On December 8, 2020, the U.S. House of Representatives approved final passage of a $740.5 billion annual defense policy bill, the William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021 (“National Defense Authorization Act” or “NDAA”), by a vote of 335-78-1, a veto-proof majority. Following a filibuster on December 10, on December 11, the U.S. Senate approved the NDAA by a vote of 84-13, also a veto-proof majority. The bill now heads to the President for his signature, who has threatened a veto because the bill does not include a repeal of Section 230 of the Communications Decency Act. Passage of the NDAA marks the 60th consecutive year that the Congress has adopted this legislation, which the Chairman and Ranking Member of the Senate Armed Services Committee noted “fulfills our most important constitutional duty: to provide for the security of this nation and the men and women who lay their lives on the line to defend it.”[1] Generally, the bill sets forth Department of Defense policies and programs, includes pay raises for America’s servicemembers, modernizations for equipment and provisions to require more scrutiny before troops are withdrawn from Germany or Afghanistan. Tucked into the legislation is Section 6501, Investigations and Prosecution of Offenses for Violations of the Securities Laws, which amends Section 21(d) of the Securities Exchange Act of 1934 (the “Exchange Act”) to provide the Securities and Exchange Commission (“SEC” or “Commission”) with statutory authority to seek disgorgement as a remedy for unjust enrichment gained through a securities law violation. The provision also establishes up to a 10-year statute of limitations for disgorgement, and a 10-year statute of limitations for equitable remedies. Both measures seek to address the SEC’s long held desire to have the statutory authority to pursue ill-gotten gains in federal court.
Background
The SEC uses disgorgement to recover wrongdoers’ ill-gotten gains and often returns these funds to victims. Currently, the federal securities laws authorize the SEC to seek injunctive relief in federal district court, which has its own equitable powers to order remedies for wrongdoing. The Exchange Act, however, only explicitly provides that the SEC can obtain disgorgement as a civil remedy in administrative proceedings.[2] The Commission has nevertheless obtained disgorgement in federal courts under the “equitable relief” provision of the Exchange Act[3] in a number of proceedings, including offering frauds, Foreign Corrupt Practices Act resolutions, and settlements with regulated entities.[4]
Current Legal Precedent
In 2017, the Supreme Court held in Kokesh v. SEC that disgorgement is a punitive remedy, rather than a restorative one vis-à-vis the statute of limitations.[5] As detailed in our prior alerts, the Court found that disgorgement is a penalty and therefore subject to the five-year statute of limitations under 28 U.S.C. § 2462.[6] The Court, however, did not reach the question of whether the courts have the authority to order disgorgement in the first instance.
Just three years after Kokesh, in June 2020, the Supreme Court issued its decision in Liu v. SEC,[7] and held that disgorgement awards that do not exceed a wrongdoer’s net profits (gross profits reduced by legitimate expenses) are considered equitable relief under 15 U.S.C. § 78u(d)(f).[8] In that case, the petitioners relied heavily on Kokesh and argued that it foreclosed the SEC’s argument that its authority to seek equitable relief and injunctions justifies a disgorgement remedy.[9] Petitioners argued that disgorgement is punitive because money obtained from defendants is not always returned to victims and is, in certain cases, given to the U.S. Treasury. Accordingly, petitioners noted that disgorgement is an equitable remedy because it cannot, by its nature, restore the status quo that existed prior to the alleged wrongdoing.
Liu was considered a partial victory for the SEC. Specifically, while the Court upheld the Commission’s power to disgorge ill-gotten gains in federal court actions, it limited the recovery to the amount of net income generated from the unlawful conduct. Additionally, the Court rejected the petitioners’ argument under Kokesh that because disgorgement is treated as a penalty for the purposes of the statute of limitations, it cannot be an equitable remedy, as an equitable remedy cannot, by definition, be punitive.
Legislation as a Remedy
Although the Supreme Court has upheld the SEC’s ability to obtain disgorgement in the federal court context, there is currently no statutory provision that explicitly states that. Congress has taken several opportunities to address the issue. For example, Section 6501 of the NDAA resembles the House of Representative’s H.R. 4344, the “Investor Protection and Capital Markets Fairness Act”,[10] which passed the House in November 2019 by a vote of 314-95 and was endorsed by SEC Chairman Jay Clayton, who has not been shy about his frustration with the Kokesh decision. The bill sought to give the SEC 14 years to pursue disgorgement in federal court, but still remains before the Senate’s Committee on Banking, Housing, and Urban Affairs.[11] Similarly, the Senate’s legislation , S. 799, the “Securities Fraud Enforcement and Investor Compensation Act”, sought a 10-year statute of limitations.[12] Like the House bill, S. 799 remains before the Senate Committee on Banking, Housing, and Urban Affairs.[13] The inclusion of Section 6501 in the NDAA effectively ends the consideration of the stand-alone bills introduced to address Kokesh, which will nevertheless expire at the end of the 116th Congress.
