Vedder Price

Vedder Thinking | Articles SEC v. Bartek: Fifth Circuit Court of Appeals Rejects Discovery Rule in Options Backdating Case


Reader View

On June 30, 2008, the SEC filed a complaint against Microtune, Douglas Bartek (Microtune’s CEO) and Nancy Richardson (Microtune’s CFO) (collectively, the Defendants). The Complaint alleged that the Defendants engaged in, and aided and abetted, fraudulent behavior pursuant to an options backdating scheme by which “from 2000 to 2003, the Defendant improperly backdated stock options that [Microtune] granted to newly hired and existing employees and executives.” Specifically, the SEC alleged that Microtune did not properly expense the stock options and Bartek retrospectively selected the option grant dates by reviewing preceding two-week periods to locate the point at which Microtune’s stock price was at its lowest. Bartek and Richardson contended that the alleged backdating was never hidden, was the result of vague accounting rules and was approved by outside counsel and accountants.

The SEC sought the following relief: (1) civil monetary penalties; (2) injunctive relief permanently barring the defendants from violating securities laws; and (3) a bar against Bartek and Richardson serving as officers or directors of any public company. Shortly after the Complaint was filed, Microtune settled with the SEC. Bartek and Richardson and the SEC then filed cross-motions for summary judgment. The U.S. District Court for the Northern District of Texas granted Bartek’s and Richardson’s motion on the basis that the statute of limitations had expired before the Complaint was filed. The SEC appealed the ruling to the Fifth Circuit.

The two main issues on appeal were: (1) whether the discovery rule applied to the SEC’s claims, thereby tolling the limitations period until the SEC discovered the alleged scheme, and (2) whether the remedies of permanent injunctive relief and a bar against serving as directors and officers were equitable in nature and, therefore, not subject to the statute establishing the disputed limitations period.

The relevant statute setting forth the applicable limitations period provides, in pertinent part:

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 . . . .

28 U.S.C. § 2462 (“Section 2462”) (emphasis added). Because the SEC alleged that the backdating scheme commenced in 2000, the limitations period appeared to have expired.

The SEC, however, contended that the limitations period did not begin running until the alleged scheme was discovered in 2003. Thus, the main issue to be decided was the point at which the SEC’s causes of action accrued. The Fifth Circuit affirmed the district court’s determination that the causes of action accrued at the time that the alleged violations occurred, not at the time the alleged violations were discovered by the SEC. In reaching this conclusion, the Fifth Circuit relied on four main factors. First, the court looked to the plain language of Section 2462, noting that the statute itself “reveals no discovery rule exception.” Second, the court noted that non- SEC case law interpreting Section 2462 supported the notion that the five-year limitations period began to run as of the date of the underlying violation. Third, the court found that Bartek and Richardson had not actively concealed the alleged fraud. Fourth, the court held that the alleged backdating scheme was not inherently self-concealing. Thus, because the SEC’s causes of action accrued in 2000 at the time of the first alleged violation, the limitations period had expired before the Complaint was filed, and the district court’s granting of summary judgment in favor of Bartek and Richardson was affirmed.

In an attempt to salvage its claims, the SEC also contended on appeal that two of its remedies— a permanent injunction against future violations of securities laws and a bar on Bartek and Richardson serving as officers or directors of public companies— were equitable in nature and therefore “would not be subject to § 2462’s time limitations.” Specifically, the Fifth Circuit was tasked with determining whether the two disputed remedies constituted “penalties” under Section 2462. The court rejected the SEC’s contention that the term “penalty” was “strictly used for monetary or property sanctions” and that the two disputed remedies were thus remedial—not penal—in nature. In reaching its conclusion, the court applied an objective analysis of “the nature of the remedies sought by the SEC.” Here, the two disputed remedies constituted penalties because they (1) would have a stigmatizing effect and long-lasting repercussions; (2) would not address past harm allegedly caused by Bartek and Richardson; (3) would not address the prevention of future harm “in light of the minimal likelihood of similar conduct in the future”; and (4) were sufficiently long-term to be considered punitive. In sum, the Fifth Circuit affirmed the district court’s determination that the two disputed remedies were punitive “[b]ased on the severity and permanent nature of the sought-after remedies.”

This case seeks to clarify that the five-year statute of limitations established in Section 2462 is not susceptible to tolling based on the discovery rule and that the SEC must more appropriately tailor its remedies to the facts of the specific case if it wishes to seek equitable relief beyond the five-year limitations period. However, it will take some time to empirically assess its impact— if any—on the SEC’s investigation practices.

Click below to download the complete newsletter featuring this article.