The SEC must file cases seeking civil penalties for securities fraud within five years of the alleged incident, the Supreme Court ruled today.
That's potentially bad news for an agency already strapped for cash facing further belt-tightening if automatic government spending cuts take effect in the event that President Barack Obama and Congress fail to reach a budget reduction plan by the end of this week.
The decision will put a premium on quick action by the SEC's Division of Enforcement, particularly if it's considering cases related to the 2008 financial crisis.
“It could put stress on the enforcement process,” said Jay Baris, a partner at Morrison & Foerster LLP. “It's certainly going to set the SEC scrambling to beat the clock in enforcement cases.”
The high court unanimously held that the statute of limitations “five-year clock begins to tick when the fraud occurs, not when it is discovered.”
In the case, the SEC brought an action against Gabelli Funds LLC, which is an investment adviser to the Gabelli Global Growth Fund. The agency alleged that from 1999 through 2002, the fund company allowed Headstart Advisers Ltd. to use market-timing techniques in exchange for Headstart investing in a hedge fund run by Gabelli Funds.
No other participant in the Gabelli fund was allowed to use market timing. Headstart achieved returns of up to 185%, while the return for other long-term investors was less than -24%.
Gabelli argued that by filing its case in 2008, six years after the last alleged fraud incident, the SEC had violated the statute of limitations. A district court ruled in favor of Gabelli. The 2nd U.S. Circuit Court of Appeals reversed that decision.
But the Supreme Court reversed the appeals court's decision, holding the SEC to a higher “discovery” standard when seeking civil penalties for fraud than that to which it holds an individual fraud victim seeking compensation.
“The SEC, for example, is not like an individual victim who relies on apparent injury to learn of a wrong,” Chief Justice John Roberts Jr. wrote for the majority. “Unlike 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.”
The ruling means that potential defendants in SEC cases will not have to look over their shoulders indefinitely.
“I'm pleased that, as the court noted, there will now be finality,” said Eugene Goldman, a partner at McDermott Will & Emery LLP and a former SEC prosecutor. “We will not have clients hounded eight, nine, 10 years after the alleged fraud took place.”
Although the enforcement clock is ticking particularly quickly this year on potential cases involving fraud related to the 2008 financial crisis, the SEC maintains that the ruling will not limit its ability go after securities law violators.
SEC spokesman John Nester noted that it does not prevent the SEC after five years from forcing companies to return illegal profits to investors or throwing a financial executive out of the industry.
“We are reviewing the decision, but we do not expect an immediate impact on our ability to successfully hold violators accountable for their misconduct,” Mr. Nester said in a statement. “The court also left open whether the SEC can pursue financial penalties after five years when violators have taken steps to conceal their illegal conduct, such as submitting false information in a commission filing.”
Nonetheless, if the SEC is considering financial crisis cases, deadlines are creeping closer.
“Now is the time to do it,” Mr. Baris said.
In another securities case, the Supreme Court ruled 6-3 that plaintiffs do not have to prove that an alleged securities fraud affected the value of an investment before the complaint is certified as a class action.