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Supreme Court: No Discovery Rule for SEC Enforcement Actions
Practical Law Legal Update 9-524-6827 (Approx. 3 pages)
Supreme Court: No Discovery Rule for SEC Enforcement Actions
by PLC Litigation
| Published on 05 Mar 2013 • USA (National/Federal) |
The US Supreme Court held in Gabelli v. SEC that the five-year statute of limitations for the government to bring enforcement actions begins to run when the fraud occurs, not when it is discovered.
Key Litigated Issue
The key litigated issue was whether the five-year statute of limitations set out in 28 U.S.C. Section 2462 began to run when the fraud occurred or when the fraud was discovered for a Securities and Exchange Commission (SEC) civil enforcement action.
Background
The SEC can bring enforcement actions against investment advisers in violation of the Investment Advisers Act of 1940, which prohibits an investment adviser from committing fraud on any client or prospective client. The general statute of limitations for civil penalty actions in 28 U.S.C. Section 2462 states that an action must be commenced within five years from the date when the claim first accrued.
The case began when the SEC brought a civil enforcement action against the petitioners, who were the CEO of an investment adviser company and the portfolio manager of a mutual fund. The complaint alleged that as part of a quid pro quo agreement, the petitioners allowed an investor to engage in "market timing" (a strategy to exploit the time delay in the daily valuation system of mutual funds) without disclosing the investor's activity or agreement to other investors in the fund.
The district court dismissed the SEC's civil penalty claim as time barred because the case was brought in April 2008 and the complaint only alleged market timing activities up until August 2002. The US Court of Appeals for the Second Circuit reversed. Applying the "discovery rule," the Second Circuit held that the statute of limitations does not accrue until the claim is discovered or could have been discovered with reasonable diligence since the underlying violation was fraud.
Outcome
In a unanimous decision on February 27, 2013, the Supreme Court reversed the Second Circuit and held that the discovery rule does not apply to the government bringing an enforcement action. It found that the rule is intended to benefit private parties who are unaware of injury and who do not have any reason to suspect fraud.
The court pointed out the differences in:
- The purpose of the discovery rule and the SEC's mission to investigate these violations as well as the tools at its disposal to fulfill this mission.
- The compensatory relief sought by private parties versus the civil penalties sought by the SEC.
- The level of difficulty of determining knowledge and discovery of a fraud by a government agency versus determining knowledge of a private party. The court explained that this challenge would leave defendants vulnerable to enforcement actions for an uncertain period of time.
The court therefore concluded that the five-year statute of limitations in 28 U.S.C. Section 2462 starts accruing when the fraud occurs, not when it is discovered.