A Key SEC Enforcement Issue Is Argued Before the Supreme Court

The Supreme Court heard argument yesterday in Gabelli v. SEC, No. 11-1274, a case which could have a significant impact on the SEC’s enforcement program. The action centers on the application of the five year statute of limitations for imposing a penalty in government actions under Section 2442 of Title 28. That Section provides in pertinent part that “except as otherwise provided by Act of Congress” any penalty action brought by the government must be “commenced within five years from the date when the claim first accrued.” The issue debated during the argument is whether “accrual” means when there is a cause of action or if, as in many civil cases, the SEC and other government agencies can claim the benefit of a discovery rule. Under such a rule the time clock would not begin until the agency discovered or reasonably should have discovered the claim.

The Commission’s case centered on claimed false statements by Marc Gambelli, the portfolio manager of Gabelli Global Growth Fund, and Bruce Alpert, the COO of the Fund’s adviser, Gabelli Funds, LLC. From 1999 until 2002 the defendants permitted trader Headstart to engage in “time zone arbitrage” according to the SEC, a form of market timing. At the same time defendants banned at least 48 other accounts from engaging in market timing. The deal with Headstart was not disclosed to the Fund’s board of directors who were thus deceived. Even after Headstart halted the practice, the defendants continued to mislead the board and investors, according to the SEC.

The Commission filed its complaint in April 2008. The underlying investigation began in the Fall of 2003 following the publicized inquiry of the New York Attorney General into market timing. At one point the SEC had sought tolling agreements. The complaint alleged violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1) and (2). The district court concluded that the claim for a civil penalty was time barred. The Second Circuit reversed.

Petitioner’s argument sought to limit the question to penalties rather than the government’s cause of action and focused largely on the literal language of the statute which does not provide for a discovery rule. At the outset counsel thus noted: “This case concerns the statute dealing exclusively with penalty claims brought by government agencies to punish conduct made unlawful by statute . . . The case does not concern . . . the Government’s power to seek remedial remedies such as disgorgement and injunction. Consistent with Congress’s normal approach in penal situations, Congress fixed a statute of limitations for penalties.”

Questions from the bench initially focused on the difference between the application of the statute of limitations in criminal and civil cases. Justice Kennedy, for example, noted that “Justice Ginsburg points out that you’re talking about the statute, but the statute uses the term ‘accrual.’ Is it correct to say the term ‘accrual’ is not used in statute of limitations for crimes – generally – for crimes? While Petitioner conceded that is correct, he quickly returned to the predicate of his argument, noting that Respondent’s position is “an argument to depart from the plain language . . . “

Following a series of questions from Justice Breyer demonstrating that the five year statute of limitations at issue here applied not just to the SEC but to a broad array of government actions, Petitioner hit on what became a key theme of questions from the Court during the presentation by the Commission: “. . . the position that the SEC is taking now is a novel position that to our knowledge has not been taken by other regulators and hasn’t been taken by the SEC until – until quite recently. This statute’s been on the books for quite a long time, and it’s notable that agencies that have not urged that – that interpretation.”

The Assistant to the Solicitor General focused his argument on the contention that the statute had been written against a well established common law history in which the running of the statute of limitations in a civil action does not begin in a fraud case until the claim is discovered or reasonably could have been discovered. Picking up on Justice Kennedy’s question about the language of the statute Respondent told the Court that “I think Justice Kennedy started us off in the right place by focusing on the statute and its use of the term ‘accrual.’ And when counsel concedes that that term had an established meaning at common law and this statute picks it up, I think he gave away his case, because there were a cluster of concepts. One was the general rule governing accrual: It accrues when the plaintiff can – has a right to sue.”

Justice Scalia then asked “And never in a criminal case, right? Do you have a single case in which the discovery rule was – was applied in a criminal case with respect to a penalty or criminal sanction?” When the Assistant to the Solicitor General conceded that he did not, arguing that criminal cases are fundamentally different from civil cases Justice Breyer echoed his earlier statements demonstrating the broad application of the statute and began developing what would become the dominant theme for the remainder of the argument: “I certainly agree with Justice Scalia that this is not an SEC statute . . . it is a statute that applies to all government action, which is a huge category across the board and it’s about 200 years old. And until 2004 I haven’t found a single case in which the government ever tried to assert the discovery rule where they were seeking a civil penalty . . . Is there any case at all until the year 2004 . . . “

Respondent had to concede that there is no case while seeking to move the argument forward by contenting that this is a relatively recent problem. That effort resulted in Justice Scalia asking: “This is a brand-new assertion by the government . . . is there much difference between the rule you are arguing for and a rule that there is no statute of limitations?” While the Assistant to the Solicitor claimed that there was a significant difference he could not escape suggestions that since this is a government enforcement action seeking a penalty it is of little consequence that it is labeled “civil.”

The argument then turned to the question of discovery and how a party would prove that the government was on notice so the time clock would begin to run. Respondent argued that this was not a problem since it typically turned on available facts. The Court expressed skepticism. Justice Sotomayor began: “. . . how does a party ever accomplish that? Aren’t you going to raise the law enforcement privilege, the – some other privilege to block discovery?” When the Assistant to the Solicitor disputed that contention the Chief Justice noted asked if “it depends really on how many enforcement officers the SEC has . . . Maybe if they’ve got 1,000 people reviewing it, but maybe not if they have 10 . . . It seems to me that it’s going to be almost impossible for somebody to prove that the government should have known about something.”

Toward the end of the argument Justices Ginsburg and Kagan summed up what may be some of the underlying concerns about the SEC’s position. Justice Ginsburg began by noting: “And it is a generous period. It’s 5 years . . . maybe you can explain the SEC’s pursuit of this . . . The alleged fraud went on from 1999 to 2002. It was discovered in 2003. The SEC waited from 2003 to 2008 to commence suit.” The Assistant to the Solicitor attempted to respond but then Justice Kagan noted: “The Government had decided not to go after market timers. And it changed its decision when a State attorney general decided to di it, and it embarrassed them . . .”

Respondent concluded his argument by returning to the central theme of the SEC’s argument: “for 300 years English and American courts looking at this problem have said where the defendant’s misconduct, be it fraud or be it concealment [an issue the parties agreed is not before the Court] of a non-fraud, but where the defendant’s deception prevents a plaintiff from knowing that he, she or it has a cause of action, equity suspends the running of a statue of limitations.”

A decision is expected later this term.

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