology for the Goldendale Energy Storage Project, a proposed pumped-water storage hydropower system adjacent to, but off-stream from, the Columbia River. A nonprofit (Columbia Riverkeeper) and the Confederated Tribes and Bands of the Yakama Nation appealed the certification, contending that it failed to impose necessary conditions and monitoring requirements to protect the water quality of the Columbia River. Most saliently, the plaintiffs argued that the project had the potential to leak 100 acre-feet of water per year into tributaries of the Columbia River. The Court of Appeals broadly rejected plaintiffs’ challenge to the state’s conclusion that “the project was designed not to leak.” That said, the Court of Appeals did reverse on one narrow issue. Specifically, the court determined that the state’s conclusion that “leakage from the project’s tunnels would be monitored and reported” was not supported by the evidence because the certification “does not explicitly require monitoring and reporting to determine whether there is any leakage.” Accordingly, the court remanded the matter to the state to impose monitoring and reporting requirements but otherwise affirmed the certification. Legislative Developments California Legislates Restrictions on Data Center Energy Use and Grid Costs On September 21, 2026, California Governor Gavin Newsom signed seven bills broadly regulating data centers in the state. SB 1168 directed the California Public Utilities Commission to assess the energy used by data centers. It also requires the PUC to pass costs of transmission and distribution upgrades and load increases on to data centers, rather than customers. SB 886 and SB 887 compel data centers to pay for infrastructure upgrade and generation costs, and wildfire mitigation costs, in addition to imposing environmental review. The statutes additionally increase local oversight of data centers. AB 1577 imposes a monthly reporting requirement that requires data centers to supply energy consumption and efficiency data to the California Energy Commission. AB 2383 contains incentives for data centers to use onsite clean energy generation. Finally, AB 2469 and AB 2619 require data center developments to assess water supply and develop a water scarcity plan. The statutes also mandate statewide water reporting as a precondition to obtaining and renewing business licenses.

Insights

SEC Proposes Expansion of Investment Adviser Performance-Based Compensation Rule

On September 30, 2026, the Securities and Exchange Commission (the “SEC”) proposed amendments to Rule 205-3 under the Investment Advisers Act of 1940, as amended (the “Advisers Act”), which provides an exemption from the general prohibition under Section 205(a)(1) of the Advisers Act on registered investment advisers receiving performance-based compensation (the “Proposal”) so long as performance-based compensation is limited to “qualified clients”.1 Most notably for private fund sponsors, the Proposal would expand the definition of “qualified client” to include any investors that satisfy the “accredited investor” definition under Regulation D. The Proposal may also have implications for private fund managers that rely on exemptions from investment adviser registration under state law because certain state-level investment adviser registration exemptions incorporate or otherwise reference the federal qualified client definition. Expansion of the Qualified Client Definition Under the current Rule 205-3, an investor generally may qualify as a qualified client if, among other alternatives, the investor has at least $1.4 million under management with the adviser or has a net worth exceeding $2.7 million. These thresholds are higher than the financial thresholds applicable to many accredited investors under Regulation D. As a result, an investor may currently qualify as an accredited investor for purposes of investing in a private offering without qualifying as a qualified client for purposes of paying performance-based compensation. The Proposal would expand the qualified client definition to include any natural person or legal entity investor that satisfies the accredited investor definition under Regulation D. The Proposal would also remove the assets under management and net worth thresholds under the current Rule 205-3 qualified client test. For private funds relying on Section 3(c)(1) of the Investment Company Act of 1940, this change could reduce the need to apply a separate qualified client standard to investors that already qualify as accredited investors. Dorsey Observations and Next Steps If adopted as proposed, the expanded qualified client definition could be particularly significant for private fund managers. Most private fund offerings are already limited to accredited investors under Regulation D. However, the Proposal could expand the pool of prospective investors available to emerging private fund managers while reducing the regulatory burden associated with complying with Rule 205-3. The Proposal could also benefit advisers operating below the SEC registration threshold that rely on a state private fund adviser exemption. A number of states have adopted exemptions modeled on the North American Securities Administrators Association (“NASAA”) private fund adviser exemption, which may condition relief for advisers to certain funds relying on Section 3(c)(1) on each beneficial owner satisfying the federal qualified client definition. However, state requirements vary, and any effect of the Proposal would depend on the text of the applicable state exemption and how it incorporates Rule 205-3. Many emerging private fund managers may have a larger network of accredited investor relationships than qualified client relationships during the early stages of their investment advisory business. Currently, under Rule 205-3, private fund managers may receive performance-based compensation from investors who do not satisfy the qualified client definition if those investors were admitted to their private funds prior to registration with the SEC. Following registration with the SEC, however, managers may continue to permit investors that are not qualified clients to invest in future private funds but may not receive performance-based compensation from those investors with respect to such investments. In addition, because the net worth and assets under management thresholds for qualified client status are adjusted for inflation every five years, the pool of qualified client investors may diminish over time as previously eligible investors no longer satisfy the applicable thresholds. The Proposal could provide the dual benefit of greater flexibility for private fund managers to establish and maintain relationships with accredited investors as their businesses scale and they become registered with the SEC, and greater flexibility for certain accredited investors to participate in investment strategies that historically have been restricted to much larger institutional investors. Unless and until the Proposal is adopted, investment advisers should continue to comply with the existing qualified client requirements. If the Proposal is adopted, private fund sponsors should consider whether corresponding changes are appropriate for their subscription documents, investor questionnaires, and other offering materials. Advisers that are state-registered or rely on a state-level exemption should also consult the laws and regulations of each relevant jurisdiction before changing investor eligibility standards or performance-based compensation practices, because adoption of the federal amendments may not automatically modify state requirements. Comments on the Proposal will be due 60 days after publication in the Federal Register. 1 Investment Adviser Performance-Based Compensation Modernization, Investment Advisers Act Release No. IA-7022 (Sept. 30, 2026), available at https://www.sec.gov/rules-regulations/2026/09/s7-2026-28#33-11443proposed.

