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January 03, 2014 Articles

The New Statute of Limitations Battle Post-Gabelli

The defense bar faces a new battleground

By Mauro M. Wolfe and Melissa S. Geller

Back in February 2013, a date that will not likely be enshrined in the halls of Securities and Exchange Commission (SEC) history, the United States Supreme Court shut down the SEC’s practice of trying to avoid the statute of limitations on its enforcement actions through reliance on the “discovery rule.”

Apparently, this came as a complete shock to the SEC. It reacted like Superman when confronted with Kryptonite: dropping into a crippled heap. But query how many tolling agreements were issued by the SEC that week? In case you were living in a cave at the time, the roar of applause you heard that day came from all of us in the securities defense bar who were cheering that decision. (As Mauro recalls, the anthem that day was “Whoomp, there it is.” The decision was great and long overdue. Probably 80 years overdue, and, in fact, so late that he was reminded of his nine-year-old’s favorite sarcastic line: “Seriously!”) The pressing question now is how far can the defense bar push the statute of limitations argument? Following Gabelli, does the statute of limitations apply to equitable relief often sought by the SEC? The answer, if you are a member of the defense bar, must be, yes, it does. Now let’s try to make the case.

In Gabelli, the Supreme Court finally said to the SEC enough is enough—even superheroes have limits. The Court resolved a circuit split and rejected the SEC’s practice of bringing enforcement actions outside the five-year statute of limitations based on the “discovery rule.” After Gabelli, the SEC must bring any enforcement action for “civil penalties” within five years of the wrongful conduct, pursuant to the general statute of limitations in 28 U.S.C. § 2462. Gabelli, however, seemingly let stand the underlying district court ruling that no statute of limitations applies to equitable relief and disgorgement claims. Therefore, the open question following Gabelli is whether the five-year statute of limitations applies to so-called “equitable” relief such as injunctions, censures, suspensions, and industry bars. This is the next natural battleground following Gabelli, and there is split authority on this issue.


The Federal Statute at Issue
Section 2462 provides:


Except as otherwise provided by Act of Congress, an action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise, shall not be entertained unless commenced within five years from the date when the claim first accrued if, within the same period, the offender or the property is found within the United States in order that proper service may be made thereon.


Without question, a monetary fine (not to be confused with restitution or disgorgement) constitutes a civil fine or penalty under section 2462, and so any action seeking such a fine must be brought within five years. But what about equitable relief? Can the SEC still bring an action for injunctions and censures and suspensions and bars more than five years after the fact? The SEC says yes and so do some courts, but not all. There is hope yet for the defense bar.


It is clear that the SEC is empowered to bring enforcement actions seeking equitable remedies such as disgorgement, restitution, injunctions, suspensions, officer and director bars, and censures. See SEC, About the Division of Enforcement. Labeling these sanctions as “equitable” relief makes them sound harmless, but here on Earth, a.k.a. the real world, censures, suspensions, and injunctions can have serious career consequences that can often be worse than monetary sanctions. An injunction typically seeks to enjoin an individual from further violations of securities laws. Violators of an injunction, however, may be found in contempt of court, which carries some steep penalties and additional SEC action. Injunctions, suspensions, and censures may also trigger, among other things, revocation of a license by a state body or other official agency. It also leaves a public, negative and permanent mark on a client’s reputation. Injunctions may also allow the SEC to bar a client from registering as a broker-dealer or investment adviser. 15 U.S.C. §78o et seq. These are serious, life-altering consequences.


How the Courts Apply This Statute
The central question is when does an equitable remedy trigger § 2462. Most courts agree that restitution and disgorgement, focusing as they do on making injured parties whole, do not constitute punishment and so do not trigger the statute of limitations. Zacharias v. SEC, 569 F.3d 458, 471 (D.C. Cir. 2009) (disgorgement remedial because it restores status quo ante by depriving wrongdoer of ill-gotten gains and is thus not punitive); SEC v. Jones, 476 F. Supp. 2d 374, 385 (S.D.N.Y. 2007) (disgorgement remedial because primary purpose is to deter future fraud by depriving violators of ill-gotten gains). However, at least one court recognizes that disgorgement may, where not causally connected to the wrong, still be punitive. Riordan v. SEC, 627 F.3d 1230, 1234 n.1 (D.C. Cir. 2010)(noting that disgorgement is remedial only so long as it is causally connected to the wrongdoing and not imposed solely to “fill the Federal Government’s coffers”).


As to other equitable sanctions, significant differences exist in the various circuits. Some courts, led by Johnson v. SEC in the D.C. Circuit and SEC v. Bartek in the Fifth Circuit, engage in a fact-specific inquiry of the requested sanction, focusing on the intent, nature, and long-term consequences of the sanction. In effect, the courts question whether the remedy acts, walks, and sounds like a punishment. SEC v. Bartek, 484 F. App’x 949 (5th Cir. 2012); Johnson v. SEC,87 F.3d 484 (D.C. Cir. 1996); see also United States v. Telluride Co., 146 F.3d 1241 (10th Cir. 1998) (equitable relief subject to section 2462 if it goes beyond compensation for the injury caused by the defendant). Other courts, such as SEC v. Rind (as explained by SEC v. Berry), have held that some or all forms of equitable relief are inherently not subject to section 2462. SEC v. Berry, 580 F. Supp. 911, 919 (N.D. Cal. 2008)(citing SEC v. Rind, 991 F.2d 1486 (9th Cir. 1993)). Where a circuit has not definitively ruled, district courts within that circuit often take different approaches. Compare SEC v. Kelly, 663 F. Supp. 2d 276, 287–88 (S.D.N.Y. 2009) (equitable remedies not subject to section 2462), with SEC v. Jones, 476 F. Supp. 2d 374 (S.D.N.Y. 2007) (section 2462 applies to equitable relief that seeks to punish, but not relief that protects from future harm or remedies past wrongs).


