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Posted: February 24, 2014

First Department Rules That Disgorgement May Be Available As An Equitable Remedy For Attorney General Claims Under Martin Act and Executive Law

On February 20, 2014, the First Department issued a decision in People v. Ernst & Young, LLP, 2014 NY Slip Op. 01257, reversing New York County Commercial Division Justice Jeffrey K. Oing’s dismissal of the New York Attorney General’s claims under the Martin Act and New York’s Executive Law for disgorgement of profits earned by Ernst & Young in allegedly facilitating an accounting fraud by its client Lehman Brothers.

In urging dismissal of the disgorgement claim, Ernst & Young argued that the Martin Act and the Executive Law provide for particular remedies—namely, injunctive relief, restitution and cancellation of a business certificate—and that disgorgement, which is not mentioned in the statutes, is not an available form a relief. It also argued that disgorgement could be duplicative of restitutionary relief that might be obtained in a class action settlement. The First Department rejected these arguments and concluded that:

where, as here, there is a claim based on fraudulent activity, disgorgement may be available as an equitable remedy, notwithstanding the absence of loss to individuals or independent claims for restitution . . . . Disgorgement is distinct from the remedy of restitution because it focuses on the gain to the wrongdoer as opposed to the loss to the victim. Thus, disgorgement aims to deter wrongdoing by preventing the wrongdoer from retaining ill-gotten gains from fraudulent conduct. Accordingly, the remedy of disgorgement does not require a showing or allegation of direct losses to consumers or the public; the source of the ill-gotten gains is “immaterial.” Therefore, while the Attorney General does not allege direct injury to the public or consumers as a result of defendant’s alleged collusion with Lehman Brothers in committing fraud, the equitable remedy of disgorgement is available in this action, and it was premature to categorically preclude it at the pleading stage. Nor would ordering disgorgement be tantamount to an impermissible penalty, since the “wrongdoer who is deprived of an illicit gain is ideally left in the position he would have occupied had there been no misconduct.” We further note that maintaining disgorgement as a remedy within the court’s equitable powers is crucial, particularly where the Attorney General may be precluded from seeking restitution and damages if defendant settled the private class action against it.

This decision gives the Attorney General another potent weapon in securities and other fraud-based enforcement actions. In an earlier decision, People v. Applied Card Systems, Inc., 11 N.Y.3d 105 (2008), the Court of Appeals suggested in dicta that the Attorney General “might be able to obtain disgorgement” in a claim under the Executive Law, relying on federal cases recognizing a district court’s authority to award disgorgement “[a]s an exercise of its equity powers” in SEC enforcement actions. Id. at 125-126 (citing SEC v. Fishbach Corp., 133 F.3d 170, 175 (2d Cir. 1997) & Official Comm. Of Unsecured Creditors of WorldCom, Inc. v. SEC, 467 F.3d 73, 81 (2d Cir. 2006)). However, there is apparently no other New York appellate authority expressly recognizing the remedy in this context.

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