March 21, 2013

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SUPREME COURT CLARIFIES TIME LIMIT ON SECS ABILITY TO SEEK CIVIL PENALTIES FOR FRAUD UNDER THE INVESTMENT ADVISERS ACT

Travis P. Brennan (949) 725-4271 Tbrennan@sycr.com

On February 27, 2013, the U.S. Supreme Court unanimously held that the fiveyear statute of limitations applicable to the SECs ability to seek civil monetary penalties for fraud under the Investment Advisers Act begins to run when the alleged fraud occurs, not when it is discovered. The ruling in Gabelli v. SEC, No. 11-1274, places a clearer time constraint on one of the SECs most potent enforcement remedies.

FIVE-YEAR STATUTE OF LIMITATIONS The Investment Advisers Act empowers the SEC to bring civil enforcement actions against investment advisers accused of defrauding their clients and against individuals accused of aiding and abetting such fraud. Remedies available to the SEC in such actions include civil monetary penalties, which can reach seven figures or more. The SECs ability to seek such civil penalties is limited by the general federal statute of limitations for civil penalty actions, which provides that a civil penalty action must be commenced within five years from the date when the claim first accrued. 28 U.S.C. 2462.

John F. Cannon (949) 725-4107 JCannon@sycr.com

Kathleen M. Marcus (949) 725-4080 KMarcus@sycr.com

The time at which a claim for fraud first accrued is not necessarily the time at which the alleged fraud occurred. Courts often apply the discovery rule to determine when the limitations period commenced. Under the discovery rule, a fraud claim does not accrue, and the limitation period does not begin to run, until the plaintiff discovers the fraud. A fraud is deemed discovered when in the exercise of reasonable diligence, it could have been discovered. In fraud cases, private plaintiffs frequently employ the discovery rule to effectively extend the limitations period, contending that because a fraud was not discovered, or discoverable, until long after the alleged fraud occurred, claims asserted more than five years after the fraud occurred are not time-barred.

THE SUPREME COURT'S RULING In Gabelli, the Supreme Court drew a bright line by rejecting application of the discovery rule in an SEC action for civil penalties under the Investment Advisers Act. The SEC sued under the Investment Advisors Act in 2008, and sought civil penalties, alleging fraud stemming from market timing that occurred between 1999 and 2002. The individual defendants accused of aiding and abetting the fraud moved to dismiss the civil penalties action against them, arguing that, because the alleged fraud occurred at least six years before suit was filed, the action was time-barred. The SEC invoked the discovery rule in an attempt to preserve its action for civil penalties. In rejecting the SECs arguments, the Court reasoned that the discovery rule is inapplicable where the plaintiff is not a defrauded victim seeking recompense, but is instead the Government bringing an enforcement action for civil penalties. (Slip. Opinion at 6.) In the Courts view, the discovery rule exists to preserve the claims of private plaintiffs that do not typically have the means to ferret out concealed wrongdoing. In contrast, the SEC needs no additional help in preserving its fraud-based claims because it is in the constant business of investigating potential violations of the federal securities laws. (Id. at 8.) Also central to the Courts ruling was its recognition that civil penalties are designed to punish a wrongdoer, not compensate a victim. The prospect of leaving defendants exposed to potential punishment for an additional uncertain period into the future, as the discovery rule has the potential to do, struck the Court as unjust. (Id. at 9.) After the Courts ruling in Gabelli, the SEC must bring a civil penalty action for fraud under the Investment Advisors Act, or under the other penalty provisions of the federal securities laws, within five years of the time the alleged fraud occurred. The ruling does not impose limitations on other remedies available to the SEC in instances of fraud, including injunctive relief and disgorgement. If you have any questions about how the Courts ruling in Gabelli may impact your business, or other questions about securities law enforcement, please feel free to contact the Stradling attorney with whom you work, or:

Travis P. Brennan (949) 725-4271 Tbrennan@sycr.com John F. Cannon (949) 725-4107 JCannon@sycr.com Kathleen M. Marcus (949) 725-4080 KMarcus@sycr.com