SEC OPTION BACKDATING CLAIMS AND RELIEF HELD TIME BARRED
In SEC v. Microtune, Inc., Civil Action no. 3:08-CV-1105 (N.D. Tx.) the court concluded that the Commission’s option backdating claims and virtually of its remedies were time barred. In reaching this conclusion the court held that the Commission had not diligently pursued its claims. The court also ruled that the Commission’s requests for injunctions, officer and director bars and the repayment of incentive based compensation under SOX Section 304 were in the nature of penalties and thus barred by the five year limitation period of 28 U.S.C. Section 2462.
In Microtune the Commission brought an enforcement action against the company and two of its former executives, CEO Douglas Bartek and CFO and General Counsel Nancy Richardson. According to the SEC, stock options of the company were fraudulently backdated between 2000 and mid-2003. The complaint requested the Commission’s usual remedies – permanent injunctions, disgorgement, officer director bars, civil monetary penalties and the repayment of discretionary compensation under SOX 304. The individual defendants moved for summary judgment based on Section 2462 arguing that the claims are time barred.
The court concluded that all claims and remedies, except disgorgement are barred by Section 2462. First, the SEC claimed that the doctrine of fraudulent concealment precluded granting the motion. To prevail on this claim the SEC must establish that the defendant’s wrongdoing was concealed from it either through active concealment by the defendants or because the nature of the conduct was such that it was self-concealing the court held. The SEC must demonstrate that it acted diligently once it is on inquiry notice – that is, that it “knew of or should have known of the facts giving rise to his claim . . . “
In this case the court concluded that the limitation period has not been tolled. The court rejected the SEC’s contention that securities fraud claims are inherently self-concealing. In this regard silence or the “simple fact that a fraud was unknown to the plaintiff is not enough to establish that a fraud itself is self-concealing.” Rather, the fraud must be incapable of being known even in the exercise of due diligence to be self-concealing. While there is a conflict of fact on the question of whether defendants concealed their conduct through affirmative acts that does not preclude summary judgment the court held.
Rather, a party seeking to toll the statute of limitations under the fraudulent concealment doctrine must also show that it acted diligently. Thus once the SEC had notice it was required to diligently purse and file its claims. Here it is not in dispute that during the limitations period the SEC was put on inquiry notice. In 2003 the Commission received evidence which it concedes was sufficient to put it on inquiry notice. At that time the Commission questioned certain witnesses but took no further action until the company brought its option practices to the attention of the agency in 2006, announcing an internal investigation. The Commission waited until the completion of that inquiry to finalize its investigation, filing suit in 2008.
On this record the court concluded that the SEC failed to act diligently. While the Commission’s claim that it waited for the conclusion of the internal investigation as a matter of resource allocation, the court noted that “[w]hile perhaps an understandable method of allocating Commission resources, such justification does not excuse the SEC’s apparent inactivity from mid-2004 to mid-2006, when further investigation would have uncovered the full extent of Microtune’s backdating and would have allowed the SEC to bring a complaint against Microtune much earlier than 2008.” In reaching this conclusion the court rejected the SEC’s argument that it was entitled to five more years from the date of inquiry notice to file suit.
Finally, the court held that the statute of limitations only applies to the remedies which are in the nature of a penalty. Clearly it does not apply to the disgorgement request. Whether the other requested relief is a penalty is a facts and circumstances assessment which must be made in each case.
In this instance the injunctions and requests for officer and director bars are in the nature of a penalty. The collateral consequences are significant. Perhaps more importantly, the conduct occurred years ago. Neither remedy specifically addresses the past conduct nor is it tied to preventing future harm due to the low likelihood that either defendant would engage in similar conduct in the future.
Likewise, the repayments sought under Section 304 are also in the nature of a penalty. While the Commission argued that this remedy is in the nature of disgorgement, in fact it is not tied to any ill-gotten gain or any wrongful conduct. The amount is not keyed to harm caused to the company or wrongdoing. Rather, the Commission simply seeks the repayment of all sums paid. As such it is in the nature of a penalty and is time barred.