In 1805, it would have been “utterly repugnant to the genius of our laws” to provide the government with impunity from statute of limitations restrictions for a penalty action, and now, two hundred years later, the United States Supreme Court has reiterated that maxim.
Statutes of limitations have long been an integral aspect of the United States legal system. These statutes promote efficiency and certainty with regards to a plaintiff’s ability to recover damages, while also preserving a defendant’s ability to produce evidence in support of his or her defense before that evidence disappears over time. Many statutes of limitations, like 28 U.S.C. §2462, bar lawsuits initiated a certain number of years after the claim “accrued,” legal jargon for when the claim became enforceable. Yet, since the 18th Century, courts have recognized the “discovery rule” as an exception to the standard accrual language when a claim involves fraud. Because the difficulties in discovering fraud may prevent a plaintiff from recognizing his or her loss before the statute of limitations has passed, the discovery rule delays the running of the statute until the fraud is, or should have been, discovered.
In Gabelli v. SEC (S.D.N.Y. 2010), the SEC alleged investment advisors Marc Gabelli and Bruce Alpert aided in the fraudulent trading of the Gabelli Global Growth Fund (“GGGF”) by allowing Headstart Advisers, Ltd to engage in trades using “market-timing.” In exchange for leniency, Headstart agreed to invest in Gabelli’s own hedge fund. While market timing is not illegal per se, the SEC alleged that the nondisclosure of this agreement, combined with GGGF’s policy to reject trades the fund suspected of using market timing, constituted fraudulent activity. The issue was that the SEC’s complaint alleged market-timing until August 2002, but the complaint was not filed until April 2008––a period of almost six years. Applying the standard reading of Section 2462, the district judge held that the cause of action for civil penalty was time barred and dismissed the case. The Second Circuit reversed the district court, applying the discovery rule to the benefit of the SEC.
On February 27, 2013, the United States Supreme Court, in Gabelli v. SEC, unanimously held that that the discovery rule did not apply in an SEC civil enforcement action seeking civil penalties. Recognizing the rationale behind the discovery rule––to protect plaintiffs damaged by fraudulent actions and promote recovery––the Supreme Court declined to extend the rule’s lenient treatment to an unharmed third-party. The Court reasoned that extending the discovery rule to the SEC, in this instance, would be contrary to its duties to investigate and protect against potential federal securities violations.
Is this limited application of the discovery rule new? Well, yes and no. Historical analysis of the doctrine reveals that its uses have been limited to instances where the party seeking relief and the defrauded party were one in the same. Rarely has this issue come to light in civil actions under Section 2462. When questioned during oral arguments, the SEC conceded that this application of the discovery rule did not exist prior to 2008. Thus, while historically the discovery rule was limited to private actions, recent history demonstrates otherwise. The Gabelli decision has resolved this issue for practitioners. It is now clear that the discovery rule will not be applied to SEC enforcement actions for civil penalties.
What makes this decision so important? First, considering the repercussions of a contrary finding demonstrates the far-reaching impact this ruling. Since section 2462 does not just apply in the securities litigation context, allowing the use of the discovery rule in conjunction with this statute may very well have opened Pandora’s box. As numerous practitioners speculated before this decision was handed down, a Supreme Court ruling that allowed the discovery rule in civil penalty cases would allow the government to reopen cases long since forgotten. Second, this decision implicates current SEC investigative practices. The SEC must renew their focus on litigating claims within prescribed time constraints. The only way to avoid the statute of limitations for this type of action is to investigate more quickly and less thoroughly. The SEC may also file suit more quickly than otherwise, in order to ensure that the full range of potential claims is available.
What is the impact going forward? It is crucial to note that Gabelli, Alpert, and GGGF did not escape unscathed. The final disposition of the case dismissed the SEC’s action seeking civil penalties––a monetary fine that would discourage named defendants, as well as others, from similar actions. This does not foreclose the use of the discovery rule in SEC cases seeking equitable relief. In fact, the Supreme Court does not address the SEC causes of action against Gabelli, et al., for disgorgement and injunction except to the extent the Court reaffirms, in a footnote, that such claims were timely made and properly allowed by the district court. This distinction centers on the language of Section 2462 itself, which bars “an action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise.” While the Supreme Court’s decision in Gabelli is noteworthy, it does not completely forestall recovery beyond five years, in the context of federal securities fraud.
Where does the interpretation of Section 2462 move next? While Gabelli v. SEC has settled the dispute with regards to the application of the discovery rule in civil penalty contexts, a new basis for tolling the statute of limitations may yet arise. Discussing Gabelli in light of two conflicting outcomes in recent Federal Corrupt Practices Act (“FCPA”) litigation, New York-based law firm Davis Polk & Wardwell LLP has raised the issue of whether basic understandings of personal jurisdiction – notably the ability to attach the courts powers to foreign nationals – could create an exception to the standard statute of limitations rule set forth in Section 2462. Given the Supreme Court’s rationale behind its refusal to extend the discovery rule to civil enforcement actions, it will be interesting to monitor how other courts respond to novel applications of, and proposed exceptions to, the scope of Section 2462.