The Securities and Exchange Commission’s disgorgement powers have made legal headlines a couple of times over the last few years – most notably, with the U.S. Supreme Court’s decisions in Kokesh v. SEC, 137 S. Ct. 1635 (2017) and Liu v. SEC, 140 S. Ct. 1936 (2020). Disgorgement surfaced again with the recent passage of the National Defense Authorization Act for Fiscal Year 2021, Section 6501 of which doubled the statute of limitations for some disgorgement actions from five years to 10. Here are four things you need to know about this significant legislative development:
- What is disgorgement?[1] Broadly speaking, disgorgement is a remedy available to the SEC under which a party that was unjustly enriched can be forced to pay back its ill-gotten gains to make injured parties whole. The SEC regularly seeks disgorgement from wrongdoers and relief defendants (i.e., defendants who may not be wrongdoers but who were unjustly enriched).
- What’s the back story to the current legislation? In Kokesh, the U.S. Supreme Court rejected the SEC’s position that disgorgement is not a penalty subject to the five-year limitations period of 28 U.S.C. § 2462, applicable to proceedings to recover civil fines, penalties, and forfeitures. Last summer, the U.S. Supreme Court upheld the SEC’s right to seek disgorgement in Liu but placed additional restrictions on the disgorgement remedy – most notably, that disgorgement be limited to net income or net profit and must be for the benefit of injured parties, rather than the U.S. government. The SEC was disappointed with both decisions and estimated that it would forego over a billion dollars in disgorgement as a result of Kokesh alone. Section 6501 appears to be a direct response to Kokesh and Liu.
- What does Section 6501 do? Section 6501 extends the limitation period for a disgorgement action to 10 years for certain offenses involving intentional misconduct (i.e., scienter). In effect, it permits the SEC twice the time to bring suit to recover unjust enrichment for the benefit of an injured party in egregious cases, such as violations of Section 17(a)(1) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934. Section 6501 does not extend the limitations period for cases that do not involve intentional misconduct.
- What unanswered questions remain?
- Is the statute-of-limitations extension retroactive? Section 6501 appears to apply to pending cases, meaning it is intended to be retroactive. Litigation over its retroactive effect is likely. For example, could the SEC amend its complaint in a pending disgorgement action to reach back seven years even if the applicable limitations period when the proceeding was filed was only five years?
- Do Liu’s restrictions on disgorgement still apply? The safer position is yes, but expect to see litigation over this issue as well.
- Does the requirement that a proceeding involve intentional misconduct for the 10-year limitations period to apply incentivize the SEC to charge more intentional misconduct offenses?
[1] One of the authors of this post once received a breathless response to a statement about disgorgement: “I don’t know what disgorgement is, but it doesn’t sound fun!” The agitated speaker was relieved to learn that disgorgement, while unpleasant, is not disembowelment.