'Discovery Rule' Does Not Apply

The SEC sued Marc Gabelli, the portfolio manager of the Gabelli Global Growth Fund (GGGF), and Bruce Alpert, the Chief Operating Officer of GGGF's investment adviser, alleging that the defendants allowed a GCCF investor to engage in market timing between 1999 and 2002 in exchange for investing in a hedge fund run by Gabelli. GGGF's prospectus stated that it prohibited market timing. The SEC alleged violations of the anti-fraud provisions of the Investment Advisers Act, 15 U.S.C. ' 80b, and sought civil damages and injunctive relief.

The SEC began investigating in 2003, securing agreements from the defendants that tolled the limitations period through late 2007, but did not file suit until April 24, 2008. The defendants moved to dismiss the SEC's claim for civil penalties as untimely under Section 2462, which provides that “an action, suit or proceeding for 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.”

The defendants argued that the SEC's claim accrued no later than Aug. 7, 2002, when the market timing at issue ceased. The SEC argued in turn that under the discovery rule, the limitations period did not start to run until September 2003, when the SEC started investigating the matter. The district court dismissed the case, holding that: 1) the discovery rule did not apply; and 2) the SEC could not rely upon fraudulent concealment because it failed to allege that the defendants took “affirmative steps” to conceal their wrongdoing. SEC v. Gabelli, No. 08-civ-3868, 2010 WL 1253603, at *6-7 (S.D.N.Y. Mar. 17, 2010) (citations omitted).

The Second Circuit reversed, holding that in fraud cases “the discovery rule defines when the claim accrues and, correlatively, that the SEC need not plead that the defendants took affirmative steps to conceal their fraud.” SEC v. Gabelli, 653 F.3d 49, 60 (2d Cir. 2011).

Gabelli's Holding

The only issue before the Supreme Court was whether the five-year limitations period under Section 2462 began to run when the alleged misconduct occurred, or when the SEC discovered the alleged misconduct. Fraudulent concealment was not at issue because the SEC abandoned that theory in its briefing to the Court.

In a unanimous decision written by Chief Justice Roberts, the Court reversed, offering four reasons why Section 2462 is not subject to the discovery rule.

First, the Court reasoned that the discovery rule would be inconsistent with the plain meaning of Section 2462, noting the statute uses the specific term “accrued,” and the “standard rule” is that a claim accrues “when the plaintiff has a complete and present cause of action.” Gabelli, 2013 WL 691002, at *4. The Court contrasted Section 2462 with other federal statutes that expressly apply the discovery rule to the government. Id. at *7.

Second, the Court explained that while the discovery rule has been applied in cases where civil plaintiffs sought damages, it is unwarranted in the enforcement context. The Court observed that “[u]nlike the private party who has no reason to suspect fraud, the SEC's very purpose is to root it out, and it has many legal tools at hand to aid in that pursuit.” Id. at *6. These tools include authority to issue subpoenas, compel production of records, award whistleblowers, and offer cooperation agreements.

Third, the Court opined that the policy interests underlying limitation periods ' including finality, repose, and eliminating stale claims ' were particularly strong in enforcement actions. That is because penalties “go beyond compensation, are intended to punish, and label defendants as wrongdoers.” Id. at *7.

Finally, the Court reasoned that applying a discovery rule to government penalty actions would enmesh lower courts in complex factual questions of when the government ' whose “agencies often have hundreds of employees, dozens of offices, [and] several levels of leadership” ' knew of the alleged misconduct. Id.

Implications

Section 2462 is a statute of general applicability. The Court itself underscored that Section 2462 “is not specific to the Investment Advisers Act, or even to securities law; it governs many penalty provisions throughout the U.S. Code.” Id. at *1. Gabelli therefore will affect penalty actions brought by federal agencies under a wide range of statutes, including environmental and consumer protection statutes. See, e.g., 3M Co. v. Browner, 17 F.3d 1453, 1455 (D.C. Cir. 1994) (Toxic Substances Control Act); United States v. Advance Mach. Co., 547 F. Supp. 1085, 1090 (D. Minn. 1982) (Consumer Protection Safety Act); U.S. v. C & R Trucking Co., 537 F. Supp. 1080, 1083 (N.D. W.Va. 1982) (Federal Water Pollution Control Act).

Yet Gabelli's scope may be limited in several respects.

First, the Court suggested that the government might rely on the discovery rule when, as the victim of the misconduct, it seeks damages for its own loss, rather than civil penalties.'

