In a unanimous decision issued last week, the Supreme Court declined to apply the “fraud discovery rule” to SEC enforcement actions seeking civil penalties under 28 U.S.C. § 2462. See Gabelli v. U.S. Securities & Exchange Commission. In Gabelli, the SEC had filed a complaint in April 2008 alleging that the defendants had improperly permitted an investor in a mutual fund to engage in “market timing” from 1999 to 2002, and that the Commission had not uncovered the scheme until 2003, due to its secret nature. Even though 28 U.S.C. § 2462 states that any government enforcement action to obtain a civil “fine, penalty, or forfeiture, pecuniary or otherwise” must be brought within five years from the day “when the claim first accrued,” the SEC had argued that the statute of limitations did not begin to run until the Commission discovered the alleged fraud in 2003. Reversing the Court of Appeals for the Second Circuit, which had sided with the SEC, the Court held that a “discovery rule” should not be read into 28 U.S.C. § 2462 in SEC enforcement cases. Instead, the Court held that a “natural reading” of the statute supported the conclusion that a fraud-based claim “accrues” when the allegedly fraudulent conduct occurs, and not – as urged by the Commission - when it is either discovered by the government or should have been discovered by exercising reasonable diligence.
As discussed below, Gabelli is a significant litigation setback for the Commission, and can be expected to have a meaningful impact on the SEC’s short-term enforcement and litigation agenda. At the same time, the decision leaves other important issues relating to SEC enforcement actions unresolved for now.
First, the Gabelli decision is notable for the Court’s lack of sympathy to the SEC’s argument that fraud, by its nature, is often difficult for the government to uncover and challenging to investigate. Contrasting the SEC with a private plaintiff seeking compensatory damages – as to whom the application of a “fraud discovery rule” might remain appropriate - the Court observed that the SEC’s “very purpose” is to root out fraud and that the Commission “has many legal tools at hand to aid in that purpose.” In light of the many weapons in the SEC’s enforcement arsenal, the Court apparently saw no reason to adopt a strained interpretation of the statute that would create substantial uncertainty among potential respondents or defendants in SEC actions as to exactly how long they might be exposed to penalty claims. The Court’s literal reading of 28 U.S.C. § 2642 is consistent with other Court opinions in recent years that have rejected the SEC’s preferred interpretations and narrowly construed the reach of the federal securities laws.
Second, Gabelli was announced at a critical time for the SEC, which has been criticized for its response to the financial crisis and currently has a backlog of financial crisis-related investigations that may soon bump up against the five-year statute of limitations. While the SEC may seek to mitigate the decision’s impact by asking individuals and entities currently under investigation to enter into voluntary “tolling agreements” that suspend the running of the statute, some may refuse to do so. Gabelli will thus place pressure on the SEC to make decisions soon in some pending enforcement matters, and increase the odds that defendants in cases that are brought will be able to assert successfully that the statute of limitations has run on the Commission’s penalty claims.
Third, the Court took pains in Gabelli to make clear that it was not addressing whether the statute of limitations under 28 U.S.C. § 2462 could be tolled in cases involving “fraudulent concealment” – i.e., situations where a defendant allegedly takes steps beyond the underlying alleged misconduct to conceal such conduct from the government or other plaintiffs. Instead, the Court expressly noted that the SEC had abandoned any reliance in the Gabelli case on the fraudulent concealment doctrine or other equitable tolling principles. In the wake of Gabelli, however, the SEC may assert in future cases that defendants did, in fact, take steps to “fraudulently conceal” securities law violations from the Commission, while defendants are likely to respond that the SEC is seeking to circumvent the Court’s decision.
Fourth, while Gabelli makes clear that a “discovery rule” does not apply to SEC actions to obtain civil penalties, the Court left undecided exactly what constitutes a “fine, penalty, or forfeiture” within the meaning of 28 U.S.C. § 2462. While the phrase clearly encompasses civil monetary penalties, the Court of Appeals for the Fifth Circuit held last year in SEC v. Bartek that, in some circumstances, SEC requests for injunctive relief and the imposition of officer-and-director bars on defendants also are “penalties” subject to the five-year statute of limitations. Read together, the Gabelli and Bartek decisions up the ante on the SEC to justify its requests for injunctive and other forms of relief, such as director-and-officer bars, as remedial, rather than punitive, in nature, since defendants will have every incentive to point out the draconian consequences that such sanctions can be expected to have on their professional livelihoods and future careers.