In a decision that will limit the SEC’s ability to obtain fines in actions alleging fraud, the Supreme Court recently held that the five-year statute of limitations on antifraud actions begins to run when the fraud is committed, not when the SEC could reasonably have discovered the fraud.
The Investment Advisers Act, like the other securities laws, generally requires that a case seeking civil penalties under the Act be brought within five years. The underlying case, which the SEC brought against two individuals at Gabelli Funds, was rooted in the market timing scandal. The SEC alleged that the two individuals had aided and abetted the fraud, but it filed the case more than five years after the conduct in question had ceased.
The Second Circuit Court of Appeals nonetheless permitted the case to go forward. That court relied on the discovery rule, which generally holds that in a case involving fraud, the statute of limitations (here, the five year requirement) does not begin to run until, in the words of the Court of Appeals, “[the] claim is discovered, or could have been discovered with reasonable diligence, by the plaintiff.”
On appeal, the Supreme Court rejected this result, holding that only the person who was actually defrauded can rely on the discovery rule to, in essence, extend the statute of limitations. The Court rationalized that victims of fraud need this protection because “when the injury is self-concealing, private parties may be unaware that they have been harmed. Most of us do not live in a state of constant investigation; absent any reason to think that we have been injured, we do not typically spend our days looking for evidence that we were lied to or defrauded.” In contrast, according to the Court, “[t]he SEC … is not like an individual victim…. Rather, a central ‘mission’ of the Commission is to investigate potential violations of the federal securities laws. Unlike the private party who has no reason to suspect fraud, the SEC’s very purpose is to root it out, and it has many legal tools at hand to aid in that pursuit.” Therefore, according to the Court, in an action brought by the SEC, the five-year statute of limitations begins to run when the fraud is commited.
This decision will clearly force the SEC to bring fraud cases in a timely manner. However, the SEC did note following the decision that the statute of limitations does not apply to cases in which it seeks injunctive relief or disgorgement of ill-gotten gains, and also does not apply to cases in which it seeks to bar an individual from the securities industry.
The Supreme Court’s decision can be found here. The Second Circuit decision, which the Supreme Court reversed, can be found here. And finally, for a Reuters story discussing the case, including the SEC’s reaction to the case and its views on how the case will impact its enforcement program, click here.