“Time zone arbitrage” is an investment practice that takes advantage of the time difference between markets in the United States and abroad but that may harm international institutional investors. In its initial action against defendants, Marc J. Gabelli and Bruce Alpert (collectively, “Gabelli”), the SEC alleged that Gabelli allowed a single investor in the mutual fund they managed to engage in a time zone arbitrage. The SEC argued that Gabelli committed securities fraud by allowing such a practice while simultaneously representing to the directors and investors of the mutual fund that time zone arbitrage would not be tolerated. The SEC action was dismissed in the United States District Court for the Southern District of New York for having exceeded the statute of limitations. However, the Court of Appeals for the Second Circuit reversed, stating that the period did not begin running for statute of limitations purposes until the SEC discovered the alleged misconduct, rather than when the alleged misconduct first occurred. The defendants now appeal, arguing that potential targets of government enforcement actions should not have to live under the constant threat of penalty for conduct long since passed. The SEC counters that wrongdoers should not benefit by virtue of their conduct being more difficult to uncover. The Supreme Court’s resolution of this case will have long lasting implications on the government’s efforts to regulate the securities market.
Section 2462 of Title 28 of the United States Code provides that “except as otherwise provided by Act of Congress” any penalty action brought by the government must be “commenced within five years from the date when the claims first accrued.” (emphasis added). This Court has explained that “[i]n common parlance a right accrues when it comes into existence.” United States v. Lindsay, 346 U.S. 568, 569 (1954).
Where Congress has not enacted a separate controlling provision, does the government's claim first accrue for purposes of applying the five-year limitations period under 28 U.S.C. § 2462 when the government can first bring an action for a penalty?
Whether the five-year limitation for government enforcement actions begins running when the government discovered an alleged violation or when the alleged violation took place.
The defendants, Marc J. Gabelli and Bruce Alpert (collectively, “Gabelli”), manage a mutual fund by the name of Gabelli Global Growth Fund (“the fund”) and an adviser to that fund by the name of Gabelli Funds, LLC, respectively. See SEC v. Gabelli, 653 F.2d 49, 52 (2d. Cir. 2011). According to the Securities and Exchange Commission (“SEC”), Gabelli gave preferential treatment to one investor, allowing it to engage in an investing strategy that is particularly harmful to mutual funds that invest in foreign securities, and then misled the fund’s directors and other investors. See id. at 52–53, 55. Known as “time zone arbitrage,” the practice takes advantage of the fact that foreign securities markets close before those in the United States. See id. As a result of this lag, investors can buy or sell securities based on events in the foreign markets before those events affect prices in the U.S. markets; then, once the price changes in the U.S., the investor can sell or buy the securities, thereby profiting from the time delay. See id. While not illegal, time zone arbitrage nevertheless hinders the operation of mutual funds by forcing them to keep extra money on hand to buy back securities from investors who want to sell. See id.
According to the SEC, Gabelli represented to the fund that such a practice was not tolerated—indeed, Gabelli even actively blocked others from doing this—while simultaneously allowing one investor to continue the practice. See Gabelli, 653 F.2d at 55. The SEC alleges that it only learned of this wrongdoing in 2003. See id. In 2008, the SEC sued Gabelli, alleging securities fraud under various statutes, including an allegation of aiding and abetting fraud in violation of the Advisers Act of 1940. See id. Among other remedies, the SEC sought a fine against Gabelli. See id. Following a motion by Gabelli, the District Court dismissed the SEC’s claims of securities fraud against Alpert, concluding that he had made not misled the fund’s directors or other investors. See id. at 55–56. The District Court also ruled that, although the SEC could continue with its Advisers Act claims, it could not pursue a fine. See id. at 56. The District Court explained that a fine was inappropriate because the SEC had exceeded the statute of limitations, as it had not brought its claim against Gabelli until more than five years after the last alleged misrepresentation. See id.
