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Supreme Court Reverses SEC V. Gabelli On Discovery Rule Grounds
Written: February 27, 2013

In Gabelli et al. v. Securities And Exchange Commission (568 U. S. ____ (2013), February 27, 2013), the Court considered an enforcement action brought  by the Securities And Exchange Commission (“SEC”) under the Investment Adviser Act in April 2008, when the SEC  filed aComplaint seeking civil penalties arising from allegations of illegal activity up to August 2002. The Investment Advisers Act makes it illegal for investment advisers to defraud their clients, and authorizes the SEC to seek civil penalties; however, under the general statute of limitations for civil penalty actions, the SEC has only five years to seek such penalties. In this case, the courts were faced with deciding whether the five-year clock begins to tick when the fraud is complete or when the fraud is discovered.

On August 17, 2010, the District Court dismissed the SEC’s Complaint against Marc J. Gabelli, the portfolio manager of the mutual fund Gabelli Global Growth Fund (“GGGF” or the “Fund”), and Bruce Alpert, the chief operating officer for the Fund’s adviser, Gabelli Funds, LLC (“Gabelli Funds” or the “Adviser”) because the court found the civil penalty claim as time barred. In 2008, the SEC brought the underlying civil enforcement action against Alpert and Gabelli that alleged that from 1999 until 2002 Alpert and Gabelli allowed one GGGF investor—Headstart Advisers, Ltd.—to engage in“market timing” in the fund. According to the SEC, petitioners did not disclose Headstart’s market timing or the quid pro quo agreement, and, instead, banned others from engaging in market timing and made statements indicating that the practice would not be tolerated. In noting the impact of such disparate treatment, the Complaint asserted that during the relevant period, Headstart earned rates of return of up to 185%, while “the rate of return for long-term investors in GGGF was no more than negative 24.1 percent.”

On appeal, the United States Supreme Court noted that it had never applied the Discovery Rule in a matter where the plaintiff is the government bringing an enforcement action for civil penalties, in contradistinction to a defrauded victim seeking recompense. In declining to extend the Discovery Rule to government civil penalty enforcement actions, the Court cast the government as a unique plaintiff often tasked with rooting out fraud and armed with many arrows in its quiver just for such an undertaking. Viewing the Discovery Rule as something of an equalizer designed to assist wronged parties seeking recompense, the Court was not compelled to offer such assistance to regulators seeking not compensation but punishment aimed at wrongdoers.  Further, the Court deemed that there were many motivating factors to avoid having courts attempt to parse through what the government knew or reasonably should have known about an alleged fraud.  Accordingly, the Court reversed and remanded SEC v. Gabelli (2nd Circuit, 653 F. 3d 49, August 1, 2011).On August 1, 2011, on appeal, the Second Circuit reversed accepting the SEC’s argument that because the underlying violations sounded in fraud, theDiscovery Rule applied, meaning that the statute of limitations did not begin to run until the SEC discovered or reasonably could have discovered the fraud.

In setting forth its rationale, the Court noted, in part:

There are good reasons why the fraud discovery rule has not been extended to Government enforcement actions for civil penalties. The discovery rule exists in part to preserve the claims of victims who do not know they are injured and who reasonably do not inquire as to any injury. Usually when a private party is injured, he is immediately aware of that injury and put on notice that his time to sue is running. But when the injury is self-concealing, private parties may be unaware that they have been harmed. Most of us do not live in a state of constant investigation; absent any reason to think we have been injured, we do not typically spend our days looking for evidence that we were lied to or defrauded. And the law does not require that we do so. Instead, courts have developed the discovery rule, providing that the statute of limitations in fraud cases should typically begin to run only when the injury is or reasonably could have been discovered.

The same conclusion does not follow for the Government in the context of enforcement actions for civil penalties. The SEC, for example, is not like an individual victim who relies on apparent injury to learn of a wrong. Rather, a central “mission” of the Commission is to “investigat[e] potential violations of the federal securities laws.” SEC, Enforcement Manual 1 (2012). Unlike the private party who has no reason to suspect fraud, the SEC’s very purpose is to root it out, and it has many legal tools at hand to aid in that pursuit. It can demand that securities brokers and dealers submit detailed trading information. Id., at 44. It can require investment advisers to turn over their comprehensive books and records at any time. 15 U. S. C. §80b–4 (2006 ed. and Supp. V). And even without filing suit, it can subpoena any documents and witnesses it deems relevant or material to an investigation. See §§77s(c), 78u(b), 80a–41(b), 80b–9(b) (2006 ed.).

The SEC is also authorized to pay monetary awards to whistleblowers, who provide information relating to violations of the securities laws. §78u–6 (2006 ed., Supp. V). In addition, the SEC may offer “cooperation agreements” to violators to procure information about others in exchange for more lenient treatment. See Enforcement Manual, at 119–137. Charged with this mission and armed with these weapons, the SEC as enforcer is a far cry from the defrauded victim the discovery rule evolved to protect. . .

Page 7 – 8 of the Opinion.

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