February 27, 2013

Supreme Court Decides Gabelli v. Securities and Exchange Commission

On February 27, 2013, the Supreme Court decided Gabelli v. Securities and Exchange Commission, No. 11-1274, holding that 28 U.S.C. § 2462's five-year statute of limitations on SEC actions for civil penalties against investment advisers based on fraud begins to run when the fraud occurs, not when it is discovered.

The Investment Advisers Act of 1940 ("the Act") prohibits an investment advisor from defrauding a client or potential client. The Act authorizes the SEC to bring enforcement actions and seek civil penalties against investment advisers who violate the Act or individuals who aid and abet such violations. Such actions for civil penalties are subject to section 2462's five-year statute of limitations. In 2008, the SEC brought a civil enforcement action seeking penalties against the chief operating officer and the former portfolio manager of an investment advisor to a mutual fund. The SEC alleged that the defendant individuals allowed one investor to engage in market timing in exchange for investment in a separate hedge fund run by one of the defendants from 1999 until 2002, in violation of the Act. The defendants sought dismissal on the ground that the claim was untimely under section 2462. The District Court agreed and dismissed the SEC's civil penalty claim as time barred. The Second Circuit reversed, accepting the SEC's contention that the discovery rule applied because the underlying violations sounded in fraud and determining that a claim does not accrue until the claim is discovered or could have been discovered with reasonable diligence.

The Supreme Court reversed and remanded. The Court determined that, under the "most natural reading" of section 2462, the fraud claim accrues, and the statute of limitations therefore begins to run, when the "allegedly fraudulent conduct occurs." The standard rule in place since the 1830s "is that a claim accrues 'when a plaintiff has a complete and present cause of action.'" The Court noted that the natural reading also sets a fixed date, thereby promoting the policies of "repose, elimination of stale claims, and certainty about a plaintiff's opportunity for recovery and a defendant's potential liabilities."

Rejecting the SEC's argument for the discovery rule, the Court noted that it has never applied the discovery rule in the context "where the plaintiff is not a defrauded victim seeking recompense, but is instead the government bringing an enforcement action for civil penalties." The Court distinguished the SEC, whose mission is to root out fraud using the many legal tools at its disposal, from individuals, who do not and are not required to live in a state of constant investigation for evidence of fraud. The Court noted that the discovery rule is applied to ensure that an injured party receives recompense, while the purpose of civil penalties goes beyond compensation and punishes wrongdoers. Finally, the Court discussed the practical difficulties inherent to determining when an agency knew or should have known about a claim. For all these reasons, the Court refused to apply the discovery rule to section 2462 for claims under the Act.

Download Opinion of the Court

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