Second, Gabelli does not foreclose the SEC's ability to rely on other theories to extend the time in which to bring a penalty action, where such theories are supported by the facts. For example, Gabelli does not address whether the fraudulent concealment doctrine, which tolls the “applicable limitations period when the defendant takes steps beyond the challenged conduct itself to conceal that conduct from the plaintiff,” applies to Section 2462.

Therefore, Gabelli seemingly does not preclude enforcement agencies from relying upon fraudulent concealment or other equitable tolling principles, or from alleging a continuing course of conduct through the limitations period. Moreover, enforcement agencies commonly negotiate tolling agreements, and Gabelli may prompt increased
vigilance in obtaining and extending such agreements.

Finally, the ruling does not address Section 2462's applicability to injunctive relief or disgorgement of ill-gotten monetary gains ' relief the government characterizes as remedial or equitable, instead of punitive. Lower courts are divided on this issue. Compare, e.g., SEC v. Kelly, 663 F.Supp.2d 276, 286-87 (S.D.N.Y. 2009) (concluding that the “great weight of the case law in this jurisdiction” holds that “equitable remedies are exempted” from Section 2462) with SEC v. Bartek, 484 F. App'x. 949, 956 (5th Cir. 2012) (affirming the finding that the officer/director bar was punitive).

Conclusion

Although Gabelli notes that relief “which go[es] beyond compensation, [is] intended to punish, and label[s] defendants wrongdoers” would be considered “penalties” under Section 2462 (Gabelli, 2013 WL 691002, at *7), the precise line between “equitable” and “remedial” relief, as opposed to “punitive” sanctions, remains an open question.

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Elissa Preheim, a partner in Arnold & Porter LLP's litigation practice, focuses on securities enforcement and litigation, complex commercial and environmental litigation, and professional liability. Arthur Luk, a partner in the same practice, focuses on securities enforcement and litigation, white collar criminal defense, and business litigation. Arpan Sura is an associate at the firm. All are resident in the Washington, DC, office.

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On Feb. 27, 2013, the Supreme Court decided Gabelli v. Securities and Exchange Commission, No. 11-1274, 2013 WL 691002 (U.S. Feb. 27, 2013), holding that the “discovery rule” does not apply to the general statute of limitations for civil penalties, 28 U.S.C. ' 2462 (Section 2462), in the context of an enforcement action by the Securities and Exchange Commission (SEC). The Court unanimously concluded that Section 2462's limitations period began to run from the date of the alleged misconduct, not from the date the SEC discovered the alleged fraud.

Although Gabelli clarifies when the SEC and other federal agencies must commence an enforcement action for penalties, it leaves unaddressed several questions regarding Section 2462's applicability. It does not address whether or how Section 2462's limitations period may be extended through theories of equitable tolling. Nor does Gabelli directly address what constitutes a “penalty” subject to Section 2462, as opposed to remedial or equitable relief considered outside of Section 2462's scope.

Background

The SEC sued Marc Gabelli, the portfolio manager of the Gabelli Global Growth Fund (GGGF), and Bruce Alpert, the Chief Operating Officer of GGGF's investment adviser, alleging that the defendants allowed a GCCF investor to engage in market timing between 1999 and 2002 in exchange for investing in a hedge fund run by Gabelli. GGGF's prospectus stated that it prohibited market timing. The SEC alleged violations of the anti-fraud provisions of the Investment Advisers Act, 15 U.S.C. ' 80b, and sought civil damages and injunctive relief.

The SEC began investigating in 2003, securing agreements from the defendants that tolled the limitations period through late 2007, but did not file suit until April 24, 2008. The defendants moved to dismiss the SEC's claim for civil penalties as untimely under Section 2462, which provides that “an action, suit or proceeding for 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.”

The defendants argued that the SEC's claim accrued no later than Aug. 7, 2002, when the market timing at issue ceased. The SEC argued in turn that under the discovery rule, the limitations period did not start to run until September 2003, when the SEC started investigating the matter. The district court dismissed the case, holding that: 1) the discovery rule did not apply; and 2) the SEC could not rely upon fraudulent concealment because it failed to allege that the defendants took “affirmative steps” to conceal their wrongdoing. SEC v. Gabelli, No. 08-civ-3868, 2010 WL 1253603, at *6-7 (S.D.N.Y. Mar. 17, 2010) (citations omitted).

The Second Circuit reversed, holding that in fraud cases “the discovery rule defines when the claim accrues and, correlatively, that the SEC need not plead that the defendants took affirmative steps to conceal their fraud.” SEC v. Gabelli , 653 F.3d 49, 60 (2d Cir. 2011).

