SEC v. Graham: SEC’s Delay in Filing Causes Ponzi Scheme Claims To Be Dismissed

In a brief interlude in the ongoing discussion of the development of insider trading law, I would like to note a May 12, 2014 decision entered against the SEC in an enforcement action.  In SEC v. Graham, Case No. 13-10011-CIV-KING, Judge King of the Southern District of Florida ruled that the applicable statutory statute of limitations precluded jurisdiction of the court to adjudicate a stale SEC enforcement proceeding.  This is the latest in a series of recent considerations of how the limitations period in 28 U.S.C. § 2462 impacts SEC enforcement actions.  (Click here to open the slip opinion in SEC v. Graham.)

Based on the court’s description, Graham sounds like it involved a classic Ponzi scheme, in which the alleged perpetrators promised wealth-creating returns to purchasers of condominium units that were to be renovated and rolled into a large, nationwide resort.  As alleged, the returns paid to investors were funded by later purchases of new investors.  This sounds like the kind of case the SEC should be bringing, quickly and efficiently.

Instead what happened was that the SEC investigated the case “for at least seven years.”  The last condominium sale by any of the defendants under this alleged scheme occurred in 2007, at which point the real estate and credit collapse led to the company sponsor’s abandonment of development efforts.  The SEC did not file its complaint until January 2013.

This is an all-too-common refrain for the SEC.  It is not at all unusual that staff investigations will go on for many years before decisions are made about whether or how to proceed.  This occurs not only in complex cases that may present difficult facts and law to parse through, but also in cases of alleged out and out, blatant fraud.  Because of these endemic delays, the SEC has always been arguing that it is either not subject to any statute of limitations, or that what limitations period exists does not prevent delaying cases for many, many years.  Of course, even if this were true, it would not change the fact that by delaying these cases for so long, the SEC makes them ineffective law enforcement vehicles.  In short, the SEC is often bringing to court stale cases involving alleged conduct that occurred many years before.

Section 2462 states:

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.

The SEC’s enforcement actions typically seek relief from alleged securities law violations in the form of civil penalties, injunctions barring future violations, bars against future activities of the defendants, and “disgorgement” of alleged ill-gotten gains.  Section 2462 bars government civil claims for fines, penalties, or forfeiture, “pecuniary or otherwise” if they are not commenced “within five years from the date when the claim first accrued.”  For many years, the SEC contended that for claims alleging fraud, the “claim first accrued” language really meant when the SEC first discovered that a fraud had occurred, even if that was many more than five years after the fraudulent conduct occurred.  The SEC also contends that apart from its penalty claims, the other forms of relief it seeks are not fines, penalties or forfeitures, and therefore are not subject to any statute of limitations.  (See the earlier post, Why Isn’t the SEC Committed to a Just and Fair Enforcement Process?, on the SEC’s larger fairness issues.)

In 2013, the Supreme Court ruled that when section 2462 refers to “when the claim first accrued” it means when the offensive conduct occurred, not when the SEC may have discovered it.  Gabelli v. SEC, 133 S. Ct. 1216, 1220-21 (2013).  The Court’s decision explains the critical importance of statutes of limitation as a means of providing a limit on the government’s ability to accuse people of misconduct, quoting Chief Justice Marshall’s statement that “it would be utterly repugnant to the genius of our laws if actions for penalties could be brought at any distance in time.”  Id. at 1223, quoting Adams v. Woods, 2 Cranch 336, 342 (1805).

In Graham, District Judge King found that the language of section 2462 did not just prevent claims after more than five years, but was jurisdictional in nature – that is, it withdrew from the federal courts the power to hear such claims.  It based this decision in part on the language of section 2462, which states that such claims “shall not be entertained.”  (As compared, for example, to language like “no claim shall be brought more than five years after ….”.)  Because this was stated as a jurisdictional issue, the court also found that because the burden of showing jurisdiction always falls on the plaintiff, it was the SEC’s burden to come forward with some evidence of violations within the five year period, and its failure to do so required that the claims be dismissed.  (If the issue were not jurisdictional, because the issue arose on a motion for summary judgment by the defendants, the SEC could prevent dismissal by showing disputed material facts about when the violations occurred – which it apparently failed to do in any event.)

Judge King’s decision is noteworthy for another reason as well: he rejected the SEC’s contention that its requests for injunctive relief and disgorgement were not covered by section 2462.  This is always the SEC’s backstop; even if the penalty claims are time-barred, the SEC argues that the claims for equitable relief — like injunctions, disgorgement, and orders barring defendants from future business activities involving securities or public companies — are not subject to the same time limitation.  The Graham court rejected this argument as one of form over substance, noting: (1) the SEC’s complaint seeks to have the court “label defendants wrongdoers”; (2) the injunctive relief sought “can be regarded as nothing short of a penalty ‘intended to punish,’” especially when there was no evidence of ongoing conduct or continuing harm; and (3) the “disgorgement of ill-gotten gains . . . can truly be regarded as nothing other than a forfeiture (both pecuniary and otherwise),” which is expressly covered by section 2462.  “To hold otherwise would be to open the door to Government plaintiffs’ ingenuity in creating new terms for the precise forms of relief expressly covered by the statute in order to avoid its application.”

This last ruling is dagger for the SEC.  Its litigation position is always that the non-penalty relief involves equities, not penalties, which relieves the SEC of unpleasant litigation burdens (including taking those issues away from a jury).  To be fair, most courts have historically agreed with that view, although the analysis is typically thin.  But in recent years the courts have tended to take a much more critical view of the relief the SEC always seeks because it often is highly punitive, even though the SEC portrays it as otherwise.  But that is an issue for another day.

Straight Arrow

May 14, 2014

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2 thoughts on “SEC v. Graham: SEC’s Delay in Filing Causes Ponzi Scheme Claims To Be Dismissed

  1. Pingback: Opposition Growing to SEC’s New “Star Chamber” Administrative Prosecutions | Securities Diary

  2. Pingback: Let’s Get Real: When SEC “Disgorgement” Remedy Is Used as Punishment It Should Be Treated that Way | Securities Diary

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