By Britt K. Latham and M. Jason Hale
(Britt K. Latham is a Member of Bass, Berry & Sims PLC, focusing his practice on complex business, securities and class action litigation and the representation of clients in connection with internal and governmental investigations. M. Jason Hale is an attorney at Bass, Berry & Sims PLC, focusing his practice on general commercial litigation with an emphasis in business disputes, corporate and securities matters, and financial products and broker-dealer litigation).
The SEC continues to bring enforcement actions against directors and officers related to bank failures. In October 2011 and April 2012, respectively, the SEC filed civil enforcement actions against former officers of UCBH Holdings, Inc., the holding company for the failed United Commercial Bank, and the former officers of the publicly traded holding company of the failed Franklin Bank.
Even as recently as September 25, 2012, a little over two years since the FDIC closed the bank, the SEC charged former bank executives of the failed TierOne Bank with participating in a scheme to understate millions of dollars in losses and mislead investors and federal regulators. See SEC Litigation Release, “SEC Charges Bank Executives in Nebraska With Understating Losses During Financial Crisis,” 2012-198.
What does this continued activity and the continued focus of federal agencies on such liability mean for directors and officers of failed or troubled banks? It means that even as banking regulators wind down their actions in the wake of the financial crisis, exposure to liability under the securities laws remains a risk. As discussed below, a new Supreme Court case—Gabelli—could extend the life of that risk.
Banks and their executives may be wondering how the SEC can continue to bring enforcement actions so many years after the events of the financial crisis. With respect to civil enforcement actions, generally speaking, courts have held that the SEC has five years from the challenged acts to bring an action. See, e.g., SEC v. Johnson, 87 F.3d 484 (D.C. Cir. 1996). However, the Supreme Court may change that in the coming term, and banking executives should be aware of the potential impact of this case.
In Gabelli et al. v. SEC, 653 F.3d 49 (2d Cir. 2011), the SEC brought a civil enforcement action in April 2008 alleging that two individuals who worked for the portfolio manager of a mutual fund secretly allowed an investor to engage in non-disclosed market-timing transactions in violation the Investment Advisers Act of 1940. Id. at 52.
The transactions at issue occurred between 1999 and 2002; the SEC claimed it discovered the misconduct in September 2003 shortly after the New York Attorney General began an investigation into the fund for market-timing and the company responded to the announcement with a public memorandum. Id. at 55.
The defendants argued that the claims were barred by 28 U.S.C § 26421 because their actions occurred—and therefore “accrued”—more than five years before the SEC’s Complaint, and that the text of the statute did not provide for a “discovery” rule. Id. at 59.
The SEC argued that its action was not time-barred because the “discovery rule”—the doctrine that holds that a cause of action cannot begin to accrue until the discovery of the alleged misconduct — applies to the five-year statutory limitation on agency actions to enforce securities fraud. Id. The 2nd Circuit agreed with the SEC and held that the claims did not accrue, and the limitations period did not begin to run, until after the SEC discovered facts regarding the alleged misconduct. Id. at 59-60.
The Supreme Court has now agreed to hear this appeal and will decide whether the “discovery rule” applies to civil enforcement actions. Gabelli et al. v. SEC, U.S. Supreme Court, No. 11-1274. If the Supreme Court endorses the SEC’s view, the ruling could breathe new life into possible civil enforcement actions related to banks or other financial institutions that collapsed or severely declined during the financial crisis that might otherwise have been barred with the passage of time, including actions against executives and directors.
Even for events that took place in 2007-8 during the credit crisis, for example, the SEC could possibly bring a claim if the agency didn’t “discover” the alleged wrongdoing until banking regulators brought the facts to light — similar to how the SEC claims it discovered misconduct by virtue of actions prompted by the New York Attorney General’s investigation in Gabelli — or referred the case to the SEC.2 Consequently, if Gabelli is upheld, there may be aggressive efforts by the SEC to continue to file actions like the recently-filed TierOne Bank action.
Thus, five years after the beginning of this global crisis, bank executives may still not be out of the woods for liability under the federal securities laws, given the possible expansion and use of the “discovery rule.” Any strategy of hoping to “run out the limitations clock” on these kinds of claims because of the SEC’s limited resources to quickly investigate potential claims may become less reliable.
Moreover, if Gabelli is upheld, purchasers of failed banks in the past five years may find themselves inheriting liability that they thought expired or fighting D & O carriers over whether these are covered claims.
1 28 U.S.C § 2642 provides that “[e]xcept as otherwise provided by Act of Congress,” an enforcement action must be “commenced within five years from the date when the claim first accrued[.]”
2 Bank executives should also be aware that the “discovery rule” already applies to actions by private litigants asserting securities fraud claims. See Merck & Co. v. Reynolds, 130 S. Ct. 1784 (2010). And, even though securities class action filings have slowed, publicly-held banks and bank holding companies still face the risk of private litigants instigating a class action lawsuit in connection with the financial crisis. See, e.g.,In re Temple-Inland/Guaranty Bank Corp. Securities Class Action, Case 3:11-cv-03119-B (N.D. Tex. Dallas division)(filed November 11, 2011) (class action alleging that a failed bank misrepresented the true financial condition in public disclosures).