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Seventh Circuit Applies Discovery Rule to Claim for Civil Penalty

By Amy G. Doehring, Litigation News Associate Editor – May 14, 2009

Departing from the view of many other circuits, the Seventh Circuit Court of Appeals has applied the discovery rule to an action for civil penalties brought by the Securities and Exchange Commission. SEC v. Koenig [PDF].

Applying the statute of limitations set forth in 28 U.S.C. § 2462, the Koenig court held that the SEC has five years from the date it discovers, or should have discovered, a violation to bring an action for civil penalties.

The SEC’s claim for a civil penalty against the corporation’s former chief financial officer accrues when the SEC discovers the fraudulent accounting strategies, rather than when the defendant commits the fraud, the court reasoned. Dating back to the nineteenth century, courts have “recognized a special rule for fraud, a concealed wrong,” the Seventh Circuit opinion notes.

This ruling, “issued in an environment in which revelations of fraudulent schemes are disclosed with alarming frequency and magnitude, often impacting large numbers of victims who have limited private recourse, is not surprising and [is] almost certainly intended to have a deterrent effect,” explains Barrie L. Brejcha, Chicago, cochair of the Section of Litigation’s Securities Litigation Committee.

But Koenig represents a departure from the holdings of other circuits that have rejected the application of the discovery rule to the limitations period prescribed by § 2462. Many courts have concluded that the statute of limitations under § 2462 begins to run on the date of the regulatory violation.

For instance, the Sixth Circuit has expressed that view in National Parks Conservation Association v. TVA [PDF] and SEC v. Mohn [PDF].Also contrary to Koenig, the Eleventh Circuit in Trawinski v. United Technologies rejected applying the discovery rule to § 2462.

Fifteen years ago, in 3M Co. v. Browner, the D.C. Circuit held that the discovery rule is contrary to the language of § 2462 and is inconsistent with the historical judicial interpretations of the statute. The court explained that the discovery rule was developed for cases involving latent injuries, and that it “rests on the idea that plaintiffs cannot have a tenable claim for the recovery of damages unless until they have been harmed.” The 3M court noted that damages or injuries resulting from the violation are not part of the federal agency’s claim for a civil penalty, and thus the discovery rules was inapplicable to § 2462.

“The reasoning of the 3M decision is far more persuasive than that of the Seventh Circuit in Koenig,”opines Kent A. Lambert, New Orleans, cochair of the Section’s Pretrial Practice and Discovery Committee (and a contributor to Litigation News).

“The imposition of fines, penalties, and forfeitures is not premised in any way upon the existence of any actual harm—it is by definition premised upon the offense itself irrespective of any avowed harm to a particular constituency or interest group,” he says.

Importantly, the five-year statute of limitations under § 2462 applies to actions involving federal statutes as diverse as the Fair Housing Act, the Export Administration Act, and the Clean Air Act. “Application of the Koenig case to other regulatory contexts invites abuse, giving too much power to federal agencies to control the timing of civil penalty and enforcement actions. It threatens to make the agency the master not only of its complaint, but of the limitations period as well,” Lambert opines.

Can Koenig be squared with 3M and other previous cases? “The statute of limitations issue in the Koenig decision turns on the fact that the SEC’s case involved fraud-based claims,” recognizes Brejcha.

Craig C. Martin, Chicago, IL, the Section’s Pretrial and Discovery Committee cochair, agrees. “The Seventh Circuit explained that traditionally there is equitable tolling for a concealed wrong,” Martin notes. “Koenig should not be read to expand the statute of limitations for all claims by any federal agency for a civil penalty, but only those involving fraudulent concealment of the violation,” he says.

Keywords: SEC v. Koenig, discovery rule, penalties


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