Chairman Clayton has also made known to Congress his view of the Kokesh decision, including during testimony on SEC oversight, where he claimed that he was “troubled by the substantial amount of losses” the SEC could not recover for investors, and urged Congress to address Kokesh to ensure that investors “can get their investment dollars back.”[14] It was therefore of no surprise that he expressed support for H.R. 4344 stressing it as “an important response to real harms suffered by innocent victims of the worst types of securities frauds” and one that ensures “sophisticated fraudsters who carry out some of the most harmful frauds, including Ponzi schemes that can defraud investors for long periods of time before being uncovered, cannot keep their victims’ money.”[15] The NDAA will be a welcome Congressional response to the SEC following years of jockeying by the SEC for such explicit statutory authority and will override doubts as to the Commission’s ability to go after wrongdoers’ ill-gotten gains.
Conclusion
Increasing the statute of limitations for disgorgement to ten years will undoubtedly raise the stakes in SEC enforcement cases. This may be only the beginning, as Congress’s willingness to provide legislative support for the SEC’s plenary authority may continue, particularly under a Biden Administration that will likely emphasize and increase agency enforcement, inspection and examination efforts. At the very least, the NDAA, once signed into law, will certainly set the stage for the SEC’s increased use of the federal courts particularly where its use of administrative proceedings has been under attack for the last several years. With disgorgement being available for ten years after the alleged wrongdoing, we expect to see the SEC demand markedly increased amounts in settlements and in administrative and court actions as well.
[1] U.S. Senate Committee on Armed Services, “Senate and House Armed Services Committees Complete Conference on FY 2021 National Defense Authorization Act” (Dec. 3, 2020), available at https://www.armed-services.senate.gov/press-releases/senate-and-house-armed-services-committees-complete-conference-on-fy-2021-national-defense-authorization-act.
[2] Exchange Act, 15 U.S.C. §78u-2(e).
[3] Jonathan Barr, Patrick Campbell, John Carney, Jimmy Fokas, Teresa Goody Guillén, Jeff Martino, and Michelle Tanney, BakerHostetler, SEC Wins Fight to Retain Disgorgement Power But There’s a Catch (June 1, 2020), available at https://www.bakerlaw.com/alerts/sec-wins-fight-to-retain-disgorgement-power-but-theres-a-catch#1.
[4] Steven Peikin, U.S. Sec. & Exch. Comm’n, speech, “Remedies and Relief in SEC Enforcement Actions” (Oct. 3, 2018, available at https://www.sec.gov/news/speech/speech-peikin-100318.
[5] Kokesh v. SEC, 137 S. Ct. 1635 (2017).
[6] See, e.g., John J. Carney and Lauren P. Berglin, BakerHostetler, Limited SEC Disgorgement – Unanimous Supreme Court Draws a Bright Line Five-Year Rule (June 12, 2017), available at https://www.bakerlaw.com/alerts/limiting-sec-disgorgement-unanimous-supreme-court-draws-a-bright-line-five-year-rule.
[7] Liu v. Securities and Exchange Commission, 591 U.S. ___ (2020).
[8] See supra note 3.
[9] Id. (citing Liu v. SEC, No. 18-1501 (S. Ct. filed Dec. 16, 2019), Br. For Pet’rs at p. 13).
[10] H.R. 4344, the Investor Protection and Capital Markets Fairness Act, Congress.gov, available at https://www.congress.gov/bill/116th-congress/house-bill/4344/.
[11] Id.
[12] S. 799, the Securities Fraud Enforcement and Investor Compensation Act, Congress.gov, available at https://www.congress.gov/bill/116th-congress/senate-bill/799.
[13] Id.
[14] Jay Clayton, Testimony on “Oversight of the U.S. Securities and Exchange Commission” (Dec. 11, 2018), available at https://www.sec.gov/news/testimony/testimony-oversight-us-securities-and-exchange-commission-0.
[15] Congressman Ben Adams and Congressman Bill Huizenga, Dear Colleague Letter, available at http://dearcolleague.us/2019/11/vote-yes-h-r-4344-the-investor-protection-and-capital-markets-fairness-act/#.