The Court of Appeals for the Second Circuit reversed the District Court, ruling that the SEC had not exceeded the statute of limitations and so could continue its pursuit of a fine. See Gabelli, 653 F.2d at 58–59. The court stated that the applicable statute of limitations required claims seeking civil penalties to be brought within five years from the date that those claims accrued. See id. at 58 (citing 28 U.S.C. § 2462). The Second Circuit accepted the SEC’s argument that accrual for a claim of fraud is governed by the “discovery rule,” under which a claim accrues when the plaintiff knew or should have known of the fraud. See id. at 58–60. Stating that the defendants had not shown that the SEC should have known of their fraud earlier than 2003, the court concluded that dismissal of the SEC’s claim was inappropriate and reversed the District Court. See id. at 60–61.
The Supreme Court granted Gabelli’s petition for writ of certiorari on September 25, 2012. See Supreme Court October 2012 Term Granted and Noted List at 4.
The parties dispute when the statute of limitations began running for the SEC’s enforcement action. Gabelli argues that, under the general rule for government actions, the five-year period started when the SEC could first have brought its action seeking a fine. See Brief for Petitioners, Marc J. Gabelli and Bruce Alpert at 11–13. In opposition, the SEC contends that a different rule applies because the case involves fraud and the period instead started when the SEC first discovered Gabelli’s alleged violation. See Brief for Respondent, SEC at 12.
The Need for Repose for Potential Defendants
Gabelli contends that one of the reasons for having a statute of limitations is the opportunity for repose for potential defendants. See Brief for Petitioners at 37. With a discovery rule for securities fraud, Gabelli argues, a potential defendant could never feel safe from liability. See id. Writing in support of Gabelli, Former SEC Commissioners and Officials (“Former Commissioners”) add that repose promotes not only fairness in law enforcement but also public confidence in the law. See Brief of Amicus Curiae Former Commissioners in Support of Petitioners at 11. They argue that certainty and finality are key to the public’s belief that law enforcement is just and that extending the time in which the government could bring an enforcement action would undercut these values. See id. at 11–12.
The SEC counters that implementing a discovery rule would properly balance the principle of repose with effective law enforcement. See Brief for Respondent at 46. The SEC explains that defendants are not as deserving of repose where their very wrongdoing made it difficult to discover. See id. The SEC claims that defendants should disclose their conduct to the public, thus starting the clock for the statute of limitations, if they want repose. See id. Furthermore, according to the SEC, a discovery rule provides adequate repose by starting the limitations period when the wrongdoing should have been discovered, rather than when it actually was. See id. at 48. As a result, the SEC argues, there is no perpetual threat of government enforcement hanging over market participants. See id.
Access to Evidence in Enforcement Actions
Gabelli expresses concern that extending the limitations period would be unfair to defendants due to the increased likelihood that evidence to mount a defense would not be as readily available. See Brief for Petitioners at 42–43. Arguing in support of Gabelli, the Securities Industry and Financial Markets Association and the Chamber of Commerce of the United States of America (collectively, “SIFMA”) note that trials may add years beyond the limitations period, further increasing the risks of lost evidence and unavailable witnesses. See Brief of Amicus Curiae SIFMA in Support of Petitioner at 20. However, in support of the SEC, Occupy the SEC counters that advances in technology have reduced this risk of lost evidence. See Brief of Amicus Curiae Occupy the SEC in Support of Respondent at 20.
The Former Commissioners further emphasize that inquiry into the SEC’s knowledge (or what it should have known) would result in a very burdensome discovery process, including depositions of staff members access to the SEC’s investigative files. See Brief of Former Commissioners at 15–16. The Former Commissioners note that, because a defendant could gain access to government files during discovery in a lawsuit, confidential and sensitive information might be exposed. See id. at 21.
In response, the SEC claims that a discovery rule for fraud has proved workable for over two centuries. See Brief for Respondent at 48. The SEC argues that courts have not previously had difficulty in determining when the government first learned (or should have learned) of wrongdoing. See id. at 49. Moreover, the SEC notes that defendants could take limited discovery and obtain summary judgment for meritless claims. See id. at 51.
Effective Enforcement of Securities Laws
Occupy the SEC argues that fraud may be particularly hard to discover in the banking and finance world, and that wrongdoers should not profit because their conduct is hard to spot. See Brief of Occupy the SEC at 6–7. It adds that the SEC has myriad regulatory and enforcement responsibilities but only limited resources, making fraud even more unlikely to be discovered. See id. at 7–9. Furthermore, Occupy the SEC argues, antifraud laws exist to protect investors as well as the market in general, and shortening the timeframe in which the SEC may bring an enforcement action hinders that important goal. See id. at 13–14. Occupy the SEC concludes that statutes of limitations are not meant to allow wrongdoers off the hook simply because the enforcement agency was overburdened and so unable to discover misconduct more quickly. See id. at 18.
