- Supreme Court Limits SEC’s Ability to Seek Penalties
- March 11, 2013
- Law Firm: Bingham McCutchen LLP - Boston Office
The United States Supreme Court held this week that the U.S. Securities and Exchange Commission must bring a civil enforcement action seeking a penalty or fine within five years of the completion of the alleged fraud or wrongful conduct. The unanimous decision in Gabelli v. SEC, No. 11-1274 (U.S. Feb. 27, 2013) represents a defeat for the United States, which argued that the five-year limitations period did not begin to run until the government discovered facts sufficient to give it notice of the alleged wrongdoing. The decision significantly limits the SEC’s ability to seek a fine or penalty for wrongful conduct that occurred years before the Commission learned about the alleged fraud. Gabelli also has ramifications for other federal civil enforcement actions because the relevant statute, 28 U.S.C. § 2462, is a catch-all limitations period that generally applies to action for a civil penalty or fine brought by the United States.
Writing for the Court, Chief Justice John Roberts relied on the standard presumption that a cause of action accrues (and the limitations period begins to run) when the fraudulent conduct occurs. The Chief Justice noted that courts developed an exception to this standard rule for private parties alleging fraud because the deceptive conduct may delay their ability to detect the fraudulent acts. But this exception should not apply to a civil enforcement action, the Court held, because the government’s investigatory powers and the punitive nature of an enforcement proceeding give the United States unique advantages in detecting fraud. Without any evidence that Congress intended the discovery rule to apply to such proceedings, the Court held that the standard accrual rules govern the limitations period set forth in Section 2462. The decision overturned a prior ruling by the United States Court of Appeals for the Second Circuit in favor of the SEC.
The statutory provision at issue provides in relevant part that, “[e]xcept as otherwise provided by Act of Congress, an action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture . . . shall not be entertained unless commenced within five years from the date when the claim first accrued[.]” 28 U.S.C. § 2462. Since the Court of Appeals for the D.C. Circuit’s landmark decision in SEC v. Johnson, 87 F.3d 484 (D.C. Cir. 1996), Section 2462 is the primary limitations period that governs civil enforcement actions brought by the SEC that seek to impose a penalty.
In Gabelli, the SEC brought an enforcement action alleging violations of the Investment Advisers Act by two officers of a mutual fund. The defendants argued that the claims were barred by Section 2462 because their alleged wrongful actions occurred (and thus the claim “accrued”) more than five years before the filing of the Complaint. The district court agreed with the defendants and dismissed the Advisers Act claims. The Second Circuit reversed, accepting the SEC’s argument that the claim did not accrue, and the limitations period did not begin to run, until after the SEC discovered facts regarding the alleged fraud. In doing so, the Second Circuit “presume[ed] that the discovery rule applies to these claims unless Congress directs otherwise.” Id. at 60.
The defendants petitioned the Supreme Court for a writ of certiorari, which the Supreme Court granted on September 25, 2012. The Court heard arguments on the case on January 8, 2013, and issued its decision relatively quickly, on February 27, 2013.
The Supreme Court’s Decision
The Court’s decision began by agreeing with the petitioner-defendants that “the most natural reading of the statute” was that the five-year limitation period set forth in Section 2462 “begins to tick . . . when a defendant’s allegedly fraudulent conduct occurs.” Gabelli, No. 11-1274 (slip op.), at 4. The Court went on to note that this was consistent with the “standard rule” that “has governed since the 1830s when the predecessor to [Section] 2462 was enacted.” Id. at 5. The Court further noted that by setting a fixed date by which the government had to bring an enforcement action seeking a penalty, this reading of Section 2462 advanced “the basic policies of all limitations provisions: repose, elimination of stale claims, and certainty about a plaintiff ’s opportunity for recovery and a defendant’s potential liabilities.” Id. (quoting Rotella v. Wood, 528 U. S. 549, 555 (2000)) (quotation marks omitted).
Turning to the government’s argument, the Court noted that although there was a long history of applying the discovery rule to protect private plaintiffs‘ claims for losses due to fraud, there was no such history applying the discovery rule to government enforcement actions. At argument, the Court noted, the government was “unable to point to any example from the first 160 years after enactment of this statute of limitations where it had even asserted that the fraud discovery rule applied in such a context.” Id. at 6. The Court distinguished the decision in Exploration Co. v. United States, 247 U. S. 435 (1918) because in that case “the Government was itself a victim; it had been defrauded and was suing to recover its loss.”
Civil enforcement actions are different, the Court held, because the SEC is not analogous to a private party, who cannot reasonably be expected to be ever-vigilant for fraud and on alert with respect to each transaction. The “very purpose” of the SEC is to root our fraud, “and it has many legal tools at hand to aid in that pursuit.” Id. at 8. The Court noted the SEC’s broad authority to request trading information, books and records; to subpoena documents and witnesses; to pay monetary awards to whistleblowers; and offer cooperation agreements to violators who provide valuable information. “Charged with this mission and armed with these weapons, the SEC as enforcer is a far cry from the defrauded victim the discovery rule evolved to protect.” Id. (We highlighted these precise concerns in our Legal Alert dated Sept. 26, 2012.)
Finally, the Court emphasized some of the practical difficulties of applying the discovery rule to the government, since it normally requires a showing of when a “reasonably diligent” party would have discovered the fraud. “It is unclear whether and how courts should consider agency priorities and resource constraints in applying that test to Government enforcement actions.” Id. at 9-10. Moreover, “the Government can be expected to assert various privileges, such as law enforcement, attorney-client, work product, or deliberative process, further complicating judicial attempts to apply the discovery rule.” Id. at 10. Because “[a]pplying a discovery rule to Government penalty actions is far more challenging than applying the rule to suits by defrauded victims, and we have no mandate from Congress to undertake that challenge here,” Id. at 11, the Court rejected the government’s arguments and reversed the decision of the Second Circuit.
The decision in Gabelli substantially hampers the SEC’s ability to enforce a penalty or fine for conduct that occurred more than five years prior to the filing of an action. It does not, however, necessarily preclude the government from arguing that a defendant’s affirmative acts of concealment would equitably toll the applicable statute of limitations. The decision also does not address the issue of whether seeking injunctions or other equitable remedies (including disgorgement) could in some situations be considered a “penalty” subject to the statute of limitations - an issue on which lower courts have split. Nor does it prevent the SEC from seeking tolling agreements that would extend the limitations period beyond the five years set forth in Section 2462. The decision thus may have the greatest effect on cases in which the Commission’s investigation of conduct does not begin until five years after the conduct occurred. However, because the primary events in the 2007-2008 financial crisis occurred nearly (and in some cases more than) five years ago, the decision may have a significant effect on the SEC’s ability to bring additional cases relating to the financial crisis.