U.S. Supreme Court Limits Timing of Federal Enforcement ActionsMarch 2013 – Securities Alert
On February 27, 2013, the U.S. Supreme Court in Gabelli v. U.S. Securities and Exchange Commission limited the time frame in which federal regulators, such as the SEC and CFTC, can bring enforcement actions seeking civil penalties for alleged fraud.1 Specifically, the Supreme Court held that the five-year statute of limitations for federal regulators to seek penalties accrues at the time the alleged fraud occurred, and not when it is later discovered by the regulator. This ruling is significant because it limits the time for regulators to bring enforcement actions and puts the burden on the regulators to discover, investigate and prosecute potential violations in a timely manner.
The SEC's Case Against Alpert and Gabelli
On April 24, 2008, in connection with an alleged market timing scheme carried out through investment advisor Gabelli Funds, LLC, the SEC charged its chief operating officer, Bruce Alpert, and portfolio manager Marc Gabelli with securities fraud. The SEC's complaint sought civil penalties against Alpert and Gabelli and alleged that they permitted a particular investor in one of the investment advisor's mutual fund products to engage in a market timing scheme between 1999 and 2002, and failed to disclose this practice to other investors.2
While the allegations of fraudulent misconduct ended in August 2002, the SEC did not file an enforcement action seeking civil penalties until April 2008. As a result, Alpert and Gabelli sought and obtained a dismissal of the action based on the grounds that the action was untimely because it was not brought within the applicable five-year statute of limitations. The SEC appealed the decision to the Second Circuit Court of Appeals arguing that because the SEC alleged fraud, the "discovery rule" should apply. Under the "discovery rule," accrual of the statute of limitations is delayed "until the plaintiff has 'discovered' his cause of action."3 The Second Circuit agreed with the SEC and held that the exception applied to such federal enforcement actions seeking civil penalties. The U.S. Supreme Court reversed and held that the discovery rule does not apply and that the five-year statute of limitations for civil penalty actions should have been strictly applied.
The Federal Regulator's Limited Statute of Limitations
Writing a unanimous opinion for the U.S. Supreme Court, Chief Justice Roberts held that federal regulators cannot apply the discovery rule to accrue the applicable statute of limitations to "start the clock" at the point when the fraud is discovered. According to 28 U.S.C. § 2462, enforcement actions seeking civil fines, penalties or forfeitures must be commenced within five years from the date when the fraud occurs.4 The Supreme Court explained that, while private citizens have the ability to invoke the discovery rule to delay accrual of applicable statutes of limitation for fraud actions, federal regulators are not afforded such an exception. "Unlike the private party who has no reason to suspect fraud, the SEC's very purpose is to root it out, and it has many legal tools at hand to aid in that pursuit."5 In addition to this distinguishable feature, the Supreme Court added that the penalties sought by government enforcement actions are "intended to punish" and are typically not available to private litigants.6
Peace of Mind
As a result of recent legislation, the securities and derivatives industries have undergone significant changes over the past few years. As industry participants work to grasp new regulations, maintaining regulatory compliance remains a constant challenge. While the SEC, CFTC and other regulators will continue to exercise broad discretion when bringing enforcement actions, the U.S. Supreme Court has now clarified a significant limitation on the ability of federal regulators to seek civil penalties for stale claims. With this decision, industry participants can operate with peace of mind -- knowing there is at least some finality to future threats of punitive regulatory enforcement.
The Securities and Derivatives Litigation and Regulatory Group at Herrick, Feinstein LLP is here to advise you on the implications of critical legal decisions as they become part of the regulatory landscape. For more information on the issues in this alert, please contact:
Therese M. Doherty at (212) 592-1516 or [email protected]
Arthur G. Jakoby at (212) 592-1438 or [email protected]
Copyright © 2013 Herrick, Feinstein LLP. Securities Alert is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.
1 No. 11-1274, 2013 WL 691002 (Feb. 27, 2013).
2 Market timing is described as a "trading strategy that exploits time delay in mutual funds' daily valuation system," but was not, on its own, an illegal practice. See Slip Op. at 2-3.
3 Slip Op. at 6, quoting Merck & Co. v. Reynolds, 559 U.S. __, __ (2010) (slip op., at 8).
4 It is important to note that enforcement claims seeking injunctive relief, such as disgorgement of illicit profits, are not subject to the statutory five-year statute of limitations. Therefore, such claims will not be barred as untimely. Slip Op. at 4, n. 1.
5 Slip Op. at 8. For example, regulators can still attempt to toll the five-year statute of limitations by claiming the existence of "fraudulent concealment" or by alleging that the violation is ongoing. See Slip Op. at 4, n. 2 (explaining that the SEC did not allege the existence of certain equitable tolling doctrines that serve to toll the applicable statute of limitations for a given period of time).