SIFMA disputes that the SEC is severely restricted by limited resources. See Brief of SIFMA at 23–25. Rather, SIFMA contends that the SEC has not only vast resources but also a rewards system to incentivize tipsters to come forward with information regarding misconduct. See id. Consequently, SIFMA argues, the SEC does not need a discovery rule to adequately enforce securities laws. See id. at 22–25. Moreover, SIFMA maintains that the SEC’s purpose is not to punish wrongdoing but instead only to stop it and provide remedy for those who have been harmed. See id. at 21. SIFMA adds that the victims of securities fraud may already protect themselves by bringing lawsuits under other statutes that use a discovery rule, so applying one to SEC enforcement actions is unnecessary. See id. at 23.
Petitioner Gabelli argues that even in a lawsuit based upon fraud, there is a presumption against postponing the statute of limitations until the plaintiffs could actually or constructively discover the facts giving rise to the lawsuit (“discovery rule”). Respondent SEC asserts that in the case arising from a fraud, there is a presumption that the statute of limitations will not begin until the fraud could be discovered.
Section 2462 of Title 28 of the United States Code provides: “Except as otherwise provided by Act of Congress, an action, suit, or proceeding . . . shall not be entertained unless commenced within five years from the date when the claim first accrued if . . . the offender or the property is found within the United States.” 28 U.S.C. § 2462.
Language of the Statute
Gabelli argues that the word “accrued” dictates when the statute of limitations begins. See Brief for Petitioners at 12. Gabelli asserts that the current plain meaning of the word “accrue” as well as the meaning of “accrue” when the statute was enacted both refer to when a potential plaintiff has the right to file a lawsuit, not when a potential plaintiff discovers that right. See id. at 14-15. Gabelli argues that this refers to the time of the lawsuit’s underlying events. See id. at 15. Here, those events would be the market timing transactions. Additionally, Gabelli notes that “the offender or the property is found within the United States” is an express exception to the statute of limitations, yet there is not an express exception for the discovery rule, and thus Congress did not intend to include an exception for the discovery rule. See id. at 19.
The SEC asserts that a claim cannot “accrue” until a potential plaintiff is presumed to have or actually has knowledge that the events underlying the lawsuit occurred. See Brief for Respondent at 13. In fact, the SEC cited to a 2010 Supreme Court decision, Merck & Co. v. Reynolds, 130 S. Ct. 1784, 1793 (2010), to support the general rule that when there is fraud, the statute of limitations is delayed until the plaintiff has “discovered” the fraud. See Brief for Respondent at 13, 14. However, Gabelli notes that the Merck decision involved an underlying statute featuring an express exception for the discovery rule. See id. at 15. The SEC acknowledges the difference in the underlying statute from Section 2462, but notes that the Merck decision relied heavily on the common-law principle that the statute of limitations presumptively has a carve-out for cased based upon fraud. See id. at 15.
Gabelli traces Section 2462 back to a statute from 1790 and argues that in 1790, the established law recognized that the statute of limitations began when the violation occurred. See Brief for Petitioners at 49-50. Gabelli asserts that the universal dictionary definition and the common-law definition for “accrue” referred to the date of the violation. See id. at 50-51. Furthermore, Congress amended the statute multiple times; however, the statute of limitations language was not amended, thus creating a presumption that Congress knew and approved of the application of the law’s non-amended portions. See id. at 51-52.
