In Gabelli v. Securities & Exchange Commission, No. 11-1274, 2013 WL 691002 (U.S. Feb. 27, 2013), the United States Supreme Court, in a unanimous opinion by Chief Justice Roberts, held that the five-year statute of limitations for the Securities & Exchange Commission (“SEC”) to bring a civil suit seeking penalties for securities fraud against investment advisers, codified in 28 U.S.C. § 2462 (“Section 2462”), begins to run when the alleged fraud occurs, not when it is discovered. In so holding, the Supreme Court refused to extend to Government civil penalty enforcement actions the “discovery rule,” which starts the clock on the statute of limitations for civil fraud actions when plaintiff should have reasonably discovered the fraud. The Supreme Court’s decision thus limits the authority of the SEC to seek civil penalties with respect to conduct that occurred more than five years before investigators took action.

In April 2008, the SEC sought civil penalties from petitioners Alpert and Gabelli under the Investment Advisers Act of 1940, which provides that it is unlawful for an investment adviser “to employ any device, scheme, or artifice to defraud any client or prospective client” or “to engage in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client.” 15 U.S.C. § 80b-6(1), (2). The complaint alleged that petitioners aided and abetted investment adviser fraud from 1999 until 2002. Petitioners moved to dismiss, arguing in part that the civil penalty claim was untimely. Invoking the five-year statute of limitations in Section 2462, they pointed out that the complaint alleged illegal activity up until August 2002 but was not filed until April 2008. The United States District Court for the Southern District of New York agreed and dismissed the civil penalty claim as time-barred. The United States Court of Appeals for the Second Circuit reversed, accepting the SEC’s argument that because the underlying violations sounded in fraud, the “discovery rule” applied, meaning that the statute of limitations did not begin to run until the SEC discovered or reasonably could have discovered the fraud.

The Supreme Court reversed and remanded. The Court explained that “in common parlance a right accrues when it comes into existence” and that the “standard rule” is that a claim accrues “when the plaintiff has a complete and present cause of action.” The Court reasoned that such a reading sets a fixed date when exposure to the specified Government enforcement efforts ends, advancing “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.” Nonetheless, citing Merck & Co. v. Reynolds, 130 S. Ct. 1784 (2010) [see blog article here], the Court noted that “the discovery rule” doctrine is an “exception” to the standard rule, and delays accrual “until a plaintiff has actually discovered or a reasonably diligent plaintiff would have discovered the facts constituting the violation—whichever comes first.” The Supreme Court observed that this “exception” arose from the recognition that “something different was needed in the case of fraud, where a defendant’s deceptive conduct may prevent a plaintiff from even knowing that he or she has been defrauded.” Thus where a plaintiff has been injured by fraud and “remains in ignorance of it without any fault or want of diligence or care on his part, the bar of the statute does not begin to run until the fraud is discovered.”

The Court, however, drew a distinction between the former and the facts of this case. The Court noted that it has never applied the discovery rule in the context “where the plaintiff is not a defrauded victim seeking recompense, but is instead the Government bringing an enforcement action for civil penalties.” In this situation the Supreme Court noted that “there are good reasons why the fraud discovery rule has not been extended.”

First, the Supreme court noted that the discovery rule exists in part to preserve the claims of parties who have no reason to suspect fraud. The Government is a different kind of plaintiff. The SEC’s very purpose, for example, is to root out fraud, and it has many legal tools at hand to aid in that pursuit. Second, the Government in these types of cases also seeks a different type of relief. The discovery rule helps ensure that the injured receive recompense, but civil penalties go beyond compensation, are intended to punish, and label defendants as wrongdoers. Third, emphasizing the importance of time limits on penalty actions, the Supreme Court reiterated that it would be “utterly repugnant to the genius of our laws” if actions for penalties could “be brought at any distance of time.” Thus, grafting the discovery rule onto Section 2462 would raise similar concerns; it 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.” Finally, repose would hinge on speculation about what the Government knew, when it knew it, and when it should have known it. Deciding when the Government knew or reasonably should have known of a fraud would present particular challenges for the courts, such as determining who the relevant actor is in assessing Government knowledge, whether and how to consider agency priorities and resource constraints in deciding when the Government reasonably should have known of a fraud, and so on. Thus, the Supreme Court held that applying a discovery rule to Government penalty actions is “far more challenging” than applying the rule to suits by defrauded victims, and the Court declined to do so.

The Supreme Court’s decision effectively limits the authority of the Government’s top securities regulator to seek civil penalties over conduct that occurred more than five years before investigators took action. It is important to note that the decision only applies to cases where the SEC is seeking a fine for wrongdoing; it does not disturb the “discovery rule” for private plaintiffs, who can sue within five years of discovering they have been defrauded.

For further information, please contact John Stigi at (310) 228-3717 or Taraneh Fard at (213) 617-5492.