The United States Supreme Court adopted a strict interpretation of the five-year period in which the Securities and Exchange Commission may seek to impose a civil penalty on a registered investment adviser. In Gabelli v. SEC the Supreme Court ruled that when the government acts in an enforcement capacity seeking civil penalties, it cannot benefit from the more lenient “discovery rule” standard available to private plaintiffs. That means the SEC needs to bring the case within five years of the fraud, not five years after the fraud is discovered.
In 2008, the SEC brought a civil enforcement action against Bruce Alpert and Marc Gabelli under the anti-fraud provisions of the Investment Advisors Act. The SEC sought civil monetary penalties based on market timing that it claimed had taken place from 1999 to 2002. Mutual fund manager Marc Gabelli and a colleague, Bruce Alpert, permitted the market timing, allowing select investors to buy shares at favorable prices to take advantage of pricing disparities in the securities held by mutual funds. As a result, the preferred investor reaped significant profits and ordinary investors suffered large losses.
The relevant statute of limitations 28 U.S.C. § 2462 states:
“Except as otherwise provided by Act of Congress, an action… for the enforcement of any civil fine, penalty or forfeiture… shall not be entertained unless commenced within five years from the date when the claim first accrued.”
Gabelli argued that the clock started running when the fraud happened, not when the SEC discovered the fraud. If Gabelli wins the argument, then the SEC took too long to bring the case.
The SEC argued for the benefit of the discovery rule, which had been used in Merck & Co. v. Reynolds, the private securities fraud class-action suit . “[S]omething different was needed in the case of fraud, where a defendant’s deceptive conduct may prevent a plaintiff from even knowing that he or she has been defrauded.”
The SEC did not agree with the SEC’s argument.
“[W]e have never applied the discovery rule in this context, where the plaintiff is not a defrauded victim seeking recompense, but is instead the Government bring ing an enforcement action for civil penalties. Despite the discovery rule’s centuries-old roots, the Government cites no lower court case before 2008 employing a fraud-based discovery rule in a Government enforcement action for civil penalties.”
The SEC looked to a 1918 case where the the government was entitled to the benefit of the discovery rule, Exploration Co. v. United States, 247 U. S. 435 (1918). However, in that case the government was the victim of the fraud. The government was not bringing an enforcement action for penalties.
The ruling points to the examination power of the SEC and its resources to root our fraud. The Supreme Court also found that proving the date of discovery would be difficult in a federal agency as big as the SEC.
The ruling is clearly a black eye for the SEC.
- Gabelli v. SEC Supreme Court Opinion (.pdf)
- For S.E.C., a Setback in Bid for More Time in Fraud Cases by Peter J. Henning in DealBook
- Opinion analysis: That which does not kill the SEC may make the agency stronger by Jonathan Macey in SCOTUS Blog
- Supreme Court Unanimously Rejects SEC’s Statute Of Limitations Position by the FCPA Professor
- Supreme Court Rejects SEC Effort to Extend Statute of Limitations by Thomas O. Gorman in SEC Actions