On Feb. 27, 2013, the U.S. Supreme Court issued an opinion that narrows the SEC's ability to seek civil penalties in its enforcement actions. In Gabelli v. SEC, the Supreme Court held that the SEC cannot use the "discovery rule" to extend the five-year statute of limitations on the government's claims for civil penalties. Given that SEC investigations often take years, the Supreme Court's adoption of this bright-line rule will likely reduce the number of civil penalty claims that the SEC brings.
When the SEC files a civil action in federal court, it usually seeks three types of relief: 1) a permanent injunction from future violations of the securities laws; 2) disgorgement; and 3) civil penalties. Congress long ago imposed a five-year statute of limitations on actions seeking civil penalties. See 28 U.S.C. § 2462. Relying on the "discovery rule," the SEC has often argued that the five-year statute of limitations should not begin to run until the SEC discovered the fraud, and courts have reached different results on the issue. The Supreme Court has now put the issue to rest.
In Gabelli v. SEC, the Supreme Court held that the government cannot use the "discovery rule" to extend the statute of limitations, but must be held to the strict five-year limitation. In reaching this decision, the Court drew a contrast between cases brought by victims of fraud and the agencies charged with responsibility for policing fraud. The Court explained that the "discovery rule" is intended to protect victims of fraud, where a defendant's deceptive conduct prevents a victim from knowing that he or she had been defrauded. In that situation, the fraud is " 'deemed to be discovered when, in the exercise of reasonable diligence, it should have been discovered.' " Gabelli, Slip Op. at 6 (quoting Merck & Co. v. Reynolds, 130 S.Ct. 1784, 1794(2010)). The Court said it has never applied the "discovery rule" to government enforcement actions because unlike a victim who may have no reason to suspect fraud, it is the SEC's mission to investigate and root out fraud. And the SEC is imbued with considerable resources to carry out that mission, including the ability to subpoena documents and testimony before filing an action. The Court held that "[c]harged 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." Gabelli, Slip Op. at 8. The Court also recognized the practical difficulty of applying the discovery rule to a government agency, given the challenge of determining when a government agency should have discovered the fraud "in the reasonable exercise of diligence."
Although Gabelli arose in the context of the Investment Advisers Act of 1940, it is certain that courts will apply the ruling with equal force in actions brought under the Securities Act of 1933 and the Securities Exchange Act of 1934. The civil penalty provisions of the three acts are very similar. Compare 15 U.S.C. § 77t(d) with 15 U.S.C. § 78u(d)(3) and 15 U.S.C. § 80b-9(e). Moreover, the Supreme Court left room for courts to apply Gabelli to any case involving a government claim for civil penalties, noting that Section 2462 governs "many penalty provisions throughout the U.S. Code." Gabelli, Slip Op. at 2.
Finally, the Court's ruling does not address whether Section 2462 applies to claims for disgorgement or injunctive relief, and the SEC will undoubtedly argue that Section 2462 does not apply to such claims because they are not penalties. Thus, while Gabelli may not deter the SEC from bringing enforcement actions where there is a considerable amount of disgorgement to be recovered, the ruling may cause the SEC to think twice about bringing cases involving old conduct, where a defendant has obtained little or no ill-gotten gains.
The full Supreme Court opinion can be found here: http://www.supremecourt.gov/opinions/12pdf/11-1274_aplc.pdf.
To learn more about the Gabelli case, the SEC litigation release can be found here: http://www.sec.gov/litigation/litreleases/2008/lr20539.htm
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