The Supreme Court recently rebuffed an attempt by the U.S. Securities and Exchange Commission (“SEC”) to gain more time to file actions to enforce civil penalties by invoking the “discovery rule.” In the case of Gabelli vs. SEC, the Court reasoned that this rule does not apply unilaterally to the SEC because it is a “different kind of plaintiff” who has access to tools that should allow the agency to commence an enforcement action within five years of the occurrence of the allegedly wrongful conduct.
The opinion will come as welcome relief to individuals and businesses facing action not only by the SEC but other government agencies. Decisions from several Circuit Courts of Appeal have – until now – allowed the Internal Revenue Service (“IRS”) to avoid the five-year statue of limitations imposed by 28 U.S.C § 2462. Relying on the discovery rule, the IRS has pursued fraud cases under 26 U.S.C. §§6700 and 6701 up to five years after the agency discovered the allegedly wrongful acts, even if the acts had occurred more than five years before the cases were filed. The Supreme Court decision calls this practice into question.
Gabelli involved SEC allegations of a market timing scheme that violated the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940. The SEC had instituted a civil action against Marc Gabelli, the portfolio manager for the Gabelli Global Growth Fund (“GGGF”), a mutual fund, and Bruce Alpert, chief operating officer of Gabelli Funds (an investment advisor to GGGF) more than five years after the alleged conduct.
This penalty action was governed by § 2462, a general statute of limitations applicable to civil government actions to enforce statutes that do not specify a period of repose. It provides that “an action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise, shall not be entertained unless commenced within five years from the date when the claim first accrued.” The Second Circuit Court of Appeals held that the government’s claim did not “accrue” until either the SEC discovered the violation, or could have discovered it with reasonable diligence, relying on the discovery rule, which staves off the accrual of a claim in certain cases involving fraud. The Supreme Court, however, disagreed. (For an analysis of the oral argument, view the story at this link, http://www.saul.com/publications-alerts-1002.html, where we reported that based on the tenor of the argument, the Court was poised to likely rule as it did).
The Supreme Court noted that the discovery rule offers relief from the strictures of the limitations period for initiating suit in cases of fraud where a plaintiff may have been deprived of “even knowing that he or she has been defrauded.” This permits the aggrieved to seek recompense for the injury. The government, however, is “a different kind of plaintiff,” the Court observed, and seeks “a different kind of relief” in a penalty case. The Court noted that the SEC’s very purpose is to root out fraud, and it is equipped with a variety of tools for identifying it, including whistleblower incentives, “cooperation agreements” with violators in exchange for information and required inspections of books and records. These are tools unavailable to the average litigant.
Rather than seeking recompense for an injury, penalty actions seek to punish, further distinguishing these actions from those in which the discovery rule applies. The Court did take care to leave the discovery rule available to the government when it could properly be characterized as a fraud victim seeking recompense, citing Exploration Co. v. United States. In Exploration, a foreign corporation had fraudulently obtained coal-mining land in Colorado which had been part of the public domain of the United States, and the government was able to invoke the discovery rule in a suit seeking to reverse the land transfers. The Gabelli Court distinguished cases like that from those in which the government seeks a civil penalty.
The Court’s ruling in Gabelli has implications for all penalty actions governed by § 2462. Of particular note are actions prosecuted by the IRS under § 6700, which imposes a penalty for promoting abusive tax shelters, and § 6701, which penalizes the aiding and abetting of understatements of tax liability. In language tracking that of the discovery rule, the Fifth Circuit had determined in Sage v. United States that § 6700 is subject to no limitations period. The Second and Eighth Circuits have also found § 6700 unaffected by § 2462. The Sixth Circuit has regarded § 6701 as unbounded by a statute of limitations.
The rationale of Gabelli opens the door to challenging the validity of prior decisions that allowed the government to invoke the discovery rule in civil penalty cases, including not only SEC enforcement actions, but also IRS actions. The government’s inability to ward off the “accrual” of a claim for statute of limitations purposes provides a ready counterpoint to any attempt to invoke the discovery rule in such actions.