U.S. Supreme Court Rules That the Government Does Not Have an Unlimited Amount of Time in Which to Bring Civil Penalty Actions

In a unanimous decision written by Chief Justice John G. Roberts, Jr., the United States Supreme Court has ruled that the Government does not have an unlimited amount of time to bring civil penalty actions based on fraud. In Gabelli v. Securities and Exchange Commission, 11-1274 (U.S. Feb. 27, 2013), the Supreme Court ruled that 28 U.S.C. § 2462, the five-year statute of limitations applicable to civil penalty actions brought by the Government, starts running on the date the allegedly fraudulent conduct occurred and is not subject to a discovery rule in cases based on fraud. Section 2462 states that “[e]xcept as otherwise provided by Act of Congress,” an action for a civil penalty “shall not be entertained unless commenced within five years from the date when the claim first accrued.” The Securities and Exchange Commission (the “SEC”) had argued that a civil penalty claim sounding in fraud accrues when the Government discovers or reasonably should have discovered the violation. But the Court squarely rejected the SEC’s argument, noting the “lack of textual, historical, or equitable reasons to graft a discovery rule onto the statute of limitations of § 2462.”1

The SEC originally brought claims against Marc Gabelli, a former portfolio manager of Gabelli Global Growth Fund (the “GGGF”), and Bruce Alpert, the Chief Operating Officer of Gabelli Funds, LLC, alleging, among other things, that Gabelli and Alpert had aided and abetted a violation by Gabelli Funds of Section 206 of the Investment Advisers Act of 1940, 15 U.S.C. §§ 80b-6(1)-(2). According to the SEC, Gabelli Funds had violated Section 206 by allowing one investor to engage in frequent trading of mutual fund shares in exchange for a small investment in a Gabelli hedge fund without disclosing the trading or investment to the GGGF board of directors. Although Gabelli Funds had caused the trading at issue to end in August 2002, the SEC did not file its complaint until April 2008. The SEC sought to avoid the bar of Section 2462’s five-year statute of limitations by arguing that it had not discovered the alleged fraud until late 2003, after then-New York Attorney General Eliot Spitzer announced his investigation of market timing in mutual funds.

At the motion to dismiss stage of the case, the United States District Court for the Southern District of New York dismissed as time-barred the SEC’s civil penalty claim for aiding and abetting a violation of Section 206.2 But, on appeal by the SEC, the United States Court of Appeals for the Second Circuit reversed the District Court and held that, for purposes of Section 2462’s statute of limitations, a claim sounding in fraud does not accrue until the SEC discovers it or reasonably should have discovered it.3

The Supreme Court granted certiorari on September 25, 2012, and oral argument was held on January 8, 2013. In its 9-0 decision, the Court explained that “the most natural reading” of Section 2462 is that “a claim based on fraud accrues—and the five-year clock begins to tick—when a defendant’s allegedly fraudulent conduct occurs.”4 The Court noted that since the 1800s, it has been the “standard rule” that an action accrues “when the plaintiff has a complete and present cause of action.”5 Moreover, the Court said, statutes of limitation are vital to the welfare of society and advance the basic policies of repose and elimination of stale claims.6 That is particularly so in cases involving the pursuit of penalties, since they are not intended to compensate but are instead intended to punish and label wrongdoers.7

According to the Court, the discovery rule is an exception to the general rule of accrual, and can suspend the running of a limitations period where a plaintiff has been injured by fraud and remains ignorant of it, without any fault or want of diligence or care on his or her part.8 But, the Court explained, the discovery rule has not been and should not be applied in a case like this one, where the plaintiff is not a victim seeking recompense for a latent injury, but is instead the Government bringing an enforcement action.9 Unlike the situation of an individual victim who may not know he or she has been wronged until an injury becomes apparent, the Government is charged with rooting out potential claims. That is particularly so here, where the SEC has as its mission to investigate potential violations of the federal securities laws and has “many legal tools at hand to aid in that pursuit.”10

The Court further explained that the discovery rule proposed by the SEC would present particular challenges for the courts, because it would require courts to determine exactly when the Government knew or should have known of a fraud.11 This would be a very challenging inquiry to force upon courts given that many individuals and agencies might have knowledge of potential wrongdoing, issues concerning agency priorities and resource constraints play a role in the government’s determinations about whether to bring enforcement actions, and governmental privileges might come into play if discovery were sought on the issues of when the Government knew or should have known about wrongdoing.12 Given the challenges associated with applying the discovery rule to Government penalty actions, the Court held that Congress is better suited than courts are to determine whether such a rule should apply.13

The Supreme Court’s decision is a blow to the enforcement powers of all Government agencies. The Government can no longer pursue expired civil penalty claims sounding in fraud simply by pleading reliance on the discovery rule. And companies and individuals can take some comfort in the fact that conduct that occurred more than five years ago cannot form the basis of a penalty claim, unless the Government can establish fraudulent concealment, equitable estoppel or equitable tolling.14

Dechert LLP represents Petitioner Bruce Alpert in this matter.

Footnotes

1 Gabelli v. SEC, No. 11-274, slip op. at 11 (U.S. Feb. 27, 2013).

2 SEC v. Gabelli, No. 08-CV-3868, 2010 WL 1253603 (S.D.N.Y. Mar. 17, 2010).

3 SEC v. Gabelli, 653 F.3d 49, 59-61 (2d Cir. 2011). Note that this decision was based solely on the pleadings and was not a decision on the merits of the dispute.

4 Gabelli v. SEC, No. 11-274, at 4.

5 Id. at 5 (internal quotation marks and citation omitted).

6 Id.

7 Id. at 8-9.

8 Id. at 6.

9 Id. at 6-8.

10 Id. at 8.

11 Id. at 9-11.

12 Id.

13 Id. at 11.

14 Note that defendants deny any wrongdoing and the case is yet to be tried. After the case is remanded, defendants will have the opportunity to refute the SEC's claims.