SEC Disgorgement New Statute of Limitations
Congress recently promulgated several consequential amendments to the Securities Exchange Act of 1934 (the “Exchange Act”) into the National Defense Authorization Act for Fiscal Year 2021, which became effective January 1, 2021. Specifically, Congress enacted into law the following provisions as part of Section 6501, titled “Investigations and Prosecution of Offenses for Violations of Securities Laws”:
- In Securities and Exchange Commission (SEC) enforcement actions filed in federal district court, the SEC may now seek “disgorgement . . . of any unjust enrichment by the person who received such unjust enrichment as a result of [a] violation” of the securities laws;
- For any securities law violation that requires the SEC to establish scienter, Congress expanded the limitations period from five years to ten years; and
- The statute of limitations for certain SEC actions will be tolled while defendants remain outside of the United States.
By expanding the SEC’s arsenal in its prosecution of securities fraud, specifically the SEC’s ability to reach-back ten years to obtain disgorgement (a wrongdoer’s ill-gotten gains) for scienter-based violations, these Congressional Amendments immensely benefit SEC whistleblowers who stand to receive a financial award based on a percentage of the SEC’s recovery over $1 million.Codification of the SEC’s Disgorgement Authority
Prior to the passage of these Congressional Amendments, the SEC only possessed express authority to seek disgorgement in its administrative proceedings -- not in federal district court enforcement actions. Historically, the SEC maneuvered around this lack of explicit legal authority by basing its disgorgement claims on a theory of “equitable relief.” However, the validity of the SEC’s position recently came under heavy scrutiny in a pair of recent landmark Supreme Court decisions: Kokesh v. SEC, 136 S. Ct. 1635 (2017) and Liu v. SEC, 140 S. Ct. 1936 (2020).
Kokesh concerned an individual who, through two investment-adviser firms, was alleged to have misappropriated more than $30 million from business development companies, and caused the filing of false and misleading SEC reports and proxy statements. Similarly, Liu concerned a purported fraudulent scheme that deprived foreign nationals of more than $20 million invested through the Immigrant Investor Program (commonly referred to as the EB-5 Program). In both Kokesh and Liu, the SEC obtained multi-million-dollar disgorgement awards at the district court level, but were challenged on appeal.
In Kokesh, the Supreme Court held that “[d]isgorgement in the securities-enforcement context is a ‘penalty’ within the meaning of [the securities laws].” Notably though, the Kokesh Court declined to reach the threshold question of whether the SEC had the legal power, in the first instance, to seek disgorgement. Three years later, the Liu Court “granted certiorari to determine whether [the securities laws] authorizes the SEC to seek disgorgement beyond a defendant’s net profits from wrongdoing.” While the Court upheld the SEC’s ability to obtain disgorgement, it nonetheless materially limited the remedy by ruling that disgorgement: (1) cannot exceed the securities violator’s net profits (i.e., a defendant can now claim a set-off for legitimate expenses), and (2) must be used for the benefit of investors. The Liu decision thus delivered a substantial blow to the SEC’s Enforcement Program and thus derivatively to SEC whistleblowers, who stand to collect a percentage of disgorgement sums. The SEC was not shy in its public criticism of these Supreme Court rulings, noting that since Kokesh it lost out on more than $1 billion in disgorgement awards.
The recent Congressional Amendments thus serve to remedy the limitations on the SEC’s collection of disgorgement imposed by Kokesh and Liu.Benefits to Whistleblowers
At their core, the Congressional Amendments benefit SEC whistleblowers by increasing the potential monetary recovery by the SEC in which they may share, and by expanding the time period in which the SEC may sue for disgorgement. Whistleblowers who provide the SEC with original, timely, and credible information leading to a successful enforcement action resulting in collection of over $1 million may be eligible for an award of 10-30% of the total collected. Thus, now that the SEC’s legal authority to seek disgorgement is beyond reasonable question, and given its new ten-year statutory lookback to recoup a fraudster’s ill-gotten gains, the SEC will likely obtain larger recoveries in its enforcement cases, either through trial or settlement (the amendments will no doubt provide the SEC significant leverage in settlement negotiations). Under a Biden administration, it is likely we will see an even more aggressive enforcement program, now with even more potent tools.Implications
The financial benefits to SEC whistleblowers have always served as a strong incentive to report securities laws violations to the SEC. In the past three fiscal years, the SEC has obtained disgorgement orders of approximately $2.5 billion (2018), $3.2 billion (2019), and $3.5 billion (2020). In fact, 2020 included the largest SEC whistleblower award in history -- more than $100 million. Since the SEC’s first whistleblower award in 2012, the SEC has paid out in excess of $650 million to more than 100 individuals. The Congressional Amendments will not only increase SEC whistleblowers’ incentives to report violations of the federal securities laws, but will also lead to more lucrative rewards for their efforts.