On February 27, 2013, the Supreme Court reversed the 2nd Circuit in the case of Gabelli et al. v. Securities and Exchange Commission, holding that the five-year period for the government to commence actions for civil penalties for fraud begins to run when the fraud occurs, not when it is discovered.
The SEC filed the initial enforcement action in 2008 against petitioners Gabelli and Alpert under the Investment Adviser Act. The Investment Advisers Act makes it illegal for investment advisers to defraud their clients, and authorizes the SEC to seek civil penalties within five years of the alleged illegal activity. The SEC alleged that Gabelli and Alpert had aided and abetted investment adviser fraud from 1999 until 2002.
At issue in the case was whether the SEC could file claims of fraud against an investment adviser after this five-year deadline had passed on the argument that it had not discovered the violation until more recently. Courts sometimes apply a “discovery rule” to fraud cases to keep alive otherwise-lapsed securities claims by investors and other private parties.
The Supreme Court declined to extend the “discovery rule” to government civil penalty enforcement actions. The Court explained that, unlike private parties who may have no reason to suspect fraud, the SEC’s very purpose is to root out fraud. The SEC also has many legal tools at its disposal to detect and expose fraudulent activity. The Court also discussed the importance of setting time limits on penalty actions because they go beyond compensation and are intended to punish and label defendants as wrongdoers.