Last Week, This Week And The Future Trends of SEC Enforcement

As rumors swirl that the Director of the SEC’s Enforcement is about to become the latest division director to resign, the critical question is the future path of the Division. One settled case filed at the end of last week and another that will be heard by the Supreme Court on Tuesday may hold some clues.

As last week drew to a close the SEC filed its first enforcement action of the year, SEC v. Nekekim Corporation, Civil Case No. 1:13-cv-00010 (E.D. Calif. Filed Jan. 3, 2013). The complaint is similar to many the SEC has filed in recent months. It centers on an alleged investment fund fraud in which investors were led to believe they could strike it rich purchasing interests in a gold mine. Specifically, the complaint claims that Nekekim, a California based company, and its CEO, president and director, Kenneth W. Carlton, defrauded investors in the U.S. and other countries over an eleven year period beginning in 2001 by selling them interests in a gold mine. Investors were told that the mine had a special “complex ore” at its Nevada site which is worth at least $1.7 billion, according to an analysis made by a physicist.

In fact, the so-called “physicist” had no scientific training, according to the SEC’s complaint, and utilized unconventional methods to conduct his analysis. Investors were not told that the labs’ reliability had been questioned by geologists and a government study. Likewise, they were not told that other firms suggested that Nekekim’s mine actually had little gold. The Commission’s complaint alleges violations of Securities Act Section 5(a), 5(c) and 17(a) and Exchange Act Section 10(b).

Both defendants settled with the Commission, consenting to the entry of permanent injunctions prohibiting future violations of the Sections cited in the complaint. The company also agreed to disclose these sanctions in any offering of securities made in the next three years. Mr. Carlton agreed, in addition to the injunction, to pay a $50,000 penalty and to an order prohibiting him from selling securities for Nekekim or managing the company.

Nekekim is just one of what is almost a continuous stream of investment fund fraud actions the SEC has brought in recent years. As 2013 unfolds there should be little doubt that this trend will continue.

The sanctions in Nekekim, as in many cases focused not just on the traditional SEC injunction, but also a civil penalty. The ability of the SEC, as well as other government agencies, to impose such penalties may be circumscribed by a case that will be argued on Tuesday before the Supreme Court and decided later this year. Gabelli v. SEC, No. 11-1274.

Gabelli focuses on the application of the five year statute of limitations in Section 2462 of Title 28 to SEC and other government enforcement actions where a penalty is sought. The critical issue before the High Court is when the five year period begins.

The text of the statute provides that an action for the enforcement of any civil penalty “shall not be entertained unless commenced within five years from the date when the claim first accrued.” In the underlying case, the Second Circuit concluded that in a fraud case the time clock does not begin until the claim is, or reasonably could be, discovered by the SEC. The Seventh Circuit has also adopted this approach while the Fifth has rejected it.

The difficulty for the SEC is that Section 2462 does not specify that the commencement of the limitation period is tied to a discovery rule. This is problematic for the agency when arguing before the conservative Robert’s Court which tends to focus on the literal language of the statute. In view of this point the Commission is arguing that the Supreme “Court has repeatedly held that, unless Congress specifies a different rule, the limitations period in a suit for fraud does not begin to run until the plaintiff discovers, or in the exercise of reasonable diligence could have discovered, the facts underlying his claim.” The Commission refines this argument by specifying that it only applies if the claim is fraud. For all other claims the five year time period begins when the cause of action accrues. Success for the SEC thus turns on convincing the High Court to read the statute one way if the claim is based in fraud and another if it is not which no help from the text of the statute.

Whether the SEC can prevail in Gabelli may have a significant impact on its enforcement program. Since the Remedies Act the Division has increasingly relied on civil penalties as the remedy of choice. Indeed, last year the SEC called on Congress to increase the ability of the agency to impose fines. If the Court declines the Commission’s invitation to read a discovery rule into Section 2462 it could delimit the remedies available to the agency in some enforcement actions. That in turn may impact the approach taken during investigations and when instituting enforcement actions. Thus while Nekekim may suggest that the Division will continue to at least in part focus on investment fund fraud actions, Gabelli could alter the overall approach of the Division.

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