Gabelli's Holding

The only issue before the Supreme Court was whether the five-year limitations period under Section 2462 began to run when the alleged misconduct occurred, or when the SEC discovered the alleged misconduct. Fraudulent concealment was not at issue because the SEC abandoned that theory in its briefing to the Court.

In a unanimous decision written by Chief Justice Roberts, the Court reversed, offering four reasons why Section 2462 is not subject to the discovery rule.

First, the Court reasoned that the discovery rule would be inconsistent with the plain meaning of Section 2462, noting the statute uses the specific term “accrued,” and the “standard rule” is that a claim accrues “when the plaintiff has a complete and present cause of action.” Gabelli, 2013 WL 691002, at *4. The Court contrasted Section 2462 with other federal statutes that expressly apply the discovery rule to the government. Id. at *7.

Second, the Court explained that while the discovery rule has been applied in cases where civil plaintiffs sought damages, it is unwarranted in the enforcement context. The Court observed that “[u]nlike the private party who has no reason to suspect fraud, the SEC's very purpose is to root it out, and it has many legal tools at hand to aid in that pursuit.” Id. at *6. These tools include authority to issue subpoenas, compel production of records, award whistleblowers, and offer cooperation agreements.

Third, the Court opined that the policy interests underlying limitation periods ' including finality, repose, and eliminating stale claims ' were particularly strong in enforcement actions. That is because penalties “go beyond compensation, are intended to punish, and label defendants as wrongdoers.” Id. at *7.

Finally, the Court reasoned that applying a discovery rule to government penalty actions would enmesh lower courts in complex factual questions of when the government ' whose “agencies often have hundreds of employees, dozens of offices, [and] several levels of leadership” ' knew of the alleged misconduct. Id.

Implications

Section 2462 is a statute of general applicability. The Court itself underscored that Section 2462 “is not specific to the Investment Advisers Act, or even to securities law; it governs many penalty provisions throughout the U.S. Code.” Id. at *1. Gabelli therefore will affect penalty actions brought by federal agencies under a wide range of statutes, including environmental and consumer protection statutes. See, e.g., 3M Co. v. Browner , 17 F.3d 1453, 1455 (D.C. Cir. 1994) (Toxic Substances Control Act); United States v. Advance Mach. Co. , 547 F. Supp. 1085, 1090 (D. Minn. 1982) (Consumer Protection Safety Act); U.S. v. C & R Trucking Co. , 537 F. Supp. 1080, 1083 (N.D. W.Va. 1982) (Federal Water Pollution Control Act).

Yet Gabelli's scope may be limited in several respects.

First, the Court suggested that the government might rely on the discovery rule when, as the victim of the misconduct, it seeks damages for its own loss, rather than civil penalties.'

Second, Gabelli does not foreclose the SEC's ability to rely on other theories to extend the time in which to bring a penalty action, where such theories are supported by the facts. For example, Gabelli does not address whether the fraudulent concealment doctrine, which tolls the “applicable limitations period when the defendant takes steps beyond the challenged conduct itself to conceal that conduct from the plaintiff,” applies to Section 2462.

Therefore, Gabelli seemingly does not preclude enforcement agencies from relying upon fraudulent concealment or other equitable tolling principles, or from alleging a continuing course of conduct through the limitations period. Moreover, enforcement agencies commonly negotiate tolling agreements, and Gabelli may prompt increased
vigilance in obtaining and extending such agreements.

Finally, the ruling does not address Section 2462's applicability to injunctive relief or disgorgement of ill-gotten monetary gains ' relief the government characterizes as remedial or equitable, instead of punitive. Lower courts are divided on this issue. Compare, e.g., SEC v. Kelly , 663 F.Supp.2d 276, 286-87 (S.D.N.Y. 2009) (concluding that the “great weight of the case law in this jurisdiction” holds that “equitable remedies are exempted” from Section 2462) with SEC v. Bartek , 484 F. App'x. 949, 956 (5th Cir. 2012) (affirming the finding that the officer/director bar was punitive).

Conclusion

Although Gabelli notes that relief “which go[es] beyond compensation, [is] intended to punish, and label[s] defendants wrongdoers” would be considered “penalties” under Section 2462 (Gabelli, 2013 WL 691002, at *7), the precise line between “equitable” and “remedial” relief, as opposed to “punitive” sanctions, remains an open question.

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Elissa Preheim, a partner in Arnold & Porter LLP's litigation practice, focuses on securities enforcement and litigation, complex commercial and environmental litigation, and professional liability. Arthur Luk, a partner in the same practice, focuses on securities enforcement and litigation, white collar criminal defense, and business litigation. Arpan Sura is an associate at the firm. All are resident in the Washington, DC, office.

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