On Wednesday, the U.S. Supreme Court limited the authority of the Securities and Exchange Commission to seek civil penalties over conduct that occurred more than five years before investigators took action.

The nine-member court ruled by a unanimous vote that the five-year clock for the government to act on fraud begins to tick when the fraud occurs, not when it is discovered.

Wednesday’s decision is a defeat for securities regulators, who would have benefited from a favorable ruling because it could have bought them more time to bring complex cases, including cases springing from the 2007-2009 financial crisis.

The decision has implications beyond the SEC because the five-year statute of limitations applies to civil actions by numerous government agencies, from the Federal Trade Commission to the Social Security Administration.

At the same time, however, the SEC and other agencies can still ask defendants for voluntary suspensions of the statute of limitations, which defendants often grant in hopes of leniency.

Also, the restriction applies to monetary penalties, not to the SEC’s ability to recovery of ill-gotten gains and injunctions.

The case marks a victory for mutual fund manager Marc Gabelli and colleague Bruce Alpert, whom the SEC claimed allowed a firm now known as Headstart Advisers Ltd to conduct hundreds of “market-timing” trades. Such trades involve rapid trading to exploit market or price inefficiencies.

The practice, while not illegal, is considered improper. The SEC alleged they engaged in market-timing trades without properly disclosing it to board directors and other investors.

Gabelli and Alpert, who deny any wrongdoing, said the clock for enforcement action starts to tick when the alleged act occurred. The SEC said it starts when the agency is reasonably able to detect fraud.

In an emailed statement, Gabelli and Alpert’s lead counsel, Lewis Liman of Cleary Gottlieb Steen & Hamilton, praised the high court’s decision. “We are gratified that the court has upheld the plain language of the statute and affirmed a bright-line standard for the time the government has to bring a civil penalty action,” he said.

SEC spokesperson John Nester said the agency is reviewing the decision, but does not expect it to have an immediate impact on its ability to hold violators accountable.

“This ruling pertains only to penalties and does not restrict our ability to strip violators of their unlawful financial gains or bar them from the securities industry when necessary to protect investors,” Nester said in a statement.

He added that the court also “left open” whether the agency can pursue penalties after five years in cases where law-breakers conceal their conduct, such as through false filings with the commission.

Pressure On SEC

Outside observers who closely followed the case were not surprised by the Supreme Court’s decision.

During oral arguments in January, justices from across the ideological spectrum appeared frightened by the prospect of extending the statute of limitations across the government.

Decision does not restrict SEC on disgorgement of ill-gotten gains

They also raised concerns about the lack of a legal precedent and were frustrated when the Justice Department lawyer arguing for the SEC could not cite a case supporting what he called the agency’s “fairly modern” position.

Stephen Crimmins, a former SEC deputy chief litigation counsel who is now a partner with K&L Gates, said he does not think the time limit for seeking civil penalties will have a huge impact on the agency.

“They will still be able to bring, even as to old cases, litigation where they seek disgorgement of profits… and I think where it’s necessary to bring older cases, those remedies will be sufficient for them to make their law enforcement statement and to rein in any bad actors,” he said.

In this case, the SEC had accused Gabelli and Alpert of violating the law from 1999 to 2002. But the agency did not sue Gabelli and Alpert until April 2008, more than five years after it said the last market-timing trade occurred.

After Gabelli and Alpert alleged the SEC had exceeded the statute of limitations to seek penalties, the 2nd U.S. Circuit Court of Appeals sided with the agency in August 2011.

Judge Jed Rakoff wrote for the Appeals court that the regulator could not have reasonably uncovered the market timing until a high-profile investigation by then-New York Attorney General Eliot Spitzer brought it to prominence.

Chief Justice John Roberts, who wrote the opinion for the Supreme Court, shot down Rakoff’s argument.

“The government is a different kind of plaintiff,” he wrote.

“The SEC’s very purpose, for example, is to root out fraud, and it has many legal tools at hand to aid in that pursuit. The government in these types of cases also seeks a different type of relief.”

He added that extending the statute of limitations to seek civil penalties would “leave defendants exposed to government enforcement action not only for five years after their misdeeds, but for an additional uncertain period the future.”

Robert Anello, an attorney at Morvillo Abramowitz who has been closely tracking the Gabelli case, said the court’s decision is an embarrassment for the SEC, but that it will hold regulators’ feet to the fire.

“You don’t want to give the SEC the opportunity to put things on the back burner,” he said. “I think what it does… is basically tells them they have a job to do and they have to do it quickly.”

Tolling Agreements

The government’s ability to seek penalties in civil or criminal financial cases is usually limited to five years.

Authorities can extend the statute of limitations through what are known as “tolling agreements,” or voluntary agreements between the government and the targets of the investigation.

The SEC is believed to have tolling agreements in place for many of the cases it has pending from the financial crisis.

“While we always prioritize our investigative workload to meet the five-year deadline, where circumstances warrant we also obtain agreements from individuals and entities under investigation to waive the deadline in financial crisis cases and other investigations,” the SEC’s Nester said.

There are some exceptions, however, to the five-year limit.

Decision leaves open the question of whether SEC can pursue penalties after five years in cases where law-breakers conceal their conduct, SEC says.

One example is The Financial Institutions Reform, Recovery, and Enforcement Act, or FIRREA, a federal civil fraud statute that gives the Department of Justice a 10-year window to seek penalties.

FIRREA has rarely been used since it was enacted in 1989 after the savings-and-loan scandal, but the DOJ has started to use it over the past year.

Earlier this month, the DOJ used it to file a $5 billion civil lawsuit against McGraw Hill’s Standard & Poor’s in connection with mortgage product ratings issued in the years leading up to the financial crisis.

The SEC, which also has an investigation pending against S&P in connection with crisis-related ratings, cannot bring a FIRREA case. An S&P spokesman declined to comment on whether the company has a tolling agreement in the SEC case.

The Supreme Court case is Gabelli v. SEC, U.S. Supreme Court, No. 11-1274.