A fourth defendant in the SEC’s “Sharp Group” microcap fraud action is challenging the commission’s use of an expanded statute of limitations for disgorgement claims under a defense authorization measure passed earlier this year.
The case, SEC v. Frederick L. Sharp et al., represents a test of the extent of the SEC’s newfound authority under Section 6501 of the fiscal 2021 National Defense Authorization Act (NDAA), which Congress passed at the beginning of the year with a provision granting the commission a new 10-year statute of limitations to recoup certain ill-gotten gains, a process called disgorgement.
Section 6501 amended the Securities Exchange Act of 1934 to give the SEC the extended limitations period for disgorgement claims that stem from violations of the Exchange Act’sSection 10(b) and other provisions of the securities laws that require the SEC to establish scienter, essentially that the defendant had knowledge or intent behind their misconduct. Those changes apply “with respect to any action or proceeding that is pending on, or commenced on or after, the date of enactment” of the act.
The SEC in August charged nine individuals in a fraud scheme in which a group led by Frederick Sharp “provided services to various groups of public company control persons to help those control persons dump United States-quoted stocks—typically penny stocks—on retail investors,” according to the complaint. “These services included providing networks of offshore shell companies to conceal stock ownership, arranging stock transfers and money transmittals, and providing encrypted accounting and communications systems.” Also charged were control persons who allegedly dumped shares, a promoter who pitched the stocks to retail investors, and a public company chairman.
Defendant Zhiying Yvonne Gasarch, in her November 30 memorandum supporting a motion to dismiss, wrote that the SEC allegations “largely identify her as having a minor, administrative role with respect to the alleged scheme.”
Among other defenses, Gasarch incorporated arguments made by three other defendants – Jackson Friesen, Graham Taylor, and Paul Sexton – that the SEC can’t use the NDAA to resurrect claims that were already time-barred at the point of the NDAA’s enactment. (See Defendants Challenge SEC’s Interpretation of Expanded Disgorgement Powers in the November 22, 2021, edition of Accounting & Compliance Alert.)
The NDAA’s Section 6501 “lacks the unequivocal language required for it to have retroactive effect such that it can revive long expired claims,” and, further, reviving those claims would violate the U.S. Constitution’s ex post facto protections against retroactive punishments, she argued.
Like other defendants, Gasarch pointed to the Supreme Court’s 2017 ruling in Kokesh v. SEC, in which the High Court – likening disgorgement to a penalty – concluded SEC disgorgement claims are subject to a five-year statute of limitations. The SEC “alleges no activity by Ms. Gasarch within the past five years,” she argued in the filing.
The SEC, in its response to an earlier motion by Friesen, leaned on the language of the NDAA that “unambiguously” applied to any case commenced after the law’s enactment. The SEC asserted it has “express statutory authorization to seek disgorgement of ill-gotten gains derived from scienter-based charges for 10 years.” Congress made its retroactive intent clear, the commission argued.
The Constitution’s ex post facto clause applies only to criminal legislation, the commission argued, and “there is no authority for the proposition that an SEC civil enforcement action involves criminal sanctions that would bring it under the ex post facto clause.”
This article originally appeared in the December 3, 2021 issue of Accounting & Compliance Alert, available on Checkpoint.
