Securities — Section 21A of the Exchange Act Is Not a Statute of Repose — Differences between Statutes of Limitations and Repose — Statute of Limitations Barring Government Rights Strictly Construed in Favor of Government

From SEC v. Wyly, 2011 U.S. Dist. LEXIS 35793 (S.D.N.Y. Mar. 31, 2011):

On July 29, 2010, following a six-year investigation into matters spanning almost two decades, the Securities and Exchange Commission ("SEC") filed this suit alleging thirteen Claims for securities violations by billionaire brothers Samuel Wyly and Charles J. Wyly (together, the "Wylys"), their attorney Michael C. French ("French"), and their stockbroker Louis J. Schaufele III ("Schaufele"). The gist of the fraud alleged is that, from 1992 through at least 2005, the Wylys hid their ownership of and trading activity in the shares of four public companies on whose boards of directors they sat by creating a labyrinth of offshore trusts and subsidiary entities in the Isle of Man and the Cayman Islands (the "Offshore System"); transferring hundreds of millions of shares of the Issuers' stock to those entities; and installing surrogates to carry out their wishes regarding the disposition of the stock — all while preserving their anonymity and evading federal securities laws governing trading by corporate insiders and significant shareholders. Attorney French and stockbroker Schaufele were allegedly essential to the success of this scheme, which also included a singular instance of insider trading by the Wylys and Schaufele in 1999. The SEC seeks penalties, injunctive relief, and disgorgement of roughly $550 million in gains and prejudgment interest.

Defendants now move to dismiss Claims One through Four of the Complaint, which allege that, through the use of the Offshore System, the Wylys and French committed primary violations of section 10(b) of the Exchange Act (Claim One) and section 17(a) of the Securities Act of 1933 (the "Securities Act") (Claim Four); that French and Schaufele aided and abetted the fraud alleged in Claim One under section 10(b) (Claim Three); and that the Wylys and Schauefe engaged in insider trading, also in violation of section 10(b) of the Exchange Act (Claim Two). The most interesting and complicated questions raised by the defendants' motions, however, have nothing to do with the substance of the federal securities laws' antifraud provisions; rather, they concern the applicability and interpretation of various limitations periods purportedly governing the SEC's claims for monetary penalties for both their fraud claims (Claims One through Four) and their non-fraud claims (Claims Five through Thirteen). ***

2. Section 21A of the Exchange Act

Section 21A authorizes the SEC to seek treble civil penalties specifically for violations of the Exchange Act that constitute insider trading, as defined in section 21A. Unlike section 21(d)(3) of the Exchange Act, section 21A contains an express, five-year "Statute of limitations," providing that

[n]o action may be brought under this section more than 5 years after the date of the purchase or sale. This section shall not be construed to bar or limit in any manner any action by the Commission or the Attorney General under any other provision of this chapter, nor shall it bar or limit in any manner any action to recover penalties, or to seek any other order regarding penalties, imposed in an action commenced within 5 years of such transaction.

3. The Discovery Rule

The "'discovery rule' of federal common law" is "[t]he rule that postpones the beginning of the limitations period [the "accrual" date] from the date when the plaintiff is wronged to the date when he discovers he has been injured." The discovery rule applies "where a plaintiff has been injured by fraud and remains in ignorance of it without any fault or want of diligence or care on his part." *** This equitable doctrine is "read into statutes of limitations in federal-question cases . . . in the absence of a contrary directive from Congress" "in cases of fraud or concealment." *** The date of "discovery," for purposes of the discovery rule, is the earlier of "when the litigant first knows or with due diligence should know the facts that will form the basis for an action." The Second Circuit recently clarified, in a private securities fraud case, that under Merck v. Reynolds,

a fact is not deemed "discovered" until a reasonably diligent plaintiff would have sufficient information about that fact to adequately plead it in a complaint. In other words, the reasonably diligent plaintiff has not "discovered" one of the facts constituting a securities fraud violation until he can plead that fact with sufficient detail and particularity to survive a 12(b)(6) motion to dismiss.

***

4. Fraudulent Concealment

Fraudulent concealment is a doctrine of equitable estoppel that "comes into play if the defendant takes active steps to prevent the plaintiff from suing in time, as by promising not to plead the statute of limitations." Rather than postpone the date of accrual (like the discovery rule), tolling doctrines such as fraudulent concealment "stop the statute of limitations from running even if the accrual date has passed." ***

B. Discussion

1. Section 21(d)(3) of the Exchange Act

Defendants argue that all of the SEC's claims for civil monetary penalties under section 21(d)(3) that "first accrued" prior to five years before the effective date of defendants' tolling agreements are barred by the catch-all statute of limitations to which, they argue, the discovery rule does not apply. Moreover, "to the extent" the doctrine of fraudulent fraudulent concealment is inapplicable to its fraud claims, which are instead governed by the discovery rule. Under that theory, according to the SEC, it need only plead that it did not "discover" (and with diligence could not have discovered) defendants' fraud until November 16, 2004 -- the earliest date that it was "even on inquiry notice about these matters."

