By Anne Sherry, J.D.
The SEC adequately—and timely—alleged that six individuals participated in a scheme to evade the registration and beneficial owner reporting requirements of the securities laws. In an issue of first impression, the federal district court in Massachusetts held that a recent extension of the statute of limitations on the SEC disgorgement remedy applies retroactively to newly filed cases. The Commission could seek disgorgement for scienter-based violations occurring up to ten years prior to the charges, not the five years set forth in Kokesh v. SEC (U.S. 2017) (SEC v. Sharp, September 6, 2022, Young, W.).
According to the SEC’s complaint, the defendants were part of an elaborate scheme to help controllers of publicly traded penny-stock companies hide their ownership, then surreptitiously dump the stock on retail investors. This included furnishing networks of offshore shell companies to conceal stock ownership, arranging stock transfers and money transmittals, and providing encrypted accounting and communications systems.
The SEC obtained a $53 million default judgment against the alleged mastermind of the scheme in May 2022. Six of the remaining nine defendants moved to dismiss the case, arguing that the SEC’s claims were time-barred and that the complaint did not plausibly allege violations of the securities antifraud and registration provisions. The court denied the motion to dismiss in all respects.
Limitations. In the aftermath of Kokesh and Liu, Congress included in the National Defense Authorization Act for fiscal year 2021 a provision doubling the Kokesh five-year statute of limitations for disgorgement claims. This left the District of Massachusetts to decide a question of first impression: whether the NDAA applies retroactively to actions brought after its passage. Can the SEC file claims after the NDAA’s passage to disgorge profits from conduct occurring between five and ten years before the NDAA’s passage? The court ruled that it can.
In the court’s reading, the NDAA’s express application “to any action or proceeding that is pending on, or commenced on or after” January 1, 2021, clearly suggests it applies retroactively to past conduct charged in pending cases. Likewise, the language suggests it applies retroactively to new charges, and the Supreme Court held as much when examining nearly the same language in another context.
Furthermore, reading the NDAA to read only the “pending on” but not the “commenced on or after” part as applying retroactively would lead to an irrational outcome: SEC enforcement actions charging violations of the same statutes would reach either five or ten years of conduct based only on their filing dates. It would also reward the SEC for bringing claims for older conduct before it had the authority, and punish it for claims brought once it did have that authority. The legislative history of the NDAA also suggests that the expanded statute of limitations applies retroactively.
The court rejected the defendants’ argument that the enforcement action against them is a special case because it seeks to revive stale claims. It wasn’t clear to the court whether the NDAA can fairly be classified as reviving a lost right rather than a lost remedy, given the distinction between statutes of limitations and statutes of repose. The NDAA expands a statute of limitations because it affects the availability of a remedy, which is a separate element from liability. Furthermore, Congress has the power to revive stale claims as long as it is clear. The defendants’ counterargument that the statute violated the Ex Post Facto Clause failed because the defendants did not meet their burden of proving that disgorgement is punitive in purpose or effect—notwithstanding Kokesh’s holding that disgorgement is a penalty.
The SEC alleged sufficient facts within both the ten- and five-year time periods applicable to the various claims relevant to the enforcement action. The court also observed that the five-year statute of limitations may not even apply to, or have start to run for, several of the defendants who were absent from the United States.
Sufficiency of allegations. The court also determined that the SEC alleged sufficient facts with particularity as to all defendants to support the claimed violations. Regarding the Exchange Act Section 10(b) claims, the complaint adequately alleged each defendant’s involvement and substantial participation in a scheme to defraud, their knowing or reckless state of mind, and a connection to the purchase or sale of securities. Notably, the SEC did not lump defendants together but rather defined a term comprising the constituent members of a control group and then explained each individual’s role in the scheme. Using shorthand abbreviations is acceptable if the complaint explains the role of each member of a group.
The claims under Securities Act Section 17(a)(3) also survived the motion to dismiss. The SEC alleged sufficient facts to describe how the defendants undertook a deceptive scheme or course of conduct in the offer or sale of securities. Substantial participation is not a requirement, nor is scienter. The Commission also adequately alleged that the defendants violated the registration requirements of the Securities Act and the beneficial ownership reporting requirements of the Exchange Act. Likewise, the SEC’s aiding-and-abetting claims against certain defendants survived.
The case is No. 21-11276.