Congress Increases the Time Period for Which the SEC Can Seek Disgorgement
January 5, 2021
One of the final acts of the current Congress was to rewrite the rules governing SEC disgorgement requests in federal court. The new enactment confirms the SEC’s authority to seek disgorgement and significantly lengthens the statute of limitations for that and other remedies. On January 1, 2020, Congress overrode President Trump’s veto and enacted into law H.R. 6395, the National Defense Authorization Act (“NDAA”), which authorizes annual Department of Defense spending. In this year’s NDAA, Congress included an amendment designed to address the Supreme Court’s recent curtailment of the SEC’s arsenal of remedies in Kokesh v. SEC, 137 S. Ct. 1635 (2017) and Liu v. SEC, 140 S. Ct. 1936 (2020). Specifically, the NDAA amendment (1) gives the SEC the express authority to seek disgorgement in federal court for securities law violations, and (2) doubles to ten years the period for which the SEC can seek disgorgement for scienter-based violations.
Both Liu and Kokesh significantly limited the SEC’s disgorgement remedy. For decades, the SEC in federal district court actions had sought and obtained disgorgement of gross profits (or losses avoided), either pursuant to the court’s inherent equity power to fashion an appropriate remedy and/or under a statutory authorization to ask federal courts to order “any equitable relief that may be appropriate or necessary for the benefit of investors.” Section 21(d)(5) of the Securities Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. § 78u(d)(5). Historically, the SEC asserted that no statute of limitations applied because disgorgement was equitable and remedial, and not punitive. In Kokesh, the Court held that the SEC’s approach to disgorgement made it a “penalty,” subject to the general federal five-year statute of limitations under 28 U.S.C. § 2462. In Liu, although the Supreme Court upheld the SEC’s ability to obtain disgorgement in federal court actions, the Court held that disgorgement limited to net profits; must be “for the benefit of investors”; and, absent concerted wrongdoing by the defendants, cannot be imposed jointly and severally.
Against this backdrop, in the NDAA, Congress added Section 21(d)(7) of the Exchange Act, which expressly authorizes the SEC to seek disgorgement in federal court enforcement actions. But Congress appears to have codified the Supreme Court’s limitation of joint and several liability, providing for disgorgement “by the person who received such unjust enrichment.” H.R. 6395 § 6501(a)(1)(B). Although the Supreme Court recognized a potential exception for concerted wrongdoing, the NDAA does not expressly address those situations. The NDAA amendment therefore provides defense counsel with an additional arrow in their quiver when facing SEC disgorgement demands for net profits that the client did not receive.
The NDAA amendment makes major changes to limitations periods applicable to SEC federal court actions. Specifically, Congress: (i) doubled the statute of limitations to ten years for disgorgement arising from scienter-based violations; (ii) retained Kokesh’s five-year limitations period for other disgorgement claims; and (iii) imposed a 10-year statute of limitations for all equitable remedies, including injunctions. See H.R. 6395 § 6501(a)(3). Congress did not address, and therefore retained, the five-year limitations period applicable to civil penalties.
The NDAA expressly provides that these new limitations apply to actions or proceedings that are pending on, or commenced on or after, the date that the NDAA is enacted. If the SEC were to argue that this provision allows it to seek disgorgement for relevant violations that had been time-barred, defense counsel will likely challenge the SEC’s position as one impermissibly seeking the retroactive imposition of a penalty. See Landgraf v. USI Film Prod., 511 U.S. 244, 281 (1994) (retroactive imposition of penalties would “raise a serious constitutional question.”).
Additionally, the NDAA amendment provides that the limitations period for disgorgement claims excludes time that the person against whom such action or claim is made is outside the United States. It remains to be seen how courts will interpret that provision with respect to corporations that are located outside the United States.
The new limitations period may lengthen some SEC investigations. Kokesh had put additional pressure on the Enforcement staff to finish more promptly an investigation or risk losing remedies. Although the NDAA amendment removes that pressure with respect to some disgorgement and equitable remedies, the SEC’s civil penalty claims continue to be subject to a five-year limitations period.
This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Margaret L. Carter, an O’Melveny partner licensed to practice law in California, Mark A. Racanelli, an O’Melveny partner licensed to practice law in New York and Maryland, Andrew J. Geist, an O’Melveny partner licensed to practice law in New York, Seth Aronson, an O’Melveny partner licensed to practice law in California, Jim Bowman, an O’Melveny partner licensed to practice law in California, Jorge deNeve, an O’Melveny counsel licensed to practice law in California, Michael J. Simeone, an O’Melveny counsel licensed to practice law in California and New York, and David Cohen, an O’Melveny associate licensed to practice law in New York, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.
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