Supreme Court Overturns SEC v. Gabelli Ruling Based on Discovery Rule

In the legal case of Gabelli et al. v. Securities And Exchange Commission (568 U. S. ____ (2013), February 27, 2013), the Supreme Court tackled an enforcement action initiated by the Securities And Exchange Commission (“SEC”) under the Investment Adviser Act back in April 2008. The SEC filed a Complaint, seeking civil penalties for alleged illegal activities dating up to August 2002. The Investment Advisers Act prohibits investment advisers from defrauding their clients and empowers the SEC to pursue civil penalties. However, the SEC is subject to a five-year statute of limitations for seeking such penalties.

The crux of the matter rested on when the clock starts ticking on the five-year statute of limitations: at the completion of the fraud or upon its discovery.

In August 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”), and Bruce Alpert, the chief operating officer for the Fund’s adviser, Gabelli Funds, LLC (“Gabelli Funds”). The court ruled the civil penalty claim as time-barred. The SEC alleged that from 1999 to 2002, Alpert and Gabelli allowed one GGGF investor, Headstart Advisers, Ltd., to engage in “market timing” in the fund, without disclosure. The SEC argued that this disparate treatment resulted in Headstart earning significantly higher returns compared to long-term investors in GGGF.

On August 1, 2011, the Second Circuit reversed the decision, accepting the SEC’s argument that the Discovery Rule should apply because the violations sounded in fraud. This rule suggests that the statute of limitations doesn’t begin until the SEC discovers or reasonably could have discovered the fraud.

However, the United States Supreme Court, on appeal, declined to extend the Discovery Rule to government civil penalty enforcement actions. It distinguished between government enforcement and individual compensation cases, noting the government’s unique role in ferreting out fraud. The Court emphasized that the Discovery Rule is typically applied to assist defrauded victims seeking compensation, which wasn’t the SEC’s aim. Additionally, the Court highlighted the complexities and practical difficulties in determining what the government knew or should have known about alleged fraud.

As a result, the Supreme Court reversed and remanded the case, asserting that the Discovery Rule doesn’t apply to government civil penalty enforcement actions.

In summary, Gabelli et al. v. SEC addressed the application of the statute of limitations in SEC enforcement actions, with the Supreme Court ruling against extending the Discovery Rule to such cases.