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.