In Securities and Exchange Commission v. Fowler, the Second Circuit (Lohier, Nardini, and Cronan, sitting by designation) affirmed the imposition of civil penalties and disgorgement against a financial broker.[1] In so doing, the Second Circuit addressed whether the statute of limitations for the commencement of S.E.C. proceedings is jurisdictional, an issue of first impression in the Circuit, and concluded that it is not. The Court also rejected Fowler’s other arguments, including that the district court permitted the S.E.C. to improperly recharacterize its theory of Fowler’s liability, that the jury improperly found unauthorized trading in customer accounts, and that the district court erroneously imposed financial penalties as to each victim of Fowler’s conduct.
Background
In 2011, Fowler—then a broker at the brokerage firm J.D. Nicholas & Associates—began pursuing an “event-driven” investment strategy for his customers, which resulted in abnormally frequent trading in the customers’ accounts. Fowler did not obtain prior customer approval before making many of these trades. Moreover, the excessive trading substantially increased customer costs (among other such costs, customers incurred transaction fees on a per trade basis), so that the average customer of Fowler needed to generate an extraordinary 142.6 percent rate of return on investment to break even. Fowler continued employing this investment strategy even after customers complained about him and his brokerage firm placed him on special supervision in 2012.
The S.E.C. began investigating Fowler in 2014. Pursuant to 28 U.S.C. § 2462, an S.E.C. action “shall not be entertained unless commenced within five years from the date when the claim first accrued.” In early 2016, near the end of this limitations period, the agency and Fowler entered agreements tolling that statute of limitations for one year, to February 28, 2017. The S.E.C. filed an enforcement action against Fowler in January 2017, before the tolling agreement elapsed. Its amended complaint asserted, among other things, a “suitability” claim—i.e., a claim that Fowler violated his obligation not to pursue a transaction or investment strategy unless he had a reasonable basis to believe that the transaction or strategy was suitable for his customers—because he knew, or recklessly disregarded, that his high-cost, high-frequency-trading strategy was bound to lose his customers money. The amended complaint also asserted a “churning” claim—i.e., a claim that Fowler excessively traded in customers’ accounts to generate commissions, without considering or in contravention of the customers’ investment goals.
The case proceeded to trial, by which time the S.E.C. dropped its churning claim. Fowler argued in a motion in limine that the S.E.C. actually was pursuing a churning claim “masked as a reasonable basis suitability claim” and that he should be permitted to present evidence relevant to his control of customers’ accounts (proof of which would be required for a churning claim, but not for a suitability claim). The district court denied the motion, concluding that the S.E.C. could bring a suitability claim based on Fowler’s excessive trading. The trial focused on Fowler’s trading with respect to thirteen customers, of whom four testified. The jury found against Fowler on all claims, concluding that he made unauthorized trades in twelve of the thirteen customer accounts, and the district court, determining that Fowler’s conduct as to each customer constituted a separate violation for which a monetary penalty could be imposed, entered judgment ordering disgorgement and penalties of $150,000 per customer, totaling $1,950,000.
Fowler appealed, arguing primarily that: (1) the statute of limitations for S.E.C. proceedings is jurisdictional and cannot be tolled; (2) the S.E.C. improperly pursued a suitability claim regarding his excessive trading rather than a churning claim; (3) the jury improperly found unauthorized trading in customer accounts absent testimony from the customer that the trades were unauthorized; and (4) the district court should have imposed one penalty for his single scheme, rather than separate penalties corresponding to each customer.
The Second Circuit’s Decision
The panel first addressed the “most serious” argument, that the five-year statute of limitations pursuant to 28 U.S.C. § 2462 is jurisdictional, and rejected the argument. Pointing to the Supreme Court’s decision in Henderson ex rel. Henderson v. Shinseki, 562 U.S. 428 (2011), which held that filing deadlines are “quintessential claim-processing rules” that “should not be described as jurisdictional” absent a “clear indication that Congress wanted the rule to be jurisdictional,” the panel explained it found no “clear indication” of such congressional intent in the statutory text. While Fowler contended that the statute’s mandatory language—that an S.E.C. enforcement action “shall not be entertained” unless commenced within five years—demonstrated Congress’s desire to create a jurisdictional bar, the panel emphasized express language from the Supreme Court that most statutes of limitation are not jurisdictional, “even when the time limit . . . is framed in mandatory terms.” The panel similarly found the requisite clear indication absent from the context, legislative history, and advisory committee notes, and emphasized that other circuits similarly treat 28 U.S.C. § 2462 as non-jurisdictional.
