Earlier this week, we published the first in a two-part series concerning the recently enacted National Defense Authorization Act of 2021 (the “NDAA”). Our first article, which can be found here, examines the provisions of the NDAA impacting anti-money laundering laws under the Bank Secrecy Act. Today’s installment focuses on Section 6501 of the NDAA, which contains amendments to the Securities Exchange Act of 1934 (the “Exchange Act”) that enhance the SEC’s ability to obtain disgorgement. These amendments—most notably doubling the statute of limitations for SEC disgorgement claims from five to ten years for scienter-based violations—follow in the wake of Kokesh v. SEC, 137 S. Ct 1635 (2017) and Liu v. SEC, 140 S. Ct. 1936 (2020), two recent Supreme Court decisions widely viewed as curtailing the SEC’s disgorgement power.
The key amendments to the Exchange Act in Section 6501 include:
- Providing the SEC with express statutory authority to pursue disgorgement in federal court.
- Extending the statutory limitation period to ten years for scienter-based securities laws violations.
- Tolling the statute of limitations period for any disgorgement claim when such claim is brought against a person outside of the United States.
Kokesh and Liu Overview
Beginning in the 1970s, federal courts regularly ordered defendants in SEC enforcement actions to disgorge their ill-gotten gains. Although there was no express statutory authorization to order such relief, courts relied on their power to order equitable relief ancillary to an injunction.
Although largely unquestioned for decades, the Supreme Court started to apply the brakes in 2017. That year, Kokesh held that disgorgement was a “penalty” and, as such, was subject to a five-year statute of limitations. In a footnote, Kokesh expressly left open the question of whether the SEC and the courts had the authority—at all—to seek and impose disgorgement. Kokesh had real-world ramifications on the SEC’s capacity to pursue disgorgement. In 2019, for example, the SEC’s Division of Enforcement estimated that the Supreme Court’s holding “caused the Commission to forgo approximately $1.1 billion in disgorgement in filed cases.”
In 2019, the Supreme Court granted certiorari in Liu, expressly teeing up the question left open in Kokesh—whether the SEC had any power to obtain disgorgement. Despite predictions to the contrary, the Liu Court held that courts could impose disgorgement pursuant to their power to order “equitable relief” under Section 21(d) of the Exchange Act. The Justices, however, held that a court’s power was not without limits, stating that disgorgement orders must be tethered “to a wrongdoer’s net unlawful profits” and that those ill-gotten gains must be awarded to victims, not the federal fisc. The Court also noted that there are significant limits to requiring a defendant to disgorge profits accrued by his affiliate under a theory of joint-and-several liability and indicated that legitimate expenses should be deducted before imposing disgorgement.
The Exchange Act Amendments under Section 6501 of the NDAA
The amendments to Section 21(d) of the Exchange Act embedded in Section 6501 of the NDAA are a culmination of years of lobbying by the SEC, including by former Chairman Jay Clayton, and certain members of Congress to overturn Kokesh. The Section 6501 amendments—which apply to actions pending or commenced after January 1, 2021—are significant for at least three reasons.
First, Section 6501—for the first time—expressly authorizes by statute the SEC’s ability to seek, and a federal court’s power to order, disgorgement. Although Liu somewhat cautiously held that disgorgement was permissible under a court’s authority to order equitable relief, Section 6501 now constitutes an independent, statutory basis under which the SEC may request disgorgement in federal court proceedings.
Second, Section 6501 distinguishes scienter-based and non-scienter-based securities law violations for statute-of-limitations purposes. For scienter-based violations—including the fraud provisions of section 10(b) of the Exchange Act and section 17(a)(1) of the Securities Act of 1933—Section 6501 of the NDAA now permits the SEC to bring a claim of disgorgement “not later than 10 years after the latest violation that gives rise to the action.” This amendment to section 21(d)(8) of the Exchange Act doubles the limitations period allowed under Kokesh. For non-scienter-based securities laws violations, the applicable limitations period remains at five years. Notably, for remedies other than disgorgement, including “an injunction, or for a bar, suspension or cease-and-desist order,” Section 6501 states that the statute-of-limitations for those remedies shall be ten years regardless of the underlying securities law violation.
Third, Section 6501 provides for a tolling period of the statute of limitations for any disgorgement claim where “the person against which the action or claim, as applicable, is brought is outside the United States.”
The enactment of Section 6501 of the NDAA cements—indeed augments—the SEC’s authority to obtain disgorgement from would be violators of the federal securities laws. For the most serious, intentional fraud-based crimes, the SEC’s disgorgement claims can extend back as far as ten years, restoring the SEC’s pre-Kokesh power to recoup ill-gotten gains that go back farther in time. We expect that this amendment to the Exchange Act will embolden the SEC to aggressively pursue disgorgement in 2021 and beyond, giving the Commission further leverage over civil defendants in settlement negotiations and in litigation before the federal courts.
What remains to be seen is whether the court-imposed limitations to disgorgement discussed in Liu will survive the amended statute. Notably, in drafting the amendment, Congress appears to have sought to distinguish between “disgorgement” and “civil money penalties.” We anticipate Liu’s continued relevance, including whether disgorgement (i) is limited to net profits; (ii) must be earmarked for victims; (iii) can be imposed on a joint-and-several liability basis; and (iv) must be offset by legitimate expenses will continue to percolate in the courts in the years to come.
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