In the Courts

The Supreme Court granted certiorari to consider “whether the five-year clock begins to tick when the fraud is complete or when the fraud was discovered.” Id. The general statute of limitations for civil penalty actions is codified at 28 U.S.C. ' 2462, and provides that the SEC must file suit “within five years from the date when the claim first accrued.” As the Court pointed out, this provision is not confined to securities law, as it provides the statute of limitations for many penalty provisions throughout the U.S. Code. Id. at 1219.

Writing for a unanimous court, Chief Justice Roberts explained the Court's view that the “most natural reading of the statute” is that the clock begins to tick when the fraudulent conduct occurs rather than when it is discovered, citing prior precedent holding that “[i]n common parlance a right accrues when it comes into existence.” Id. at 1220 (citing United States v. Lindsay, 346 U.S. 568, 569, 74 S. Ct. 287, 98 L. Ed. 300 (1954)). The Court cited dictionaries “from the 19th century up until today” for the notion that “an action accrues when the plaintiff has a right to commence it.” Id. at 1221 (omitting internal citations). Furthermore, the Court explained that the policy behind statutes of limitations is to promote “repose, elimination of stale claims, and certainty” with the understanding that “even wrongdoers are entitled to assume that their sins may be forgotten.” Id. (internal citations omitted).

Declining to apply the so-called “discovery rule,” the Court explained that the rule was first recognized as an exception to be applied in fraud cases under the reasoning that “something different was needed in the case of fraud, where a defendant's deceptive conduct may prevent a plaintiff from even knowing that he or she has been defrauded.” Id. (citing Merck & Co. v Reynolds, 559 U.S. 633, —, 130 S. Ct. 1784, 1793, 176 L. Ed.2d 582 (2010)). According to the Court, application of the discovery rule is not appropriate in the context of a government enforcement action because, unlike a private plaintiff, a government enforcement agency does not “rel[y] on apparent injury to learn of wrongdoing” but rather has a “central 'mission' ' to 'investigate potential violations of federal securities laws.'” Id. at 1222. The Court points out that, “unlike a 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.

The Court also found it significant that the discovery rule generally applies in cases in which a plaintiff is seeking recompense, rather than in matters in which a defendant is punished and “labeled a wrongdoer.” Id. at 1223. Finally, the Court notes that applying the rule in the context of an enforcement action would be difficult as it would require courts to determine when the government “knew or reasonably should have known” of the fraud, begging many complicated questions such as when “the government” can be construed to know something, whether knowledge by one agency could be applied to another and when a “reasonably diligent” government enforcement agency would have discovered the fraud. Id.

Ultimately, the Court reversed the Second Circuit's decision, holding that, “[g]iven the lack of textual, historical, or equitable reasons to graft a discovery rule onto the statute of limitations of '2462, we decline to do so.” Id. at1224.

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In the Courts and Business Crimes Hotline were written by Associate Editors Jamie A. Schafer and Matthew J. Alexander, respectively. Both are Associates at Kirkland & Ellis LLP, Washington, DC.

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On Feb. 27, 2013, the United States Supreme Court unanimously rejected an argument advanced by the U.S. Securities and Exchange Commission (SEC) that the so-called “discovery rule” would apply to civil penalties cases involving fraud, such that the statute of limitations would not begin to run until the fraud was discovered. The case, Gabelli v. Securities and Exchange Commission , 133 S.Ct. 1216 (2013), involved an SEC civil penalties case in which the petitioners were sued by the SEC with respect to fraud allegations under the Investment Advisers Act of 1940.

The Investment Advisers Act makes it illegal for investment advisers to defraud their clients, and allows the SEC to seek civil penalties through an enforcement action against investment advisers who violate the Act. In a 2008 complaint, the petitioners, a portfolio manager and chief operating officer of an investment advisory firm, were alleged to have aided and abetted fraud between 1999 until 2002 by allowing one investor in the fund they advised to covertly engage in a trading strategy that would harm other investors in exchange for investing in a hedge fund run by one of the petitioners. Id. at 1217-19.

In response to the SEC's complaint, the petitioners filed a motion to dismiss. They argued in part that the claims were time-barred, as the alleged conduct only extended to August 2002, while the complaint was not filed until April 2008. Id. at 1220. The District Court agreed and dismissed the claim as time-barred. However, the Second Circuit reversed, accepting the SEC's argument that the “discovery rule” should apply such that the claim would not accrue until it was discovered or could have been discovered through reasonable diligence by the plaintiff. 653 F. 3d 49, 59 (2011).

The Supreme Court granted certiorari to consider “whether the five-year clock begins to tick when the fraud is complete or when the fraud was discovered.” Id. The general statute of limitations for civil penalty actions is codified at 28 U.S.C. ' 2462, and provides that the SEC must file suit “within five years from the date when the claim first accrued.” As the Court pointed out, this provision is not confined to securities law, as it provides the statute of limitations for many penalty provisions throughout the U.S. Code. Id. at 1219.

Writing for a unanimous court, Chief Justice Roberts explained the Court's view that the “most natural reading of the statute” is that the clock begins to tick when the fraudulent conduct occurs rather than when it is discovered, citing prior precedent holding that “[i]n common parlance a right accrues when it comes into existence.” Id . at 1220 (citing United States v. Lindsay , 346 U.S. 568, 569, 74 S. Ct. 287, 98 L. Ed. 300 (1954)). The Court cited dictionaries “from the 19th century up until today” for the notion that “an action accrues when the plaintiff has a right to commence it.” Id. at 1221 (omitting internal citations). Furthermore, the Court explained that the policy behind statutes of limitations is to promote “repose, elimination of stale claims, and certainty” with the understanding that “even wrongdoers are entitled to assume that their sins may be forgotten.” Id. (internal citations omitted).

Declining to apply the so-called “discovery rule,” the Court explained that the rule was first recognized as an exception to be applied in fraud cases under the reasoning that “something different was needed in the case of fraud, where a defendant's deceptive conduct may prevent a plaintiff from even knowing that he or she has been defrauded.” Id. (citing Merck & Co. v Reynolds, 559 U.S. 633, —, 130 S. Ct. 1784, 1793, 176 L. Ed.2d 582 (2010)). According to the Court, application of the discovery rule is not appropriate in the context of a government enforcement action because, unlike a private plaintiff, a government enforcement agency does not “rel[y] on apparent injury to learn of wrongdoing” but rather has a “central 'mission' ' to 'investigate potential violations of federal securities laws.'” Id. at 1222. The Court points out that, “unlike a 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.

The Court also found it significant that the discovery rule generally applies in cases in which a plaintiff is seeking recompense, rather than in matters in which a defendant is punished and “labeled a wrongdoer.” Id. at 1223. Finally, the Court notes that applying the rule in the context of an enforcement action would be difficult as it would require courts to determine when the government “knew or reasonably should have known” of the fraud, begging many complicated questions such as when “the government” can be construed to know something, whether knowledge by one agency could be applied to another and when a “reasonably diligent” government enforcement agency would have discovered the fraud. Id.

Ultimately, the Court reversed the Second Circuit's decision, holding that, “[g]iven the lack of textual, historical, or equitable reasons to graft a discovery rule onto the statute of limitations of '2462, we decline to do so.” Id. at1224.

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In the Courts and Business Crimes Hotline were written by Associate Editors Jamie A. Schafer and Matthew J. Alexander, respectively. Both are Associates at Kirkland & Ellis LLP, Washington, DC.

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