On January 1, 2021, the United States Senate joined the House of Representatives in overriding President Trump’s veto, and the National Defense Authorization Act (NDAA) became law. The NDAA was passed chiefly to authorize appropriations for military activities of the Department of Defense. The NDAA also includes a provision codifying the U.S. Securities and Exchange Commission’s (SEC) authority to seek in federal court actions disgorgement up to five years after the occurrence of securities laws violations, and expands that authority to ten years where those violations involve scienter-based (intentional) fraud. The new law resolves the much debated issues regarding the SEC’s disgorgement authority and the extended period during which the SEC now may seek disgorgement will have an immediate, significant impact on individuals and entities involved in SEC investigations and litigation.

Some context for the new law is useful. The provenance of the law is two Supreme Court opinions, Kokesh v. S.E.C., decided in 2017, and Liu v. S.E.C., decided in 2020. In Kokesh, the Supreme Court reviewed the SEC’s position on seeking disgorgement under Section 2462 of the United States Code (Time for Commencing Proceedings), which imposes a five year statute of limitations on civil fines, penalties, and forfeitures. The SEC argued, and the Tenth Circuit affirmed, that disgorgement did not constitute a penalty under Section 2462, and therefore no statute of limitations period applied. Kokesh v. S.E.C., 137 S. Ct. 1635, 1641 (2017). The Supreme Court reversed and held that disgorgement sought by the SEC in an enforcement action is subject to a five-year statute of limitations. The Supreme Court found that federal courts ordered disgorgement as a consequence of violating public law and treated the violation as an offense against the United States with disgorged funds being paid to the Treasury rather than to an individual. The Court concluded that disgorgement functioned as a penalty rather than a remedial tool, therefore subjecting it to the five-year statute of limitations under Section 2462. However, the Court clarified that this holding should not be interpreted as “an opinion on whether courts possess the authority to order disgorgement in SEC enforcement proceedings.” Kokesh, 137 S. Ct. 1642 (fn. 3).

Next came Liu. In Liu, the Court answered the question left unanswered by the Supreme Court in Kokesh, holding that disgorgement, properly tailored, was not a penalty but rather an equitable remedy under Section 21(d)(5) of the Securities Exchange Act (Investigations and Actions; Equitable Relief). Liu v. S.E.C., 140 S. Ct. 1946 (2020). Therefore, the SEC could seek disgorgement as a remedy in civil enforcement actions. However, consistent with disgorgement’s character as an equitable remedy, the Court limited the SEC’s ability to seek disgorgement to recover net profits from wrongdoers and that the disgorged funds be returned to the victims of the fraud.  Liu, 140 S. Ct. at 1940-1942. The Court left for the lower courts to sort out (1) what constituted “net profits,” (2) whether joint and several liability for disgorgement is prohibited, given the general rule against joint and several liability at equity, and (3) to what extent disgorgement could be paid into the Treasury, as opposed to being returned to victims in instances where victims are not easily identified. Further, the Court did not address whether disgorgement properly tailored to meet these limitations was subject to the five-year statute of limitations in Kokesh.

Now Congress. Section 6501 (Investigations and Prosecution of Offenses for Violations of the Securities Laws) of the NDAA amends Section 21(d) of the Securities Exchange Act and expressly authorizes the SEC to seek disgorgement in any federal court proceeding brought under any provision of the securities laws and resolves any lingering question over the time period in which it must do so. The new law provides that the SEC may bring a claim for disgorgement within five years of the latest date of the violation which gives rise to the action, and then goes one step further by extending the limitations period to ten years if the underlying conduct involved scienter-based fraud under the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Advisors Act of 1940, and any other statute under the securities laws for which scienter must be established. While the SEC’s authority and timing on disgorgement is clear, the statute is silent on the scope of disgorgement and the manner in which the SEC may seek it. Thus, it remains to be seen whether the SEC will have to abide by the limitations the Court imposed in Liu.

The ten-year limitations period also applies to actions with respect to other “equitable remedies,” such as injunctions, bars and suspensions. While the statute includes injunctions, bars, and suspensions as equitable remedies, similar to disgorgement, this too has been an area of dispute with some courts finding that under certain circumstances these remedies are not equitable, but instead constitute penalties and therefore subject to the five year statute under Section 2462 as set forth in Kokesh. It is not clear whether the statute by itself resolves the issue, but for sure the SEC will have at most 10 years to seek this kind of relief.

What Does This Mean?

The newly conferred authority will have an immediate impact on both SEC investigations and settlements as the amendments apply to “any action or proceeding that is pending on, or commenced on or after, the date of enactments.” Companies and individuals can expect the SEC to be aggressive first in determining to pursue investigations with older conduct, and then also in defining the initial scope and time-periods of those investigations. The SEC also may be reluctant to pare down broad requests for documents and information at the inception of those investigations. Furthermore, the SEC may be less flexible in resolving matters without scienter-based charges in order to obtain disgorgement of ill-gotten gains from conduct dating up to ten years old, as well as in imposing other equitable remedies at its disposal.

Further, given the disgorgement limitations imposed in Liu, companies, individuals, and litigants still can expect to expend considerable investigative resources in seeking to apply those limitations, and even potentially having to seek judicial intervention to enforce them. Finally, the industry can expect litigation over when exactly the limitations period begins to run (what exactly is the “latest date of the violation which gives rise to the action”) and the penal v. equitable nature of injunctions, bars, and suspensions in light of current case law.

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