The Second Circuit has not yet addressed whether the discovery rule applies to SEC enforcement actions seeking penalties for fraud claims, though it will soon. However, there does not appear to be a genuine dispute between the parties that, even if the discovery rule is inapplicable, the doctrine of fraudulent concealment applies. ***Therefore, because I find that the SEC has adequately pled fraudulent concealment, and because the parties appear to be in agreement that the SEC faces a higher pleading bar for fraudulent concealment than for the discovery rule, I need not address whether the discovery rule applies to section 2462 in SEC actions for fraud.***

a. The SEC Has Adequately Pled Acts of Concealment by Defendants ***

b. The SEC Has Alleged that It Did Not Discover Its Claims Until November 16, 2004 ***

c. The SEC Has Adequately Alleged Due Diligence ***

2. Section 21A of the Exchange Act (Civil Penalties for Insider Trading)

The SEC seeks penalties for the Wylys' and French's alleged 1999 insider trading violations under section 21A, a statute which allows for treble damages. The Wylys argue that section 21A's five-year "Statute of limitations" is an "explicit statute of repose" that "runs from 'the date of the purchase or sale,' without qualification," and therefore "does not permit equitable tolling."138 The SEC argues that, because section 21A suggests no restriction on the application of the discovery rule, "there is no indication that Congress intended in [s]ection 21A to override the long-standing rule of Holmberg that the discovery rule 'is read into every federal statute.'" Whether section 21A is a statute of repose, or a statute of limitations subject to the discovery rule (or the doctrine of fraudulent concealment), appears to be a matter of first impression.

a. Section 21A Is Not a Statute of Repose

In holding that section 13 of the Securities Act contained a three-year statute of repose, the Second Circuit in P. Stolz Family Partnership v. Daum devoted considerable discussion to the differences between statutes of repose and statutes of limitation. First, "[i]n general, a statute of repose acts to define temporally the right to initiate suit against a defendant after a legislatively determined time period." Thus, "unlike a statute of limitations, a statute of repose is not a limitation of a plaintiff's remedy, but rather defines the right involved in terms of the time allowed to bring suit." Section 21A's five-year statute of limitations is clearly a limitation on one of several "remedies" the SEC may seek for insider trading; it does not prevent the SEC from bringing suit for injunctive and other equitable relief under section 21(d) no matter how much time has elapsed since the violation occurred. Indeed, section 21A itself provides that it should "not be construed to bar or limit in any manner any action by the Commission . . . under any provision of this title." And although section 21A in a sense "defines the right" to bring suit for a particular type of relief (treble penalties) and for a particular type of behavior that violates the Exchange Act, 144 such behavior would be actionable under the federal securities laws even without section 21A.

Second, when discussing the purported inequities of statutes of repose — such as the opportunity they afford defendants to "secur[e] a sort of immunity to continue illicit [behavior] without civil liability" — the P. Stolz court explained that plaintiffs' "remedial results may best be furthered, without losing one of the principal benefits of a statute of repose — to provide an easily ascertainable and certain date for the quieting of litigation — by lengthening the period before repose takes effect." As an example, the court cited the Sarbanes Oxley Act, "which extend[ed] the effective date of the statute of repose from three years to five years." Section 20A of the Exchange Act, which provides "express private rights of action for those who traded securities contemporaneously with, and on the opposite side of, a transaction from the insider trader," also provides a five-year limitations period. Moreover, the Supreme Court has described section 20A as "a statute of repose" and, to this Court's knowledge, no court has ever applied the discovery rule or equitable tolling doctrines to it. In fact, consistent with P. Stolz's reasoning that Congress might lengthen a period of repose to counteract its seemingly inequitable effects, the Supreme Court in 1991 characterized section 20A's five-year limitations period as providing "enhanced protection" to private litigants injured by insider trading — compared to the two - and three-year statutes of repose that applied to nearly every other private right of action under the Securities Act and the Exchange Act at that time. Similarly, the Second Circuit has opined that "Congress perhaps specified a five-year limitations period in [section 20A] in recognition of the [difficulties of ferreting out evidence sufficient to prosecute insider trading cases]."

However, if section 20A is a statute of repose, it complicates this Court's analysis somewhat; for, aside from the caveat that section 21A should not be construed to bar or limit any other action by the SEC under the Exchange Act, sections 21A and 20A contain nearly identical five-year limitation periods, suggesting section 21A, too, is a statute of repose:

Section 20A (private right of action): "No action may be brought under this section more than 5 years after the date of the last transaction that is the subject of the violation."

Section 21A (SEC action): "No action may be brought under this section more than 5 years after the date of the purchase or sale."

Moreover, as with section 20A, no court has ever held that section 21A is anything but a statute of repose. And the SEC concedes that it has not always taken the position, as it does in this action, that section 21A (or section 20A, for that matter) is subject to the discovery rule.

Nevertheless, this Court now holds that section 21A is not a statute of repose. First, even if section 20A is a statute of repose, "Congress itself has cautioned that the same words may take on a different coloration in different sections of the securities laws." Thus, "[w]hatever [the language of section 21A] may mean in the [] context[] [of section 20A], only [] one narrow question is presented here." Second, section 20A applies to private litigants' actions for insider trading violations, while section 21A applies to the SEC, and "[s]tatutes of limitation sought to be applied to bar rights of the Government, must receive a strict construction in favor of the Government." Indeed, the P. Stolz court acknowledged the "touch of hyperbole" in its hypothetical that the statute of repose in section 13 of the Securities Act would "secur[e] a sort of immunity [for a defendant] to continue illicit offers without civil liability," noting that "it is likely that the SEC is not subject to the [section] 13 statute of repose and would be able to bring its own civil enforcement action against such a defendant under [section] 20(b) of the [Securities Act's analog of section 21(d) of the Exchange Act]. Therefore, it is unlikely that an offeror could ever operate with unfettered immunity." Third, this result is consistent with the principle that section 2462 — which applies to SEC actions for civil penalties for violations of every other provision of the Exchange Act — is a statute of limitations to which equitable principles apply. 161 It would be an absurd result indeed if the SEC's right to seek penalties under the Exchange Act were most circumscribed for the one type of behavior (insider trading) for which Congress has explicitly "[r]ecogniz[ed] [] unique difficulties in identifying evidence" — arguably the epitome of the sort of self-concealing conduct for which courts often apply the discovery rule.

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