The U.S. Supreme Court will review the Securities and Exchange Commission’s (SEC’s) five-year statute of limitations for civil actions to recover penalties. The question before the Court in Gabelli v. SEC, Docket No. 11-1274, is precisely when the statute begins to run. The SEC contends that the statute begins to run when it actually learns of an alleged violation, a position that the Second Circuit Court of Appeals affirmed in SEC v. Gabelli, 653 F.3d 49 (2nd Cir. 2011). Marc Gabelli, who petitioned the Court for certiorari, argues that the statute should have begun when the SEC’s cause of action actually accrued, i.e. when the alleged violation occurred. For small businesses and startups pursuing financing options, this case could have important implications for how the SEC investigates and prosecutes alleged wrongdoing.
Gabelli was the portfolio manager of a mutual fund known as Gabelli Global Growth Fund (GGGF). The SEC filed a complaint against him and Bruce Alpert, who was the chief operating officer of GGGF’s adviser Gabelli Funds, LLC, accusing them of engaging in a practice called “market timing” in a way that preferred certain GGGF investors over others. The practice involves making rapid trades in order to exploit short-term inefficiencies in pricing. It is not illegal per se, but it can be detrimental to a fund’s long-term investors by, for example, affecting transaction costs and disrupting the overall management of the fund.
The SEC alleged that Gabelli and Alpert allowed a form of market timing in GGGF between 1999 and the spring of 2002. While the market timing was taking place, the SEC claimed, the defendants did not notify the fund’s board, nor did they disclose the activity to the fund’s other investors. The SEC argued that this was “materially misleading” to the fund and its investors. SEC v. Gabelli, 653 F.3d at 55.
Because of the “secret nature” of the market timing and the defendants’ alleged “affirmative misrepresentations”, Id., the SEC claims that it did not discover the alleged fraud until near the end of 2003, more than a year after the defendants ceased the market timing. The SEC filed its complaint against Gabelli and Alpert on April 24, 2008, less than five years after the date it says it learned of the alleged fraud.
The U.S. District Court for the Southern District of New York granted the defendants’ motions to dismiss, finding that the SEC had not filed suit within the five-year statute of limitations. The Second Circuit reversed the District Court, finding that the standard “discovery rule,” in which a cause of action accrues when a plaintiff learned or could have learned of an injury, is not well-suited to fraud claims. It applied the “fraudulent concealment doctrine” instead, which allows tolling of the statute of limitations when a plaintiff can prove a defendant actively worked to hide the allegedly fraudulent activity from the plaintiff. The Second Circuit concluded that the five-year statute of limitations began to run in 2003, when the defendants’ alleged fraud became known to the SEC. The Supreme Court granted certiorari on the defendants’ appeal of this decision on September 25, 2012.
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