The U.S. Supreme Court recently ruled against the Securities and Exchange Commission when asked to decide when the clock starts ticking in fraud actions against registered investment advisers.
In Gabelli v. Securities and Exchange Commission, the Court ruled that the five-year statute of limitations begins to run when the fraud occurs, rejecting the SEC’s arguments in favor of the “discovery rule.”
The Facts of the Case
The SEC brought civil fraud charges against two officials of Gabelli Funds, LLC under the Investment Advisers Act. The relevant statute of limitations governing fraud actions pursuing civil penalties required the SEC to file a suit “within five years from the date when the claim first accrued.” The defendants moved to dismiss the lawsuit as untimely, arguing that the alleged fraudulent conduct occurred in 2002 but the lawsuit was not filed until 2008. The Second Circuit Court of Appeals agreed with the SEC’s interpretation of the statute of limitations, holding that the clock did not begin to tick until the SEC discovered or reasonably could have discovered the fraud.
The Supreme Court’s Decision
On appeal, the Supreme Court disagreed. It ruled that the statute of limitations begins to run when the fraudulent conduct occurs. As explained in its opinion, the justices’ interpretation is “the most natural reading of the statute.” The Court further noted that the “standard rule” is that a claim accrues “when the plaintiff has a complete and present cause of action.”
With regard to the “discovery rule,” which delays accrual until a plaintiff has “discovered” his cause of action, the Court noted that it is an exception rather than the rule. When it is applied, it is designed to protect fraud victims who, due to the defendant’s deception, may not even know they have been defrauded.
The Court found that a lawsuit brought by the government did not fall under the rationale for the discovery rule. “This Court, however, has never applied the discovery rule in this context, where the plaintiff is not a defrauded victim seeking recompense, but is instead the Government bringing an enforcement action for civil penalties,” the Court stated.
The justices went on to state that “[th]ere are good reasons why the fraud discovery rule has not been extended to Government civil penalty enforcement actions.” As explained by the Court, “The discovery rule exists in part to preserve the claims of parties who have no reason to suspect fraud. The Government is a different kind of plaintiff. The SEC’s very purpose, for example, is to root out fraud, and it has many legal tools at hand to aid in that pursuit.”
The decision is a blow to the SEC’s efforts to resurrect fraud cases related to the 2008 financial crisis, as the decision makes it clear that the clock has likely expired.
Moreover, the statute of limitations at issue is not specific to the Investment Advisers Act, but rather involves an interpretation of a general statute of limitations provision that governs many penalty provisions throughout the U.S. Code. Therefore, the decision could also impact other federal agencies that pursue civil penalties, such as the Environmental Protection Agency.