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Securities & Derivative Litigation

Supreme Court to Decide Whether SEC Can Invoke Discovery Rule in Penalty Actions

By Jean M. Flannery
January 2013
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The Supreme Court has granted the petition for writ of certiorari to review the 2nd Circuit’s decision in SEC v. Gabelli, 653 F.3d 49 (2d Cir. 2011). The Court is expected to resolve a circuit split over whether the Securities and Exchange Commission (“SEC”) can seek civil penalties long after alleged violations took place.

In Gabelli, the SEC had accused the petitioners of, among other things, aiding and abetting violations of antifraud provisions of the Investment Advisors Act of 1940. But the SEC filed its complaint in 2008—six years after the last alleged violation. This delay prompted the district court to rule that the SEC could not seek civil penalties for the Investment Advisors Act claim because of the applicable statute of limitations (28 U.S.C. § 2462). That statute requires the SEC to commence civil penalties actions within five years of when the claim “first accrued.”

The 2nd Circuit reversed the district court, holding that the claim did not accrue until September 2003—which was when the SEC apparently discovered the alleged fraud. The Court reached its holding by applying the common law “discovery rule” to the statute of limitations. Under the discovery rule, the statute of limitations for a particular claim does not accrue until the plaintiff discovers the claim, or could have discovered it with reasonable diligence. The discovery rule traditionally applies to claims for harms that, by their very nature, remain latent during the limitations period. (The discovery rule is distinct from the equitable tolling doctrine, which prevents defendants who actively conceal their crimes from relying on the statute of limitations bar.) The 2nd Circuit held that “since fraud claims by their very nature involve self-concealing conduct, it has been long established that the discovery rule applies where, as here, a claim sounds in fraud.” Gabelli, 6543 F.3d at 59.

The petitioner and supporting amicus briefs filed with the Supreme Court criticize the 2nd Circuit for ignoring the plain language of the statute and misreading the authority it relied upon in its holding. Specifically, the briefs argue that the Supreme Court has never held that all frauds are self-concealing, and that on the contrary, the cases relied upon by the 2nd Circuit involved affirmative concealment of the fraud at issue. In addition, the briefs point out that the discovery rule is intended to protect injured parties, not a government agency like the SEC. And unlike private litigants, the SEC has broad investigatory power and tools at its disposal—arguably making application of the discovery rule to this statute of limitations inappropriate. Briefs are available here.

As highlighted in last quarter’s briefing, the 5th Circuit recently held—albeit in an unpublished opinion—that the discovery rule does not apply to § 2462. See SEC v. Bartek, No. 11-10594 (5th Cir. Aug. 7, 2012). The Supreme Court’s decision in Gabelli should resolve the 5th Circuit and 2nd Circuit split.

Oral argument in Gabelli is set for today, Jan. 8, 2013; listen to it here this Friday.

Full January 2013 Quarterly Securities Enforcement Briefing

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