The National Defense Authorization Act for 2021 (NDAA), the primary purpose of which is to fund U.S. national defense at a cost of $740 billion, is front-page news this week following President Trump’s veto of the bill, which Congress appears poised to override in the next few days.
One component of the bill has thus far attracted significantly less attention: Section 6501—buried on page 1238 under a “Miscellaneous” title—which would expand the enforcement powers of the U.S. Securities and Exchange Commission (SEC), effectively reversing limitations imposed by the Supreme Court in recent years previously discussed on this blog.
Background: SEC’s Disgorgement Authority under Current Law
Under current law, the Securities Exchange Act of 1934 (the Exchange Act) does not explicitly authorize the SEC to seek “disgorgement” in enforcement actions filed in federal court. Courts, however, have permitted the SEC to seek disgorgement as a form of “equitable relief”—which is explicitly provided for under the statute. In recent years, the Supreme Court has placed important limitations on that authority.
First, in 2017, the Supreme Court held in Kokesh v. SEC that disgorgement constitutes a “penalty” for statute of limitations purposes, and that such claims are therefore subject to a five-year statute of limitations period under 28 U.S.C. § 2462.
Then, earlier this year, in Liu v. SEC, the Supreme Court confirmed that the SEC has the authority to seek disgorgement in federal court as a form of equitable relief, but placed certain limitations on that authority, including that disgorged funds must be returned to victims if practicable and that disgorgement awards cannot exceed a defendant’s net profits.
The SEC has expressed frustration at these limitations on its ability to seek ill-gotten gains for violations of the securities laws. Now, Congress appears prepared to answer the SEC’s calls for change.
NDAA’s Amendments to the Exchange Act
Section 6501 of the NDAA, titled “Investigations and Prosecution of Offenses for Violations of the Securities Laws,” would expand the SEC’s disgorgement authority by making two key amendments to the Exchange Act:
- Express Authority: A new paragraph would be added to Section 21(d) of the Exchange Act (codified at 15 U.S.C. § 78u(d)) expressly permitting the SEC to seek disgorgement “[i]n any act or proceeding brought by the Commission under any provision of the securities laws.”
- Extended Statute of Limitations: The law would extend the statute of limitations from five to ten years for disgorgement claims in connection with any violation of the securities laws for which scienter must be established (including Section 10(b) of the Exchange Act and Section 17(a)(1) of the Securities Act of 1933). All other disgorgement claims would continue to be subject to a five-year limitations period. (As discussed below, the NDAA separately provides for a ten-year statute of limitations period for claims seeking “equitable” remedies, such as injunctions and cease-and-desist orders).
The NDAA further provides that these amendments to the Exchange Act would apply not only to actions commenced following enactment of the law, but also to actions that are “pending” as of the date of enactment.
Potential Implications and Open Questions
If Congress overrides President Trump’s veto to the bill, as appears likely from recent reports, these amendments to the Exchange Act are likely to result in more aggressive enforcement actions brought by the SEC in federal courts, with the SEC taking advantage of the extended statute of limitations for scienter-based violations and for claims seeking equitable remedies. The statutory text, however, leaves some open questions.
Most significantly, would the limitations on the SEC’s disgorgement power recently imposed by the Supreme Court in Liu (e.g., the general requirement to return disgorged funds to victims) continue to apply to disgorgement claims under the amended Exchange Act? The bill doesn’t say so explicitly. Presumably the SEC will argue that the answer should be no: since the premise for the Supreme Court’s reasoning was its finding that disgorgement was an “equitable” remedy, the bill’s creation of separate statute of limitations periods for “disgorgement” and “equitable remedies” arguably suggests that Congress intends to place disgorgement outside of the “equitable remedies” category, effectively reversing the Supreme Court’s finding in Liu. But this would raise another potential problem: if the Liu limitations no longer apply, then is the law’s retroactive application to cases pending at the time of the NDAA’s enactment constitutional?
Courts may be required to answer these questions in the near future.
