National DefenseThe recently passed defense authorization act, known as the NDAA, included amendments to the Securities Exchange Act of 1934 (the “Exchange Act”)—having nothing to do with national defense. Section 6501 of the NDAA enhances the SEC’s ability to obtain disgorgement in the wake of two recent Supreme Court cases, Kokesh v. SEC, 137 S. Ct 1635 (2017) and Liu v. SEC, 140 S. Ct. 1936 (2020), that curtailed the SEC’s ability to obtain that remedy.

Briefly, Section 6501 made the following amendments to the Exchange Act:

  • Gave the SEC statutory authority to pursue disgorgement in federal court.
  • Extended the statute of limitations for scienter-based securities law violations from five to ten years.
  • Provided for a tolling of the statute of limitations period for any disgorgement claim brought against a person outside of the United States.

Kokesh and Liu 

Despite a lack of express statutory authority, federal courts regularly ordered defendants in SEC enforcement actions to disgorge their ill-gotten gains, relying on their power to order equitable relief ancillary to an injunction.

Such orders finally gained Supreme Court scrutiny in 2017 in Kokesh. In that case, the Court held that disgorgement was a “penalty” and, as such, was subject to a five-year statute of limitations.  The Court expressly left open the question of whether the SEC and the courts had the authority to seek and impose disgorgement.  In 2019, the Supreme Court teed up that question by granting certiorari in Liu. The Liu Court agreed with the SEC that courts could impose disgorgement pursuant to their power to order “equitable relief” under Section 21(d) of the Exchange Act, but imposed limits on how the amount of disgorgement could be calculated.  The Justices held that disgorgement orders must be tethered “to a wrongdoer’s net unlawful profits,” meaning that legitimate expenses should be deducted in the calculation of a disgorgement amount. The Court also imposed limits on joint and several liability in the disgorgement context and required that disgorged amounts be returned to victims rather than to the U.S. Treasury.

The Exchange Act Amendments under Section 6501 of the NDAA

Following Kokesh, the SEC lobbied Congress to overturn that decision with legislation. While not fully overturning Kokesh, Section 6501 of the NDAA goes a long way toward meeting the SEC’s goal. It enhances the SEC’s enforcement powers in several ways:

  • It provides express statutory authority for the SEC to seek, and for federal courts to order, disgorgement.  No longer does the SEC have to rely on a court’s general authority to order equitable relief.
  • It doubles the length of the statute of limitations for the SEC to bring enforcement actions under statutes where scienter is an element of the violation. Thus, the SEC now has ten years in which to charge violations of 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 also permits the SEC to bring a claim of disgorgement “not later than 10 years after the latest violation that gives rise to the action.”
  • Alleged violators who are not in the U.S. may have to wait even longer to clear the limitations period. Section 6501 provides for tolling of the limitations period for any disgorgement claim where “the person against which the action or claim, as applicable, is brought is outside the United States.”

Implications

The Section 6501 amendments augment the SEC’s authority to obtain disgorgement, most notably for the most serious, scienter-based securities law violations. They also expand the SEC’s ability to seek and obtain disgorgement of ill-gotten gains obtained farther back in time. As a practical matter, the amendments will enable the Commission to leverage higher settlements from enforcement defendants. The amendments did not, however, address the limitations on disgorgement calculations that the Supreme Court prescribed in Liu, since in drafting the amendments Congress appears to have sought to distinguish between “disgorgement” and “civil money penalties.” Also left untouched by Section 6501 were Liu’s limitations on joint and several liability and its requirement that disgorged funds be used to compensate victims. Thus, defendants and those negotiating resolutions with the SEC still can argue, based on Liu, that disgorgement is limited to gross ill-gotten gains offset by legitimate expenses.