The SEC notes that the suspending the statute of limitations for cases involving fraud has been established since the House of Lords decided Booth v. Warrington in 1714. See Brief for Respondent at 24. Additionally, the Supreme Court also applied this principle in 1830 in deciding Willison v. Watkins, 28 U.S. 43, 52-53 (1830). See Brief for Respondent at 26. Thus, the SEC asserts that, when Congress enacted the earliest version of Section 2462 in 1839, Congress understood the statute of limitations would not start until the discovery of fraud. See id. at 27. Gabelli counters that these earlier cases dealt with concealment as well as fraud, See Brief for Petitioners at 27, but the SEC cites TWR Inc. v. Andrews, 534 U.S. 19, 27 (2001), which states that the discovery rule applied to both concealment and fraud. See Brief for Respondent at 29-30. Furthermore, the First Circuit Court of Appeals in SEC v. Tambone, 550 F.3d 106, 148 (1st Cir. 2008), noted that fraud is by nature self-concealing. See Brief for Respondent at 32.
Gabelli argues that the Congressional intent of Section 2462 supports the presumption against applying the discovery rule. See Brief for Petitioners at 18-19. Notably, Gabelli identifies that Congress expressly knew how to write a statute that included the discovery rule because a number of federal statutes include a discovery rule, and the fact that Section 2462 does not include the discovery rule was a strategic choice. See id. at 19-23.
The SEC contends that Congress did not expressly include the discovery rule in Section 2462 because there is a presumption that the discovery rule will be read into federal statutes unless Congress otherwise specifies. See Brief for Respondent at 33. In making this assertion, the SEC cited the Supreme Court case Exploration Co. v. United States, 247 U.S. 435, 447 (1918), which states that in cases of fraud, the discovery rule applies even if the rule is not expressly in the statute. See Brief for Respondent at 33. Furthermore, the SEC argues that Congress will usually refer to the discovery rule in a statute when expanding or contracting the traditional rule. See id. at 38. For example, Congress refers to the discovery rule when expanding it to included cases not based on fraud, applying it to conduct that could be either fraudulent or non-fraudulent, restricting it to combine discovery with an absolute drop-dead date, or clarifying its application to remove any doubt the discovery rule would apply. See id. at 38-41.
Governmental or Private Action
Gabelli argues for the securities law principle that there are often very different rules for the government and private plaintiffs. See Brief for Petitioners at 30-31. For example, Gabelli notes that 28 U.S.C. 1658 provides private securities plaintiffs a two year statute of limitations after discovery, but that the absolute period a lawsuit could be brought is five years. See id. at 23. Thus, Gabelli argues that it would be unfair for private plaintiffs to be absolutely limited to a five-year statute of limitations under Section 1658 while the SEC’s discovery rule for Section 2462 would mean that the government would not be so constrained. See id. at 23-24.
The SEC responds that without a discovery rule in cases of fraud, someone could take advantage of his own wrong because fraudulent conduct may prevent potential plaintiffs from knowing that they were defrauded before the statute of limitations ran out. See Brief for Respondent at 13-14. Furthermore, the SEC points out that in Exploration Co., the Supreme Court notes that there would be no logical reason not to extend the discovery rule when the government is the plaintiff, given that it is so ubiquitous in the fraud context. See id. at 41-42. Additionally, the SEC argues that when a statute of limitations is ambiguous, the government is given the benefit of the doubt. See BP Am. Prod. Co. v. Burton, 549 U.S. 84, 96 (2006). Finally, the SEC asserts that a discovery rule makes sense in this context in order to deter fraudulent securities violations. See Brief for Respondent at 45.
Gabelli argues for a general rule that there is a presumption against the discovery rule, a postponing of the statute of limitations until potential plaintiffs discover the underlying facts leading to a lawsuit, unless explicit within the statute, even for cases of fraud. Conversely, the SEC asserts that there should be a discovery rule carve-out from the normal statute of limitations in cases of fraud. The analysis relies heavily on statutory interpretation, from the plain language of the statute, to the historical context in which the statute was drafted, to the intent of Congress when they passed the statute. Furthermore, this case has an additional wrinkle because the original plaintiff was the government, not a private person. Ultimately, this case will clarify how to apply various statutes when the underlying facts are affected by fraud.
- Reuters, Jonathan Stempel and Sarah N. Lynch: U.S. Top Court to Hear Marc Gabelli Appeal in SEC Case (Sept. 25, 2012)
- Thomson Reuters News & Insight, Britt K. Latham and M. Jason Hale: Pending Supreme Court Decision May Breathe New Life Into SEC Civil Enforcement Actions Related to the Financial Crisis (Oct. 15, 2012)