Case Study – Gabelli v. SEC

Allegedly, from 1999 to 2002, an investment firm called Gabelli Funds, LLC, perpetrated a specific type of fraud upon investors in their Gabelli Global Growth mutual fund (GGGF) when they allowed one of the investors in the fund to engage in “market timing.” Market timing is an investment strategy where the purchase and/or sale of fund interests is done at times during the day when fund price is not reflective of current market information. Although GGGF fund documents stated that investors in the fund would not be permitted to engage in market timing, one allegedly was. Accordingly, the SEC brought an enforcement action against Gabelli for fraud. There was only one problem: They brought it in 2008 — for activities ending in 2002. Thus, the litigation in Gabelli v. SEC, 568 U.S. 133 (2013) centered on the statute of limitations for civil actions filed by the Securities Exchange Commission (SEC) based on violations of the Investment Advisors Act of 1940. As you may know, the 1940 Act specifically prohibits investment advisers from defrauding their clients. The statute of limitations on SEC actions arising from violations of the 1940 Act is found in 28 U.S.C. § 2462, which provides that such actions must be filed, “within five years from the date when the claim first accrued.”

The Main Issue

The issue of when exactly the statute of limitations should begin to run made it to the Supreme Court. The SEC argued that it should start at the time when a particular fraud could first have been discovered through reasonable diligence, not necessarily when the fraud occurred. This position is an obvious advantage to the SEC, as it prevents actions based on undiscovered frauds from becoming time-barred. In the SEC’s view, whenever the agency ultimately becomes aware of a fraud, it should then have the option to investigate the facts, analyze the law and then make a prosecution decision, regardless of how much time has passed since the incident in question.

The Basics Regarding Statutes of Limitation

The SEC’s view would go against one of the main policy reasons that statutes of limitation are enacted: they provide parties with certainty regarding past events. If parties were continually subject to lawsuits based upon things that occurred in the distant past, judicial machinery might grind to a halt, and old companies might do little aside from litigate. In addition, memories become foggy and facts become very difficult to establish with any degree of certainty as time goes by, so lawsuits based on events from too many years ago would be quite difficult to conduct. Opponents of statutes of limitation might feel that wrongdoers ought to be held accountable for their actions no matter how much time has passed. But the balance that has historically been struck in American law is that, after a set number of years have passed with respect to a particular incident, all parties can consider themselves safe from litigation. And the price paid for this efficiency is that some known wrongdoers will never be brought to justice, like the alleged perpetrators of the fraud underlying the Gabelli litigation.

The Court’s Reasoning

The court declined to adopt the SEC’s interpretation for several reasons. The first was simply based on linguistic interpretation: a claim “accrues” when a right to sue arises, not when a right to sue is discovered. The second was the fact that discovery-based rules generally have been applied in contexts where defrauded victims had no reason to expect fraud. Because the SEC is a governmental agency specifically tasked with uncovering fraud, the Court thought it inappropriate to offer the SEC the same protection afforded to innocent laypeople. The court also noted the difficulty in determining what the SEC “knows” (i.e., since the SEC is a government entity, can it be considered to “know” whatever any person in the SEC knows? Or what about any individual in the federal government?). For these reasons, the court reversed the holding of the 2nd Circuit below, and held that the statute of limitations starts to run immediately when a fraud occurs, and not at any later time.