On January 1, 2021, Congress overrode President Trump’s veto to enact the 2021 National Defense Authorization Act (NDAA) into law. A somewhat surprising inclusion in the NDAA is a provision amending Section 21(d) of the Securities Exchange Act of 1934 (Exchange Act).1 These amendments specifically authorize for the first time the Securities and Exchange Commission (SEC) to seek disgorgement in federal court actions and extend from 5 to 10 years the period in which the SEC may bring disgorgement claims for violations of scienter based provisions of the securities laws.2 The amendments similarly provide a 10-year period for the SEC to bring claims for any equitable remedy.3 The NDAA promises to enhance the SEC’s ability and incentive to aggressively pursue enforcement actions addressing historical misconduct.
Traditionally, federal courts allowed the SEC to obtain disgorgement based on the availability of general equitable relief under Exchange Act Section 21(d)(5), even though the Exchange Act only gave the SEC express authority to seek disgorgement in administrative proceedings. In recent years, however, the US Supreme Court limited the SEC’s disgorgement power. In 2017, the Court held in Kokesh v. SEC that disgorgement in SEC actions is a penalty for statute of limitations purposes and is therefore subject to the 5-year statute of limitations for civil penalties in 28 U.S.C. § 2462.4 The SEC Division of Enforcement noted in its 2019 Annual Report that the Kokesh decision adversely impacted the SEC’s “ability to disgorge and return funds to investors injured by long running frauds.”5 The Division estimated that the Kokesh ruling caused the SEC “to forgo approximately $1.1 billion in disgorgement in filed cases.”6 It also noted that the actual impact was likely far greater because the Division was forced to shift resources to investigations with “the most promise for returning funds to investors,” thus raising the possibility that some investigations that, due to their timing or nature, were less likely to result in disgorgement remedies might not be adequately staffed or even completed at all.7
More recently, in June 2020, the Supreme Court decided Liu v. SEC, upholding the ability of the SEC to obtain disgorgement in federal court enforcement actions as a form of “equitable relief” under Section 21(d)(5).8 However, in Liu, the Court further limited the SEC’s ability to obtain disgorgement.9 The Court held that disgorgement could not exceed an individual wrongdoer’s illicit net profits and that courts must deduct legitimate expenses before ordering disgorgement.10 The Court also warned that disgorgement should not be imposed on a wrongdoer to recover benefits that accrue to his or her affiliates through joint-and-several liability except perhaps when they are partners engaged in concerted wrongdoing.11 The Court further stated that disgorgement should be returned to victims.12
The newly enacted NDAA, however, now formally provides the SEC express statutory authority to seek disgorgement in federal court actions. Specifically, the SEC can collect disgorgement of any unjust enrichment by a person who received the unjust enrichment as a result of a violation of any provision of the securities laws.13 Additionally, the NDAA also expressly addresses the Supreme Court’s decision in Kokesh by extending the statute of limitations for SEC disgorgement claims to 10 years for violations involving conduct that violates any scienter-based provision of the securities laws, including Exchange Act Section 10(b), Section 17(a)(1) of the Securities Act of 1933 and Section 206(1) of the Investment Advisers Act of 1940.14 The NDAA applies a 5-year statute of limitations for other SEC disgorgement claims.15 Finally, the NDAA sets the statute of limitations to 10 years for all equitable remedies sought by the SEC, including injunctions, bars, suspensions and cease and desist orders.
The NDAA secures one of the Commission’s most useful legal remedies and doubles the time period in which it may seek that remedy in cases involving scienter. Indeed, in the 2020 fiscal year, the SEC collected $3.6 billion in disgorgement. It is important to note, however, that even after the NDAA, some uncertainty remains about the scope of the SEC’s ability to obtain disgorgement. The limitations on SEC disgorgement articulated by the Supreme Court in Liu were based, at least in part, on the statutory language of Exchange Act Section 21(d)(5). The degree to which those limitations still apply in light of the NDAA will likely be clarified in subsequent judicial decisions.
After passage of the NDAA, the stakes are now higher for entities and individuals facing SEC action, particularly in cases involving allegations of long-running frauds or other types of historical misconduct. In matters involving alleged misconduct more than 5 years old, the SEC now has a strong incentive to charge violations of scienter based provisions of the securities laws in order to potentially recover disgorgement. This may lead to longer investigations as the SEC searches for evidence of fraud and complicate efforts to reach a settled resolution. Moreover, the NDAA removes uncertainty as to when the SEC may bring claims for equitable relief such as injunctions, bars, suspensions and cease and desist orders by specifying a 10-year statute of limitation applicable to such claims. Thus, the SEC may be more inclined to bring actions seeking such equitable relief even if civil penalties are time-barred and disgorgement is not otherwise available based on the facts of a particular matter. In short, the NDAA may lead the SEC to investigate, charge, litigate and negotiate settlements more aggressively.
Additional Mayer Brown Legal Updates on the NDAA:
- The US National Defense Authorization Act for Fiscal Year 2021: What Financial Services Companies Need to Know (Disgorgement is discussed on page 7.)
- The US National Defense Authorization Act for Fiscal Year 2021: Procurement Policy and Requirements
5 SEC Division of Enforcement 2019 Annual Report at 21, www.sec.gov/files/enforcement-annual-report-2019.pdf.