In an important decision, the Supreme Court held that the SEC has five years from when a fraud occurred to file an action to seek civil penalties. Although the ruling was limited to civil penalties, the decision might prompt lower courts to apply a five-year limitations period to other types of relief sought by the SEC. The decision will also put more pressure on the SEC to move faster in its investigations.
In a unanimous decision, the Supreme Court of the United States ruled in Gabelli v. SEC
that the U.S. Securities and Exchange Commission (SEC) has five years from when a fraud occurred, and not from the SEC’s discovery of the fraud, to seek civil penalties in enforcement actions. Gabelli v. SEC
, 568 U.S. ___ (2013).
In 2008 the SEC brought an action against defendants for aiding and abetting the antifraud provisions of the Investment Advisers Act of 1940, based on allegations of allowing market timing in a mutual fund. Gabelli, 568 U.S. at *2–*3. The complaint sought an injunction, disgorgement and a civil penalty. Because the complaint was filed more than five years after the last alleged violation, the district court dismissed the penalty claim under 28 U.S.C. Section 2462’s five-year statute of limitations. On appeal, the U.S. Court of Appeals for the Second Circuit reversed, holding that the discovery rule should be read into Section 2462 for claims based on fraud. The Second Circuit ruled that, under Section 2462, a fraud claim did not “accrue” until the SEC discovered it or could have discovered it based on “reasonable diligence.”
In the Gabelli decision, the Supreme Court declined to read the discovery rule into Section 2462 based on the plain language of the statute and strong policy reasons. Gabelli, 568 U.S. at *9–*11. The Supreme Court explained that the most natural reading of the statute was that a claim accrues when the plaintiff has a cause of action. The Court stressed that this reading furthers the purpose of the statute of limitations to reduce stale claims and create more certainty for defendants about their potential liabilities. The Court also found that historically the discovery rule had not been used to assist the government to recover penalties in enforcement actions. Instead, the rule has been used to assist “defrauded victims” to recover compensation “where a defendant’s deceptive conduct may prevent a plaintiff from even know¬ing that he or she has been defrauded.” Because private plaintiffs are not “in a state of constant in¬vestigation … and do not typically spend [their] days looking for evidence that they were lied to or defrauded,” the Court explained that they are afforded the benefits of the discovery rule. By contrast, the Court found that the SEC does not need these protections, as its mission is to investigate potential securities violations and it has an arsenal of tools for doing so (including, as discussed in the opinion, issuing subpoenas, making awards to whistleblowers and offering cooperation agreements).
The Court also relied on important policy considerations to support its decision. The Court explained that applying the discovery rule to Section 2462 would “leave defendants exposed to Government enforcement action not only for five years after their misdeeds, but for an additional uncertain period into the future.” Gabelli, 568 U.S. at *9. Additionally, the Court noted the practical difficulties that would exist if courts had to determine when the government “knew or should have known” of a fraud. For example, complications would arise when the government would assert privileges, as courts (and defendants) tried to ascertain the reasonable diligence of the government.
While the Court held that the SEC has five years to seek civil penalties, the decision did not address two related and important issues. The Court did not address whether the equitable tolling doctrine—“when the defendant takes steps beyond the chal¬lenged conduct itself to conceal that conduct from the plaintiff”—can be applied to Section 2462, and effectively provide the SEC with additional time beyond the five years. The opinion explained that because the SEC previously abandoned this issue, it was not before the Court. However, some of the Court’s reasoning in rejecting the application of the fraud discovery rule would appear to support an argument that equitable tolling is inapplicable to Section 2462. For example, the Court’s textual analysis of Section 2462, as well as its policy considerations, would support such an argument.
The second issue not discussed in the opinion was whether specific SEC remedies (such as injunctions, suspensions or bars) are considered “penalties” within the meaning of Section 2462, as some courts have held. For example, in Johnson v. SEC, the U.S. Court of Appeals for the District of Columbia Circuit held that Section 2462 precluded the SEC from suspending a brokerage firm supervisor, when the SEC filed its action after the five-year period. 87 F.3d 484 (D.C. Cir. 1996). More recently, the U.S. Court of Appeals for the Fifth Circuit relied on the Johnson case in holding that injunctions and officer and director bars constituted “penalties” subject to Section 2462’s five-year limitations period. SEC v. Bartek, No. 11-10594 (5th Cir., Aug. 7, 2012). These issues are expected to be the subject of further litigation. As a result, the SEC may face additional challenges in pursuing not only monetary penalties, but these other types of relief, based on stale conduct.
As a practical matter, the decision will put more pressure on the SEC to move faster in its investigations, something that it has tried to do for years. The decision will hopefully force the SEC to become more efficient in its approach to investigations by, among other things, adopting a more targeted approach.