In a “categorical” court, where equitable remedies will never be subject to section 2462, whether a sanction will be considered a penalty rests solely on what type of sanction is requested. SEC v. Kelly, 663 F. Supp. 2d at 288. Thus, in a case following the Kelly analysis, injunctions will always be punitive. In recent years, however, it is the case-specific approach that has gained the most traction.


Because of these differing approaches, it stands to reason that the next statute-of-limitations battleground will be in the area of equitable relief. Let’s take a look in more detail at some of the leading cases that we can rely on.


Johnson v. SEC
Arguably the leading case in this area of inquiry is Johnson v. SEC,87 F.3d 484 (D.C. Cir. 1996). In Johnson, the D.C. Circuit found a censure and six-month suspension to be punitive and, thus, subject to section 2462. The SEC argued that the requested relief was remedial, not punitive. The court disagreed after extensive analysis of the requested sanctions. Its analysis formed the framework relied on by many other circuits. Specifically, the court focused on three key factors:


1. the long-term consequences of the sanction and the impact on Johnson;


2. whether the sanction focused on preventing future harm or punishing past conduct; and


3. whether the sanctions remedied the damage done by the wrongful conduct.


The court concluded the suspension and censure was punitive because (1) the long-term consequences were drastic and would follow Johnson forever; (2) the sanctions were being imposed entirely to punish past conduct, not to protect the public from future harm; and (3) the sanctions did not seek to remedy the damage done, such as in the case of restitution or disgorgement, where money is returned to victims.


Johnson focused primarily on the purpose and focus of the sanction, giving the most weight to the backward-looking nature of the sanction as opposed to the collateral consequences. But it seems difficult to imagine how a censure could ever be anything but backward-looking. In SEC v. Jones, the court followed Johnson to find that a request for a permanent injunction was punitive and not remedial. The Jones court based its decision on the SEC’s failure to show a likelihood of recurrence, as well as the SEC’s focus on the defendant’s past behavior.


Extending Johnson: Collateral Consequences and Bartek
In a landmark move even before the Gabellidecision, the Fifth Circuit in SEC v. Bartek, ruled that equitable relief could be barred by the five-year statute of limitations. It shifted the weight afforded to the Johnson factors, leaning heavily on the collateral consequences of a sanction. Applying the Johnson factors, the court held, in part, that the severe and draconian impact of a permanent injunction renders the sanction punitive and thus subject to section 2462. The court gave significantly less weight to the forward- or backward-looking aspect of the injunction, displaying a marked difference from the analysis in the other decisions in this area.


After Bartek: Collateral Consequences or Directional Inquiry
In the wake of Bartek, courts have struggled with whether to classify injunctions as a penalty or just forward-looking relief. Unlike Bartek, however, the focus of most courts appears to be whether the relief looks forward to prevent future harm or backward to punish, and not necessarily the impact of the collateral consequences.


Thus, the Northern District of Indiana permitted the U.S. Environmental Protection Agency to bring suit for an injunction over 12 years after the offending conduct occurred. United States v. U.S. Steel Corp., No. 2:12-cv-304, 2013 WL 4495665, at *8–9 (N.D. Ind. Aug. 21, 2013). The court recognized that section 2462 can apply to injunctive sanctions if the sanction “is really just a façade for a penalty or forfeiture” and that “the government can’t get around. . . Section 2462 just by slapping the word ‘injunction’ on a claim that is functionally really a penalty.” Nevertheless, while the injunction would impose significant economic and logistical burdens on the defendant, the court found the injunction did not constitute a penalty.


The Southern District of New York, in SEC v. Wyly, attempted to formulate a more structured analysis. No. 10 Civ. 5760, 2013 WL 2450545, at *6 (S.D.N.Y. June 6, 2013). The Wyly court held that for an injunction to be forward-looking, the SEC must demonstrate some “cognizable danger of recurrent violation.”


These two cases both cited Bartek but ultimately settled the weight of the inquiry on whether the government agency demonstrated that the sanction was forward-looking in nature, not on the impact of the collateral consequences.


The Future of the Statute of Limitations
The time is ripe for creative arguments by the defense bar that the purportedly “innocuous” equitable relief sought by the SEC is time-barred under section 2462. Although many courts of appeals have yet to consider the issue, the majority of courts that have considered the issue increasingly adopt the case-specific approach, recognizing that penalties may be disguised as equitable remedies. That is, some courts are receptive to the argument that bringing, after five years, a case that will destroy an individual’s life is neither fair nor just. There simply has to be an end at some point.


Proponents of the case-specific approach received a recent bump from the Gabelli decision. While expressly refusing to rule on the equitable sanctions, the Supreme Court engaged in an extensive discussion of the purposes and intent behind statutes of limitations and section 2462 in particular. They exist, the Court stated, to provide repose, to promote justice, and to protect a defendant against lost evidence, faded memories, and missing witnesses. Statutes of limitations, the Court noted, “provide security and stability to human affairs” and are vital to the welfare of society. Gabelli, 133 S. Ct. at 1221.


This is just dicta, but it does send a clear signal that the Court is aware of the purposes behind section 2462 and that a punitive action brought so many years after wrongdoing can constitute an injustice. The issue will continue to percolate through the districts and will likely reach the Supreme Court in the not-too-distant future. In the end, to paraphrase Shakespeare, a punishment by any other name would still smart the same. Employing that theme in the appropriate case can result in extraordinary benefits and value to your client.