The US Supreme Court recently handed the US Securities and Exchange Commission (the “SEC”) a very clear message: the act of fraud – not its discovery – triggers the start of the limitation period in government enforcement proceedings.

Chief Justice Roberts’ unanimous decision in Gabelli et al v. Securities and Exchange Commission gave a strict reading to the five-year statutory limitation period for initiating civil penalty proceedings. In so doing, the Court flatly rejected the SEC’s argument that it is only the discovery of fraud which starts the clock ticking.

Background and Lower Court Decisions

In 2008 the SEC commenced civil proceedings against the chief operating officer and the former portfolio manager of Gabelli Fund LLC (the “Defendants”) under the Investment Advisers Act. The SEC alleged that between 1999 and 2002 the Defendants allowed one investor to engage in market timing in the Fund in exchange for its investment in a separate hedge fund run by the portfolio manager.

The Investment Advisers Act authorizes the SEC to seek civil penalties against investment advisers who defraud or who aid and abet in defrauding their clients. These proceedings are subject to the five-year limitation period under the U.S. Code, 28 U.S.C. §2462. However, the SEC did not start enforcement proceedings until six years after the last of the alleged offences.

The Defendants sought to have the SEC’s claim dismissed on the grounds that the Commission was out of time to bring the action, given section 2462. The District Court agreed, dismissing the SEC’s claim as statute-barred. On appeal, the Second Circuit (appeal court) reversed that decision and accepted the SEC’s argument that the limitation period did not begin to run until the alleged fraud was discovered. The Supreme Court reversed the appeal decision andsent it back to the Second Circuit for further action.

US Supreme Court Decision

The Supreme Court rendered a concise judgment rejecting the SEC’s argument in favour of extending the limitation period.

The Court reasoned that the discoverability rule is intended to enable the unsuspecting victim of fraud to obtain recourse once fraud is discovered.  However, unlike an unsuspecting victim, “the SEC’s very purpose is to root [fraud] out, and it has many legal tools at hand to aid in that pursuit”. The Court painted the SEC as a unique plaintiff for whom the protection of the discoverability rule – to grant the unsuspecting victim of fraud access to justice – was not necessary, given its mandate and resources.

Further, the Court considered the very practical challenges of applying the discoverability rule to such a vast entity, noting the difficulty in defining who is “the Government”, and in determining what “the Government” (with all of its offices, employees and levels of authority) knew or ought to have known at a point in time. The Court also noted that the Government could rely on various forms of privilege, which would further complicate any attempt to determine the state of the Government’s knowledge at any given time.

The Court therefore applied the five-year statutory period as a fixed date, after which exposure to Government enforcement efforts ended: “even wrongdoers are entitled to assume that their sins may be forgotten,” citing Wilson v. Garcia.

Potential Significance

For companies subject to U.S. government enforcement regulations, the limitation period under s.2462 is now clearly five years from the date of the last alleged offence.

For companies subject to Canadian government enforcement regulations, the state of the law on discoverability remains undefined. First, the issue is complicated by the fact that there is no single federal counterpart to the SEC;  here, securities regulators are provincial, each with its own governing statute.  There is some consistency across the statutes, since most provincial securities acts have a limitation period of six years from the date of the last occurrence of the alleged offence. Manitoba is the exception; there, the limitation period is two years after the securities commission gains knowledge of the facts of the alleged offence (imputing discoverability), and ultimately eight years after the date the offence was committed.  See The Securities Act C.C.S.M. c. S50 at s. 137.

Second, in Canada there is no defining decision comparable to Gabelli;  the only relevant case that could be found is British Columbia Securities Commission, Re: Roger F. Bapty et al. In that decision, the Supreme Court of British Columbia rejected the provincial Commission’s attempt to rely on discoverability, ruling that the B.C. Legislature explicitly intended to exclude discoverability by removing the element of “knowledge” from the 1989 amendments to the B.C. Securities Act.

While the Gabelli decision will not be determinative in Canada, it may be a powerful precedent to convince Canadian courts that the provincial governments should not be entitled to rely on the discoverability rule in civil penalty proceedings; in other words, that time should be of the essence in Canada too.

Case Information

Gabelli et al v. Securities and Exchange Commission

Docket No.: 11-274

Date of Decision: February 27, 2013