The panel next addressed Fowler’s contention that the S.E.C. should not have been permitted to proceed with a suitability claim, rather than a churning claim. The panel readily rejected this argument. It pointed out that Fowler “has never suggested that the [S.E.C.] failed to state a . . . suitability claim,” but “merely asserted that a churning claim was more appropriate.” However, as the panel, quoting the Supreme Court, explained, there is “considerable overlap” in the spheres of conduct the securities laws and regulations cover; accordingly, “churning claims and suitability claims can arise from the same general set of facts.” Indeed, the panel observed that the S.E.C. has “long held that ‘excessive trading . . . can violate . . . suitability standards.’” Thus, the S.E.C. appropriately asserted and proved a suitability claim.[2]
Then, the panel dispensed with Fowler’s argument that the jury could not properly find he had made unauthorized trades in any particular customer’s account unless that customer actually testified that he or she had not authorized the trades. The panel deemed call records, summarized in a chart also admitted in evidence, demonstrating the absence of phone communications between Fowler and his customers sufficient to demonstrate that the trading was unauthorized. Its discussion on this point was quite narrow and fact-specific, however, and because the phone records were so damning and Fowler had stipulated that he communicated with customers only by phone—a concession that may be absent in other cases—this opinion does not offer much guidance as to what sorts of evidence are sufficient or necessary to establish unauthorized trading.
Finally, the panel took up Fowler’s argument that the district court imposed excessive civil penalties. Monetary penalties in S.E.C. actions are governed by 15 U.S.C. § 77t(d)(2), which sets out three tiers of permissible penalties, depending on the nature of the offending conduct. For the most severe conduct, “involv[ing] fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement” where the conduct “directly or indirectly resulted in substantial losses or created a significant risk of substantial losses to other persons,” “the amount of penalty for each violation shall not exceed the greater of (i) $100,000 for a natural person . . . or (ii) the gross amount of pecuniary gain to [the] defendant as a result of the violation.” 15 U.S.C. § 77t(d)(2)(C) (emphasis added). By regulation, the $100,000 maximum penalty set out in the statute is adjusted for inflation, and the district court, deeming Fowler’s conduct towards each customer at issue at trial a separate violation, imposed the maximum inflation-adjusted penalty as to each. Fowler argued that such treatment was improper: his conduct as to each customer was part of a single scheme constituting a single violation. The panel, emphasizing that the statute does not define “violation” and that district courts possess “broad equitable power to fashion appropriate remedies,” treated the question whether a single violation or multiple violations occurred essentially as a discretionary determination. It deemed the district court’s reasoning that Fowler selected victims individually and that the purposes of the statute were best served by treating each as a separate violation “entirely plausible.” The panel’s decision does not attempt to articulate considerations relevant to whether to impose a single penalty versus multiple penalties, but it seems likely that the Second Circuit will revisit this question in a case involving a greater number of victims and larger aggregate penalty.
Commentary
The Court’s approval of tolling agreements in the context of S.E.C. enforcement actions is an important development for practitioners. Many securities enforcement lawyers were following the Fowler case to see whether the Court rejected their use. A decision rejecting the ability of the parties to toll the statute of limitations would have marked a significant change in existing practices, in which tolling agreements are relatively common.
Tolling agreements provide an obvious benefit to the S.E.C. In some cases, absent a tolling agreement, the statute of limitations would expire before any charges are brought. At the same time, such an agreement can provide a benefit to an individual who believes that he or she can persuade the S.E.C. not to bring an enforcement action if they had some additional time for negotiations. There is also a risk that in some cases the use of tolling agreements can delay a decision by the S.E.C. to decline to bring charges—who knows what might be uncovered in another 60 or 120 days? Some SEC investigations can take several years to resolve, a timetable that creates uncertainty for the targets of such investigations.
Tolling agreements became somewhat more important after the Supreme Court’s decision in Kokesh v. SEC, 137 S. Ct. 1635 (2017), which held that the S.E.C. was subject to a five-year statute of limitations for disgorgement actions. The importance of tolling agreements has been diminished somewhat by legislation passed on January 1, 2021, which set a 10-year statute of limitations for those disgorgement claims in which the S.E.C. must establish scienter, or where the S.E.C. is seeking an injunction or industry bar. See National Defense Authorization Act, Section 6501(a)(3). This 10-year statute of limitations is similar to the criminal statute of limitations for cases involving fraud against a financial institution. See 18 U.S.C. § 3293. In both instances, Congress has recognized that some more complicated forms of securities or financial institution fraud may take years to be discovered and investigated, longer than the usual five-year limitations period. Time will tell if this additional time—which now can be reliably extended even further using tolling agreements—will lead to better and more effective securities enforcement.
[1] The Second Circuit modified the judgment to correct what both parties and the Court agreed was an error in the amount of disgorgement ordered.
[2] Because the Court so held, it rejected Fowler’s related argument that the S.E.C. failed to prove he controlled his customers’ accounts, as the suitability claim did not require such proof.
