Jonathan Macey is a professor at Yale Law School and the author of a new book, The Death of Corporate Reputation: How Integrity Has Been Destroyed on Wall Street.
Either the SEC is living in its own little bubble world or else the Commission is operating under some masochistic urge to embarrass itself. The Supreme Court simultaneously burst the SEC’s bubble and embarrassed the agency in its yesterday’s decision in Gabelli v. Securities and Exchange Commission. The Court rejected the SEC’s proffered interpretation of 28 U.S.C. § 2462, a general statute of limitations that governs many penalty provisions throughout the federal code.
The reason this mildly technical decision interpreting a federal statute of limitations provision is embarrassing to the SEC is that a major complaint against the SEC is that it is dilatory in pursuing cases. It takes too long to notice when fraud is occurring, and when it does finally notice that fraud is occurring it cannot seem to put a case together in a reasonable period of time. By bringing this suit, the SEC seemed to be confirming the accusations of its harshest critics. In this case, the SEC took the position that the statute of limitations in this civil fraud case should not begin to run until it got around to discovering the fraud. The Court rejected this contention, ruling that “the five-year clock in § 2462 begins to tick when the fraud occurs, not when it is discovered.”
The facts of this case support the contention that the SEC is remiss in bringing cases. Following in the wake of Eliot Spitzer, who taunted the SEC for being slow to bring cases against mutual funds for allowing certain of their favored clients to engage in sketchy trading practices that were prohibited to other customers, the SEC targeted the mutual fund industry and diligently followed a cadre of state attorneys general who were suing these mutual funds. After its late start in initiating an enforcement program to address abuses in the mutual fund industry, the SEC kept going, continuing to bring suits long after market participants and more agile regulators had moved on to other, more grave, and more relevant problems.
The timing could not be worse for the SEC. Earlier this month the Justice Department sued the credit rating agency Standard & Poor’s, alleging that S&P had lowered its ratings standards and succumbed to pressures so that it could continue making money by rating complex derivatives. This was embarrassing for the SEC because the Commission had been investigating S&P for years. The DOJ not only beat the SEC to the punch, but it brought a civil, rather than criminal, suit against S&P. Usually in securities fraud cases the SEC brings the civil suits, and the DOJ brings the criminal suits. The fact that the DOJ appears to be doing the SEC’s job is an embarrassment for the Commission.
The SEC wanted a rule that would start the statute of limitations when, in the exercise of reasonable diligence, the fraud could have been discovered. The SEC is lucky that it lost because, as Chief Justice Roberts pointed out, if the SEC had won the case then it would be compelled to refute arguments in virtually every case that, had it been reasonably diligent, the SEC would have known of the fraud much earlier and therefore is time barred from bringing the case. In addition, with multiple, overlapping bureaucracies and thousands of government employees on the prowl, it would be practically impossible to know what the government knew when. As the Chief Justice put it:
Determining when the Government, as opposed to an individual, knew or reasonably should have known of a fraud presents particular challenges for the courts. Agencies often have hundreds of employees, dozens of offices and several levels of leadership. In such a case, when does “the Government” know of a violation? Who is the relevant actor? Different agencies often have overlapping responsibilities; is the knowledge of one attributed to all?
The court also made the point that government agencies like the SEC are supposed to be professional and capable. Their job is to ferret out fraud. As such, holding them to a five-year statute of limitations does not seem unreasonable.
The millions of Americans who have lost their jobs or their homes or both as a result of the fraud, marketing abuses, and ethical lapses on Wall Street over the past decade or so might well object to the outcome in this case on the ground that it will let various individual and corporate miscreants off the hook on a statute of limitations technicality. If the SEC had won this case, the government could have sued a few more bad guys, who now will be free from litigation risk because the Court affirmed a firm five-year statute of limitations and rejected the SEC’s notion that even decades-old frauds could be prosecuted as long as the suits were brought within five years of the date that the SEC got around to “discovering” the wrongdoing.
This is not a terrible argument. The force of the argument is weakened, however, by the depressing fact that the SEC has not been very vigorous in its response to the gross excesses that caused the financial crisis. The SEC continues to offer comfort and protection to the credit rating agencies. The SEC has not been very successful in suing the individual executives at the banks and credit rating agencies who were the architects of the financial crisis. On February 1, 2013, the SEC released a list of the actions it had taken that were aimed at “addressing misconduct that led to or arose from the financial crisis.” The list is striking. The SEC seems to have sued every firm on Wall Street, including Bank of America, Citigroup, Credit Suisse, Goldman Sachs, J.P. Morgan, and Wells Fargo.
The SEC has sued 154 separate entities and individuals and has obtained penalties in excess of $1.53 billion. To the extent that the SEC sues individuals, however, they tend to come from the smaller firms. Virtually none of the executives of the big firms on the list above were on the list. When the SEC does sue CEOs, it tends to be CEOs of small firms like Brookstreet Securities Corp, whose CEO Stanley Brooks was ordered to pay $10 million in a securities fraud case brought by the SEC. And its litigation record is very spotty.
Thus, the data indicate that, the costs of the decision are very low as measured by the number of high-level lawsuits against the architects of the financial crisis that will be time barred because of this decision. Because the SEC has never shown much of an interest in bringing these cases, the Court’s decision in this case will only prevent the SEC from doing things that it already showed no interest in doing anyway.
Perhaps this case is a wake-up call for the SEC: it just might provide the SEC with the incentives that it needs to become more efficient and to bring cases in a more timely way. A decade ago, Harvey Pitt – the Chairman of the SEC at the time – introduced the “radical” idea that the SEC should move to a policy of “real-time enforcement,” by which he meant that the SEC should move more expeditiously to seek out and redress potential violations of securities laws. The position that the SEC staked out for itself in Gabelli appeared to abandon any effort at real-time enforcement and to replace that policy with a policy of “any old time enforcement.” The Court did all of us a favor by rejecting that gambit.
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