Insights

The Supreme Court Update - October 8, 2026

On September 29, 2026, the Supreme Court granted certiorari in one case: Department of Homeland Security v. D.V.D., No. 26-426: This case concerns the Trump Administration’s “third-country removal” procedures, where immigrants are deported to countries not listed in the removal orders. In granting certiorari, the Court granted the Government’s application to stay a lower court decision halting the practice, which will allow third-country removals to continue pending resolution of the case. The issues presented are: (1) Whether the district court had jurisdiction over respondents’ claims; (2) whether the district court had authority to enter class-wide declaratory relief and APA vacatur under 8 U.S.C. § 1252(f)(1); (3) whether the Government’s guidance on third-country removals is unlawful under 8 U.S.C. § 1231(b), the due process clause, or FARRA/CAT and its implementing regulations; and (4) such other questions that the Government determines are appropriate for the proper disposition of the case. On October 1, 2026, the Court granted certiorari in three additional cases: Rhoney v. Barbosa da Cunha, No. 26-104: Immigration officials detained Ricardo Aparecido Barbosa da Cunha—a Brazilian citizen who had lived in the United States for approximately twenty years after entering without inspection—and denied him a bond hearing under 8 U.S.C. § 1225(b)(2)(A). The Second Circuit held that his detention was instead governed by § 1226(a), which permits release on bond, because § 1225(b)(2)(A)’s mandatory-detention requirement applies only to noncitizens apprehended while entering the country or shortly thereafter. The question presented is: Whether 8 U.S.C. § 1225(b)(2)(A) mandates the detention pending removal proceedings of aliens who, like Barbosa da Cunha, are present in the United States without having been admitted. Missionaries of St. John the Baptist, Inc. v. Frederic, No. 25-113: A Catholic religious organization sought to build a shrine to the Virgin Mary on land the organization owned adjacent to its church in Park Hills, Kentucky. Local zoning restrictions prohibited the proposed construction. The question presented is: Whether a land-use regulation that prohibits a religious institution from building a religious structure on its own property constitutes a “substantial burden” on religious exercise under the Substantial Burden Provision of the Religious Land Use and Institutionalized Persons Act, 42 U.S.C. § 2000cc(a). Marschner v. Marschner, No. 25-1349: Under the Uniformed Services Former Spouses’ Protection Act (“USFSPA”), a veteran’s longevity-based retirement pay can be divided in a divorce, but retirement pay based on disability and retirement pay that was waived to receive disability pay are indivisible. The question presented is: Does the USFSPA require state courts to refuse enforcement of indemnification provisions in a divorce settlement agreement?