NDAA Provisions
On January 1, 2021, the National Defense Authorization Act (NDAA) for Fiscal Year 2021 became law. Section 6501 of the NDAA includes amendments to the Securities Exchange Act of 1934 (the “Exchange Act”), expanding the Securities and Exchange Commission’s (the “SEC”) ability to obtain disgorgement and other equitable relief in cases involving securities fraud.
The NDAA amendments extend the statute of limitations to seek disgorgement for scienter-based violations from five years to ten years. In particular, this change applies to violations under Section 10(b) of the Exchange Act, Section 17(a)(1) of the Securities Act, and Section 2016(1) of the Investment Advisors Act. The NDAA amendments also establish a statute of limitations for equitable remedies, including injunctions, bars, suspensions, and cease-and-desist orders, to ten years.
For decades, the SEC has relied on its ability to obtain disgorgement, which requires offenders to forfeit illegally obtained profits, as one of its primary enforcement weapons. However, prior to the NDAA, the Exchange Act did not expressly authorize the SEC to obtain disgorgement as a remedy for violations of securities laws. Instead, federal courts previously allowed disgorgement as a form of equitable relief under Section 21(d) of the Exchange Act.1
Supreme Court Precedent
Prior to the passage of the NDAA, the Supreme Court limited the SEC’s ability to seek disgorgement in Kokesh2 and Liu.3 In Kokesh, a unanimous Court ruled that disgorgement amounted to a “penalty” and thus would be subject to a five-year limitations period, which is used for other civil penalties. In Kokesh, the Court did not address whether the SEC had the statutory authority to seek disgorgement, but a later decision addressed this issue.
In Liu, the Court confirmed that the SEC could seek disgorgement as a form of equitable relief but limited the SEC’s powers by stating that disgorgement must be within “the bounds of traditional equity practice.”4 The Court specified that disgorgement must be restricted so that it did not act like a punitive sanction. The Court outlined three ways that disgorgement awards historically have tested the bounds of equitable relief: (1) disgorgement was given to the Treasury instead of given to victims, (2) the SEC imposed joint-and-several disgorgement liability, and (3) the SEC declined to deduct legitimate expenses from profits. The Liu Court thus restricted disgorgement to a wrongdoer’s net profits and required that disgorgement be returned to known victims.5
Both Supreme Court decisions significantly altered the SEC’s longstanding practices and authority to seek financial fines. The Kokesh decision reportedly has cost the SEC more than a billion dollars in forgone enforcement proceedings since the decision.6 The Liu decision also restricted the SEC by minimizing its ability to seek higher fines and deposit seized funds into the U.S. Treasury.
Takeaways
The NDAA does not resolve some open questions from Liu that had previously restricted the SEC’s authority. The amendments do not address whether illegally gained profits need to be returned to harmed investors. The NDAA also does not address whether and when defendants may be held jointly and severally liable for disgorgement awards. The SEC might argue that the Liu analysis should not apply since the NDAA expressly allows disgorgement. However, the NDAA does not elaborate upon the extent of the SEC’s disgorgement abilities, and a court may find that disgorgement should still be limited by the bounds of equitable relief.
Lastly, the NDAA amendments affect investigations that are currently ongoing as well as all investigations going forward. Therefore, the SEC staff may aim to expand their focus in ongoing investigations to older conduct.
1 15 U.S.C. § 78u(d)(5).
2 Kokesh v. SEC, 137 S. Ct. 1635 (2017).
3 Liu v. SEC, 140 S. Ct. 1936 (2020).
4 Id. at 1947.
5 Id.
6 See Sec. & Exch. Comm’n, Div. of Enforcement, 2019 Annual Report at 16, available at https://www.sec.gov/files/enforcement-annual-report-2019.pdf.
