Supreme Court to hear Gabelli appeal of SEC civil fraud penalties
By Dina ElBoghdady,
The Supreme Court will hear arguments next week in a case that will determine how much time federal securities regulators have to impose civil fraud penalties.
In Gabelli v. SEC, two Gabelli Funds officials argue that the Securities and Exchange Commission waited too long to bring a civil case accusing them of authorizing an improper trading technique at their firm. The argument raises a question often debated in legal circles: When does the clock start ticking on civil fraud cases?
Some courts have ruled that the SEC can only obtain civil penalties for fraud within five years of the violation taking place, as a lower court did in the Gabelli case. But in August, the U.S. Court of Appeals for the 2nd Circuit decided that time runs out five years after the SEC discovers, or reasonably should have discovered, the alleged fraud.
The issue will be argued before the Supreme Court on Jan. 8. Experts say the resource-strapped SEC might have to step on the gas in bringing such cases if it loses.
“This would be a substantial shift for the SEC,” said John C. Coffee Jr., a law professor at Columbia Law School. “It would put them behind the eight ball.”
The impact would be felt well beyond the SEC to any part of the government that handles civil fraud cases, including the Justice Department, said Tom Gorman, who once worked for the SEC’s enforcement division and the general counsel’s office.
The Supreme Court’s decision also could have significant implications for cases stemming from the mortgage meltdown and the 2008 financial crisis, Gorman said. He cited the work of a task force of federal and state prosecutors that was created last year to investigate abusive lending practices and the packaging of risky mortgages.
“Those cases are going to be very old by the time they’re brought,” Gorman said. “Some of these cases date back to 2006 and 2007, and they’re running out of time.”
When the SEC is pressing up against a deadline, it can usually get more time by negotiating “tolling agreements” in cases under active investigation. Under those arrangements, firms or people under investigation agree to waive the five-year limit, in effect giving the SEC more time to sort through the facts and maybe drop its investigation.
The outcome of the Gabelli case presents more of an issue for potential fraud that’s discovered after the five years elapse or come close to it, and the agency has no time to prepare a case.
Marc Gabelli, a portfolio manager, and Bruce Alpert, chief operating officer at Gabelli Funds, say the SEC investigated alleged wrongdoing that took place between 1999 and 2002. The investigation began in fall 2003, and the agency filed its civil complaint in April 2008. It accused them of authorizing an investor in one of their firm’s mutual funds to engage in an improper trading technique known as “market timing.”
In court documents, the defense said the law does not permit the SEC to reach back in time as far as it wants. Rather, the law says, a suit seeking civil penalties must be brought within five years of the date the claim first “accrued” — a term that’s understood to mean when a claim was complete and the plaintiff had a right to sue.
“If the SEC believes that the current statute of limitations does not give it sufficient time to investigate any category of violation, the answer is for it to ask Congress for more time,” the attorneys said in their court document.
But the SEC said there’s been a presumption in the law for 175 years that the clock does not start ticking on fraud penalty cases until the agency knows or should have known the relevant facts. While claims should not languish and create perpetual uncertainty for the accused, people who violate the law also should not benefit from the fact that their conduct had not been discovered by a certain time, the agency’s court filing said.
For decades, the primary remedies for the SEC involved “equitable relief,” such as ordering violators to pay back ill-gotten gains or refrain from taking part in certain activities. But in 1990, Congress authorized the SEC to seek civil monetary penalties, which were thought to be more of a deterrent in discouraging securities law violations.
The agency has been focused on penalties since then. The largest fine the SEC has assessed against a financial firm came in 2010, when Goldman Sachs agreed to pay $550 million to settle a fraud suit accusing the bank of selling a subprime-mortgage investment that was secretly designed to fail.