The law requires the SEC to bring enforcement actions seeking penalties against individuals who violate the securities laws within five years. The Supreme Court issued a unanimous ruling today that rejects the SEC’s argument that the five year clock begins to tick when they discover any alleged wrongdoing rather than the date on which the wrongdoing was committed. The author previously has suggested that the application of the SEC’s proposed “fraud discovery rule” by a government agency charged with investigation and enforcement would be counter-productive and effectively would eliminate the five year statute of limitations. To put this into context, the only federal crimes that have no statute of limitations are capital offenses that warrant the death penalty and certain terrorism, child abduction, and sex offenses. If the SEC were allowed an indefinite period of time in which to bring enforcement actions, the fraud alleged in those cases would be on par with the most serious of federal crimes. Today’s decision by the Supreme Court in Gabelli v. SEC rejects such an absurd result.
In its decision, the Supreme Court noted that it has never extended the centuries-old five year rule as suggested by the SEC for “good reasons.” The discovery rule was created to ensure that victims of fraud who do not know they are injured, ala those defrauded by Bernie Madoff, are still able to bring their claims after they have discovered, or reasonably should have discovered, their injuries. According to the Court, “Most of us do not live in a state of constant investigation; absent any reason to think we have been injured, we do not typically spend our days looking for evidence that we were lied to or defrauded.” This is not true of government agencies like the SEC, however. Indeed, the agency’s “central ‘mission’” is to investigate and root out violations of the securities laws and it “has many legal tools at hand to aid in that pursuit.” Because it is always on the lookout for fraud, the agency does not need the benefit of the doubt afforded by the discovery rule.
Further, unlike a private party who is seeking money to compensate them for injuries sustained as a result of the fraud, the SEC seeks to inflict penalties on a defendant. As stated by the Court, the outcome of an SEC action is “intended to punish, and label defendants wrongdoers.” Allowing the SEC to rely on the discovery rule would “leave defendants exposed” to such punishment “not only for five years after their misdeeds, but for an additional uncertain period in the future.” The Court concluded by noting that the types of changes proposed by the SEC could only be made with congressional approval.
Because the five year limitation period also applies to other government agencies in other contexts, the Court’s decision is tremendously important. With respect to the decision’s impact on the SEC, it may spur a rash of filings as the agency rushes to bring cases related to the economic crisis of 2008 within the five year deadline. Yet the Court’s ruling is clear that the five year rule is to be strictly observed, even if that means some wrongdoing goes unpunished. An open issue that remains is whether the SEC can seek an extension of the five year statute of limitation where a defendant acts to affirmatively conceal the fraudulent conduct. The Court specifically declined to rule on this issue in Gabelli where the SEC did not assert that the defendant had engaged in any type of a cover up.
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