Supreme Court: Statute Of Limitations In SEC Fraud Cases Begins To Run When Fraud Occurs, Not When Discovered

The Supreme Court today ruled that in an SEC action to recover civil penalties, the five-year statute of limitations begins to run when fraud occurs, not when it is discovered. The Court held in Gabelli et al. v. Securities and Exchange Commission that the "discovery rule" does not apply to an SEC enforcement action sounding in fraud.

The Supreme Court's unanimous decision is sure to set the SEC scrambling to beat the clock in enforcement cases.

The general statute of limitations for civil penalty actions (28 U.S.C. §2462) gives plaintiffs, including the SEC, five years "from the date when the claim first accrued" to bring a case. The so-called "discovery rule," a long-standing exception to the general rule that allows plaintiffs to bring a case five years after discovering the fraud, is "based on the recognition that . . . in the case of fraud . . . a defendant's deceptive conduct may prevent a plaintiff from even knowing that he or she has been defrauded." In Gabelli, the SEC argued that the discovery rule should apply not only in the case of a defrauded private plaintiff but also in an enforcement action brought by the government.

The Court rejected this argument, agreeing that there should be a fixed date for when potential exposure to enforcement proceedings must end: "even wrong-doers are entitled to assume that their sins may be forgotten."

The discovery rule exists in part, the Court said, "to preserve the claims of victims who do not know they are injured and who reasonably do not inquire as to any injury. Usually when a private party is injured, he is immediately aware of that injury and put on notice that his time to sue is running. But when the injury is self-concealing, private parties may be unaware that they have been harmed."

Not so, the Court said, when the plaintiff is the government suing for civil penalties. Unlike a garden-variety individual plaintiff suing for damages, the SEC has many tools at hand to aid in its efforts: requirements for investment advisers to turn over books and records at any time; subpoena power; authorization to pay monetary awards to whistleblowers; and the ability to offer "cooperation agreements" to violators of the federal securities laws. In addition, in a civil penalty action, the SEC is seeking to enforce a punishment. It is not seeking recompense or a return to the status quo.

The Gabelli case arose out of the mutual fund market timing scandal. Two senior officers of a fund's investment...