Wednesday, January 09, 2013

US Supreme Court Hears Oral Arguments in Case Involving Discovery Rule and Statute of Limitations for SEC Enforcement Actions


Oral argument in a case involving the question of whether a discovery rule should be engrafted on the applicable limitations period for SEC enforcement actions seeking civil penalties revealed concern among Supreme Court Justices as to the broad scope of such a rule and the difficulty of showing whether a federal regulatory agency acted with due diligence in discovering alleged misconduct. The Court is reviewing a decision by a Second Circuit panel that the five-year limitations period in 28 USC 2462 did not begin to run until the SEC discovered, or reasonably could have discovered, the alleged fraudulent scheme. Gabelli v. SEC, Dkt. No. 11-1274.

In the enforcement action, the SEC alleged that market timing violated the Investment Advisers Act and sought monetary penalties for those violations. The Advisers Act, like many federal statutes, does not set forth a specific time period within which the Government must institute an enforcement action. In such instances, the five-year limitations period in 28 USC 2462 is applied. Section 2462 provides that an action for the enforcement of any civil penalty must not be entertained unless begun within five years from the date when the claim first accrued.

Justice Stephen Breyer was concerned that Section 2462 is not an SEC statute, it is not a securities statute. Rather, it is a statute that applies to all Government actions, he noted, which is a huge category across the board and it is about 200 years old. Until 2004, the Justice was unable to find a single case in which the Government ever tried to assert the discovery rule where what it was seeking was a civil penalty, not to try to make themselves whole where they are a victim, with one exception, a case in the 19th century where they did make that assertion and were struck down by the district court. Mentioning Social Security, Veterans Affairs, and Medicare, Justice Breyer noted that this has enormous consequences for the Government suddenly to try to assert a quasi-criminal penalty and abolish the statute of limitations in a vast set of cases.

Arguing for the SEC, U.S. Assistant Solicitor General Jeffrey Wall noted that it was not until 1990 that Congress gave the Commission the right to seek civil penalties, so it could only have brought these actions for the last 20 years. 

Justice Sonia Sotomayor questioned how a party could defeat the Government's claim of discovery by showing that the Government wasn't reasonably diligent. How does a party ever accomplish that, she queried.

Mr. Wall said that discovery is playing itself out in cases like these in district courts and privilege has not been a very major issue for the reason that defendants are by and large pointing to things in the public domain, such as private lawsuits, public filings with the Commission, and public statements, to say that those put the Commission on constructive notice. The way it plays out is that the Commission says that it didn't know and a defendant points to something in the public domain, such as public filings with the Commission or public statements to say that those put the Commission on constructive notice.

Chief Justice John Roberts said that it really depends on how many enforcement officers the SEC has if it is reasonable for them to have been aware of the particular item in some publication.  To the Chief Justice, it seems that it is going to be almost impossible for somebody to prove that the Government should have known about something. It does not provide a lot of repose because you have to establish that this particular federal agency should have known about this.

Justice Ruth Bader Ginsburg described the five-year limitations period in Section 2462 as a generous period. She asked Mr. Wall to explain the SEC's pursuit of this case. The alleged fraud went on from 1999 to 2002, noted the Justice, and it was discovered in 2003.  The SEC waited from 2003 to 2008 to commence suit.  What is the reason for the delay from the time of discovery till the time suit is instituted, asked the Justice. Mr. Wall noted that there was a lot of back and forth between the parties, document exchanges and such, and they wanted to make additional submissions. The Government hoped that there would be a settlement that would encompass all the defendants.  Ultimately, there was a settlement that only went to the fund and petitioners did not settle and then the Government put together and brought its case.

Justice Elena Kagan described the situation as one involving a decision about enforcement priorities.  The Government had decided not to go after market timers, but changed its decision when a State attorney general decided to do it. She questioned if that was the kind of situation that the discovery rule was intended to operate on. Mr. Wall noted that  it wasn't market timing that the Government discovered.  What the State attorney general announced was that there were advisors permitting market timing, but misleading investors about it and they were doing it in return for investments in other funds that they managed, and then the Government started doing market sweeps for those agreements.

Arguing for the petitioner, Lewis Liman noted that in this case the government is seeking a penalty, and is not acting on behalf of underlying investors, and the  recovery is not one that is brought by way of damages or disgorgement. You are talking about a penalty, he emphasized, you are not talking about recovery to victims. 

On a question from Justice Ginsburg, Mr. Liman clarified that Section 2462 applies exclusively with  respect to penalties, fines and forfeitures.  It does not apply with respect to equitable remedies, such as disgorgement.