On January 1, 2021, amendments to Section 21(d) of the Securities Exchange Act of 1934 (Exchange Act) codifying and expanding the power of the Securities and Exchange Commission (SEC or Commission) to obtain disgorgement in civil actions became law.1 The amendments are tucked within the 1,400-page National Defense Authorization Act and are a direct response to the Supreme Court’s recent decisions in Kokesh v. SEC2 and Liu v. SEC3 curtailing the Commission’s ability to obtain disgorgement. The recent amendments double the time period for which the Commission may obtain disgorgement in cases involving fraud and could expand the Commission’s authority to obtain disgorgement in other important ways.
As amended, Section 21(d) of the Exchange Act expressly grants the Commission authority to obtain disgorgement in civil actions of “any unjust enrichment by the person who received such unjust enrichment as a result of such violation.” For most violations, an action for disgorgement must be brought “not later than 5 years after the latest date of the violation that gives rise to the action or proceeding in which the Commission seeks the claim occurs.” However, the Commission may seek disgorgement up to 10 years after the latest date of the violation for scienter-based violations, including the antifraud provisions of Section 10(b) of the Exchange Act, Section 17(a)(1) of the Securities Act and Section 206(1) of the Investment Advisers Act—doubling the time previously allowed for disgorgement following Kokesh.4 These amendments are effective immediately upon enactment and apply to any matter currently pending on the date of enactment.
The amendments are notable for the SEC’s enforcement program. Most prominently, the extended statute of limitations for scienter-based fraud may incentivize Division of Enforcement staff to investigate conduct that is much more dated than the familiar five-year statute and to expend additional efforts to find evidence supporting a scienter-based charge, which risks complicating responses to Commission requests and increasing defense costs. Moreover, in order to seek disgorgement from a broader period that is only available for scienter-based fraud, the Division of Enforcement may be less inclined to accept settled resolutions that charge non-scienter-based alternatives. This has the potential to complicate settlement negotiations, including because scienter-based resolutions can trigger more significant collateral consequences for some respondents.
The amendments also leave open several questions, including the extent to which the new statutory disgorgement framework supplants the requirements for disgorgement outlined in Liu. For example, the amendments do not expressly address Liu’s requirement that the Commission return disgorged funds to injured investors. They also are silent on Liu’s holding that the Commission must net a defendant’s legitimate expenses when calculating disgorgement awards and on whether and when the Commission may hold defendants jointly and severally liable for disgorgement awards. However, the statutory language’s focus on “unjust enrichment by the person who received such unjust enrichment” provides compelling arguments in favor of netting legitimate expenses and against expansive joint and several liability.
These amendments represent a change of fortune for the SEC and its enforcement program. Although there are open questions regarding the extent to which they reverse the most restrictive elements of Liu, amended Section 21(d) provides, for the first time, express authority for the Commission to obtain disgorgement in civil actions and significantly expands the time period for which disgorgement may be sought. With the pending change in presidential administration, we expect the new Commission will aggressively use this expanded authority in 2021 and beyond.
