Defense Bill to Expand SEC Powers and Authority
Note: This page was updated on January 4, 2021, to reflect Congress's override of President Trump's veto of the discussed legislation.
The Situation: The U.S. Congress recently passed the National Defense Authorization Act ("NDAA") for Fiscal Year 2021, which includes important changes to the Securities and Exchange Commission's ("SEC") ability to seek disgorgement. Although President Trump vetoed the bill, the House of Representatives and Senate voted to override the veto on December 28, 2020, and January 1, 2021, respectively.
The Result: These changes explicitly authorize the SEC to seek disgorgement in federal district court, modify statute of limitations periods for fraud from five to 10 years, and extends the limitations period for individuals outside of the United States. The changes follow recent Supreme Court decisions seen as limiting the SEC's authority.
Looking Ahead: These provisions significantly clarify and expand the SEC's ability to pursue remedial sanctions including disgorgement and penalties. The SEC will likely utilize its expanded authority to aggressively pursue securities violations.
On December 11, 2020, Congress sent the National Defense Authorization Act for Fiscal year 2021 (H.R. 6395) to the President for signature. After President Trump vetoed the bill, the House of Representatives and Senate overrode the veto on December 28, 2020, and January 1, 2021, respectively. This bill includes important securities law changes pertaining to remedies available to the SEC. The changes provide the SEC with expanded authority to request disgorgement and other equitable remedies.
Key changes in the legislation include:
- Explicitly authorizing the SEC to seek disgorgement for violations of securities laws;
- Removing existing restrictions requiring disgorgement awards to be "for the benefit of investors";
- Providing a 10-year statute of limitations for disgorgement awards stemming from fraud violations;
- Providing a 10-year statute of limitations for equitable remedies, including cease-and-desist orders and injunctions; and
- Adding a provision to indefinitely toll the statute of limitations while defendants remain outside the United States.
Context Leading to the New Provisions
As was explained in Liu v. Securities and Exchange Commission, the SEC's authority to seek disgorgement currently stems from its power to award equitable relief under 15 U.S.C. § 78u(d)(5). The Liu Court held that disgorgement under this authority is generally limited to the net profits of defendants.
Liu included negative comments on several other SEC practices, indicating possible future challenges to certain SEC practices. The Court questioned the SEC's practice of distributing disgorgement awards to the U.S. Treasury, noting the current provision's requirement that disgorgement be "for the benefit of investors." Moreover, the Court questioned the practice of disgorgement awards based on joint-and-several liability, describing it as "in considerable tension with equity practices."
H.R. 6395's Response to Liu
The legislation contains separate provisions expressly authorizing the SEC to seek disgorgement of any illegal gains resulting from a securities violation. The new provisions maintain Liu's requirement that disgorgement be limited to net profits of defendants while removing the prior restriction requiring disgorgement to be for the benefit of investors. By removing this requirement, Congress nullified questions surrounding the SEC's distribution of disgorgement awards to the U.S. Treasury.
The new legislation also limits disgorgement awards to "any unjust enrichment by the person who received such unjust enrichment as a result of [a securities law] violation." This appears to prohibit joint-and-several liability, thus preemptively answering questions raised in Liu.
Statute of Limitations Changes
Through amendment of statute of limitations, H.R. 6395 extends the deadlines for the SEC to file a contested matter. For disgorgement, the new legislation lays out a five-year general statute of limitations and a 10-year statute of limitations for fraud-based violations. Moreover, the new provisions prescribe a 10-year statute of limitations for "any equitable remedy," which explicitly includes cease-and-desist orders and injunctions. The clock begins to run from the "latest date giving rise to the action or proceeding," thus potentially providing an increase from the ordinary five-year statute of limitations for SEC actions.
Moreover, the new provisions include an unlimited tolling provision for time spent outside the United States, meaning any time spent outside the United States is not counted in the accrual of the statute of limitations period. Thus, actions brought against individuals located outside the United States may, in essence, be tolled indefinitely or until the defendant enters the United States.
While the statute of limitations provisions grant the SEC additional time to investigate and litigate securities violations, they also raise important challenges for the SEC.
First, the more time that lapses between key events and SEC actions, the more difficult it may be for the SEC to prove securities violations. As memories fade and evidence ceases to be available, the SEC may find it difficult to prove 10-year-old violations.
Moreover, the SEC runs into the following predicament: What if the SEC believes that it will ultimately be able to prove fraud, but after five years the facts support only non-fraud violations? The SEC will likely be aggressive with requiring tolling agreements to avoid this situation. Companies will need to thoughtfully decide whether to agree to tolling the limitations period on possible non-fraud claims and should consider strict time limits in such agreements.
Regardless of how the SEC confronts new questions stemming from the proposed legislation, the NDAA would significantly expand the SEC's power and authority through amendments addressing disgorgement and statutes of limitation.
Three Key Takeaways
- The new provisions explicitly authorize the SEC to seek disgorgement for violations of securities laws, settling doubts as to the SEC's authority. The changes remove current restrictions on its disgorgement authority requiring that awards be "for the benefit of investors."
- Under the new provisions, the SEC will have a 10-year statute of limitations period for disgorgement awards stemming from fraud violations. Moreover, the provisions prescribe a 10-year period for all equitable remedies, including cease-and-desist orders and injunctions. Additionally, the legislation adds a provision to indefinitely toll the statute of limitations while individuals remain outside the United States.
- The SEC will likely be aggressive in requiring tolling agreements on possible non-fraud claims to enable the SEC to fully utilize the new statute of limitations for fraud-based violations. Companies will need to decide whether to agree to tolling agreements and should consider strict time limits in these agreements.