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Thomas O. Gorman,
Dorsey and Whitney LLP
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    Policy


    SEC Enforcement: One Step Forward, Two Back?

    The SEC’s courtroom victory in the Wyly case on Monday was a significant step forward for a program that has struggled to find its swagger. While taking that step forward the enforcement program may have taken two steps back with a ruling issued on Monday which dismissed all of the claims brought by the agency based on the five year statute of limitations in 28 U.S. C. Section 2462. SEC v. Graham, Case No. 13-1001 (S.D. Fla. Ruling May 12, 2014).

    The facts

    The SEC’s claims centered on the unregistered offering of investments in a real estate development called Cay Clubs Resorts and Marinas. The defendants include Fred Clark, President and CEO, Cristal Clark, managing member and registered agent for various related entities, Barry Graham, director of sales, Ricky Stokes, a star sales agent and David Schwarz, CFO and vice president of operations.

    The scheme supposedly impacted 1,400 investors and raised over $300 million. Beginning in July 2004, and continuing until January 30, 2008, Cay Clubs offered and sold condominium units to private investors as an investment. The resort purchased and renovated aged and abandoned condominium projects using investor funds. Those investors were told that their investment would appreciate significantly. Under the terms of the deal investors were guaranteed an immediate return of 15% of the purchase price, paid at closing, and ensured rental income from Cay Clubs management for the use of the units.

    • Key elements of the investment, investors were told, included:
    • The purchase of condominium units at undervalued prices;
    • A leaseback agreement which, while optional, provided that the club would lease the unit and investors would receive 15% of the purchase price back shortly after closing;
    • Those who entered into the lease also received up to $70,000 worth of new furnishings and fixtures;
    • Investor funds were combined with defendants’ development expertise to create a network of luxury resorts;
    • Investors became members of the Resorts which gave them access to luxury amenities at all resorts;
    • Cay Clubs would exclusively manage the units at the end of the leaseback; and
    • There was a built-in exit strategy since Cay Clubs had relationships with lenders and investors to provide a quick exit.

    With the collapse of the real estate and credit markets in late 2007 defendants abandoned development and many investor units went into foreclosure.

    The SEC investigated these transactions for seven years. The agency waited until January 30, 2013, more than five years after defendant’s sale and offering of Cay Clubs units had ceased. A five count complaint was filed alleging violations of the anti-fraud and registration provisions of the federal securities laws.

    The ruling

    At the summary judgment stage of the case the Court sua sponte raised and considered the question of whether it had subject-matter jurisdiction to “entertain the SEC’s case against each defendant. Ultimately, the Court concluded that it lacked jurisdiction.

    Federal courts possess only the limited jurisdiction granted by Congress, the Court held. While this case has proceeded through discovery and is before the Court on motions for summary judgment, it is still appropriate to consider whether jurisdiction has been properly invoked.

    Here Section 2462 is a jurisdictional statute of limitations. Jurisdiction refers to a court’s adjudicatory authority. The term subject matter jurisdiction “is defined as the ‘courts’ statutory or constitutional power to adjudicate the case,’ quoting Steel Co. v. Citizens for Better Env’t, 523 U.S. 83, 89 (1998). While some statutes of limitations relate only to how claims are processed, others are more absolute and may be jurisdictional. Thus “statutes of limitation – specifically the ‘more absolute’ type that by their very text speak to the power of a court to act in a given case as opposed to the type that ‘seek primarily to protect defendants against stale or unduly delayed claims’—can operate to remove from the court’s adjudicatory authority those claims not brought within the time limit specified by such a statute. The five-time limit contained at 28 U.S. C. Section 2462 is just such a statute.”

    This conclusion is driven by the plain language of the statute which provides in pertinent part that the “enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise, shall not be entertained unless commenced within five years from the date when the claim first accrued.” (emphasis original). In view of this language the Supreme Court in Gabelli v. SEC, 133, S.Ct. 1216, 1220-21 (2013) concluded that the statute defines the last date on which the claim can be brought. This means that the claim must be brought by the day on which the last act giving rise to plaintiff’s complete and present cause of action occurs. Here that is the date on which a defendant last sold or offered the alleged security. After that date the statute directs that the claim “shall not be entertained.”

    The SEC’s claim that Section 2462 does not apply to the disgorgement, injunction and declaratory relief it seeks here is incorrect. Indeed, it would make the “Government’s reach to enforce such claims akin to its unlimited ability to prosecute murders and rapists.” This ignores the principles on which Gabelli is built. “Penalties, ‘pecuniary or otherwise,’ are at the heart of all forms of relief sought by the SEC in this case. First of all, by its very terms, the SEC’s complaint seeks to have the Court, by way of a declaration that the defendants have violated the federal securities laws, ‘label defendants as wrongdoers’ . . . Similarly, the injunctive relief sought by the SEC in this case forever barring defendants from future violations of the federal securities laws can be regarded as nothing short of a penalty’ intended to punish,’ especially where, as here, no evidence (or allegations) of any continuing harm or wrongdoing has been presented. Finally, the disgorgement of all ill-gotten gains realized from the alleged violations of the securities laws –i.e., requiring defendants to relinquish money and property—can truly be regarded as nothing other than a forfeiture (both pecuniary and otherwise), which remedy is expressly covered by Section 2462. To hold otherwise would be to open the door to Government plaintiffs’ ingenuity in creating new terms for the precise forms of relief expressly covered by the statute in order to avoid its application.”

    Finally, plaintiffs have the burden of establishing jurisdiction. Here that means the SEC has that burden. It has failed to meet that requirement. The action was dismissed with prejudice.

    Analysis

    Graham is not the first decision to apply Section 2462 to all forms of relief typically sought in SEC enforcement actions. Prior to Gabelli the Fifth Circuit reached the same conclusion in SEC v. Bartek, No. 11-1-594 (5th Cir. Decided Aug. 7, 2012). Gabelli expressly declined to consider the issues presented in Bartek and now Graham. In the wake of Gabelli the Commission dropped its appeal of Bartek which was decided before the Supreme Court handed down its ruling.

    Now, however, the Commission may have to revisit the question of how Section 2462 applies to its enforcement actions. To be sure, the win on Monday in Wyly was significant. In the long run, however, the loss in Graham, also on Monday, may be much more significant in view of its potential impact on the enforcement program – one step forward, two back.

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