Supreme Court Holds That Statute Of Limitations Applicable To Securities And Exchange Commission Matters Begins To Run On Date Of Misconduct - Civil Law

There is a general statute of limitations that applies to many penalty provisions in the U.S. Code, including civil penalties imposed by the U.S. Securities and Exchange Commission (the "Commission").¹ Tension exists with respect to whether, in fraud actions, this five year statute of limitations applies, or whether it is tolled until such time as the Commission discovers or reasonably could have discovered the fraud. This is referred to as the "discovery rule." The Court of Appeals for the Second Circuit, among others, had held that the discovery rule applied. On February 27, 2013, however, the United States Supreme Court rejected the application of the discovery rule to civil actions brought by the Commission, instead finding that the five year statute of limitations begins to run when the underlying misconduct takes place.²

I. Background

In 2008, the Commission brought a civil enforcement action against Bruce Alpert ("Alpert") and Marc Gabelli ("Gabelli"), the chief operating officer and portfolio manager, respectively, of an investment advisor to a mutual fund. The Commission alleged that Alpert and Gabelli aided and abetted an investor in their fund, Headstart Advisors, Ltd. ("Headstart"), in "market timing"³ from 1999 to 2002. It sought civil penalties.⁴

Alpert and Gabelli moved to dismiss the action on the grounds that the Commission filed too late – more than five years after the commission of the alleged fraud.⁵ The District Court agreed, but the Second Circuit reversed, finding that the Commission need only file an action for fraud within five years of its discovery of the alleged fraud.⁶

II. The Decision

The general rule with respect to statutes of limitations is that they accrue when the triggering act is committed.⁷ An exception to this general rule arises when a wrongdoer commits deceptive fraud, such that the victim is initially unable to discover its injury.⁸ In such an instance, in order to prevent injustice, the statute of limitations will be tolled until such time as the victim discovers, or should have discovered, the wrong.⁹

Here, the Supreme Court found that the discovery rule does not apply to the Commission when it files actions for civil penalties. First, the Commission is not a victim of fraud in need of protection.¹⁰ Second, the discovery rule exists, in part, to preserve the claims of victims who are reasonably unaware of their injury and, therefore, do not investigate, but the Commission's mission is to investigate potential violations of federal securities laws, including the commission of fraud.¹¹ Third, the purpose of civil penalties is to punish wrongdoers and set an example, not right a wrong or restore the status quo.¹² Extending the statute of limitations so penalties might be assessed an unlimited number of years after commission of a fraud would not effectuate either purpose.¹³ Fourth, if the court were to attempt to apply the discovery rule, it would be difficult to determine when the Commission should have discovered the fraud because such a determination "would hinge on speculation about what the Government knew, when it knew it, and when it should have known it."¹⁴

This decision effectively restricts the amount of time that the Commission can pursue civil penalties against defendants. It is possible that, going forward, the Commission may seek tolling agreements from those entities or persons under investigation in order not to run afoul of the five year statute of limitations. The decision may also force the Commission to disclose earlier its intention to commence civil actions.

Footnotes

^{1.28 U.S.C. § 2462 states, "Except as
otherwise provided by Act of Congress, an action, suit or
proceeding for the enforcement of any civil fine, penalty, or
forfeiture, pecuniary or otherwise, shall not be entertained unless
commenced within five years from the date when the claim first
accrued if, within the same period, the offender or the property is
found within the United States in order that proper service may be
made thereon."}

^2.Gabelli ^v. ^SEC^{, No. 11-1274, 2013 U.S. LEXIS 1861
(Feb. 27, 2013).}

^{"Market timing" is the practice of exploiting the
time delay in a mutual funds' daily valuation system by buying
securities that are valued lower than they will be the following
day because the current value of the securities is based on stale
information. If the reported valuation is artificially low,
market timers will buy that day and sell the next day for a quick
profit.} ^Id. ^{at *7-*8.
"Market timing is not illegal but can harm long-term investors
in a fund." 3.}^Id^{. at
*8.}

^4.^Id^{. at *8. The Act
prohibits investment advisors from "employ[ing] any device,
scheme, or artifice to defraud any client or prospective
client" or "engag[ing] in any transaction, practice or
course of business which operates as a fraud or deceit upon any
client or prospective client."} ^Id^{. at *6 (citing 15 U.S.C. §§
80b-6(1), (2)). The Commission is authorized by federal law
to (i) bring enforcement actions against investment advisors who
violate the Act and individuals who aid and abet the violations, 15
U.S.C. § 80b-9(d), and (ii) seek civil penalties for such
violations. 15 U.S.C. §§ 80b-9(e).}

^5.^Gabelli^{, 2013 U.S. LEXIS
1861 at *8-*9.}

^6.^Id^{. at *9.}

^7.^Id^{. at *11.}

^8.^Id^{. at *12-*13.}

^9.^Id^{. at *13.}

^10.^Id^{. at *16.}

^11.^Id^{. at *17.}

^12.^Id^.

^13.^Id^.

^14.^Id^{. at *18.}

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