The ability of the Securities and Exchange Commission (SEC) to pursue the return of profits earned in fraudulent schemes has been strengthened as part of Congress’ passage of the National Defense Authorization Act (NDAA) for Fiscal Year 2021.
The SEC’s pursuit of the return of ill-gotten gains, known as disgorgement, had not previously been explicitly allowed under federal law. Instead, the agency’s ability to pursue disgorgement depended on Supreme Court rulings in two cases—Liu v. SEC and Kokesh v. SEC—which agreed the agency did have the power to pursue disgorgement under certain conditions and with certain limitations. The new law explicitly allows the SEC to pursue disgorgement through the federal courts.
“It will now be easier for the SEC to seek disgorgement, allowing them to look back at longer periods of time and collect higher amounts.”
Jay Dubow, Partner, Troutman Pepper
In addition to granting the SEC the authority to seek disgorgement, the law (H.R.6395) extends the length of time the agency can look back to seek disgorgement. The Kokesh decision had placed a statute of limitation on even the most egregious security law violations at five years; the new law extends the statute of limitations to 10 years on so-called “scienter” fraud. Scienter is a legal term referring to willful or reckless conduct. Some kinds of non-scienter fraud—say, fraud the SEC determines was perpetrated out of neglect—is still subject to a five-year lookback limitation.
The law does not change the statute of limitation on penalties, which is still set at five years. But it does increase the statute of limitation to 10 years on other actions, like injunctions and industry bans. Interestingly, the law says there is no statute of limitation on the behavior of companies or individuals based outside of the United States.
Disgorgement is “perhaps the most effective tool the SEC has, because it makes a crime non-profitable for the criminal,” said Arthur Jakoby, a former prosecutor with the SEC’s Enforcement Division and now a partner with the firm Herrick, Feinstein. “It makes sure crime does not pay.”
Investigations into securities law violations are time-consuming, and regulators often do not have the luxury of launching probes immediately after the alleged fraud was committed. As a result, the agency and its investigators are regularly bumping up against the statute of limitations, Jakoby said.
“This law gives them additional time to investigate,” he said.
The new law will make it less likely the SEC will be forced to drop a case or request that an entity under investigation sign a tolling agreement, which pauses the clock so the limitation doesn’t run out while the investigation is pursued.
“This will certainly change things for companies and individuals who are negotiating settlements with the SEC,” said Jay Dubow, a partner at Troutman Pepper and a former branch chief at the SEC’s Division of Enforcement. “It will now be easier for the SEC to seek disgorgement, allowing them to look back at longer periods of time and collect higher amounts.”
The law, which is currently in effect, is already having an impact on negotiations between the SEC and defendants accused of violating securities laws. Dubow said he is aware of several cases in which the SEC has filed notice in federal court of its intention to pursue disgorgement beyond the previously established five-year limitation.
But the new law is silent on multiple points of contention addressed in the two Supreme Court decisions. It does not address whether the SEC must return disgorgement to victims, instead of to the U.S. Treasury, and it offers no guidance on what constitutes legitimate business expenses eligible to be deducted from a disgorgement penalty.
Although it mostly favors the SEC’s ability to seek disgorgement, the law does have one provision that could benefit defendants. The law requires the SEC to pursue the return of “unjust enrichment by the person who received the unjust enrichment.” In cases where more than one person was involved in a fraud, that wording could present headaches for investigators seeking to assess disgorgement penalties, Jakoby said.
“That could be very restricting for the SEC,” he said.
Other provisions unrelated to military spending
When the NDAA was being debated, the bill received considerable media attention because it was the first vetoed by President Donald Trump that was subsequently approved by Congress. Although the bill was primarily meant to fund the country’s military, Congress and Trump skirmished over unrelated issues, like whether it should strip away libel protections for social media companies or drop the names of Confederate military leaders from U.S. military bases.
Other provisions of interest to compliance officers were also included, like anti-money laundering reforms and the creation of a whistleblower program for the Bank Secrecy Act.