Supreme Court Holds in Gabelli That Clock Starts When Fraud Is Complete, Not Discovered

On Feb. 27, 2013, the Supreme Court unanimously reversed the 2nd Circuit and held that the “discovery rule” does not apply to Securities and Exchange Commission enforcement actions for civil penalties.

As we have previously covered here and here, the 2nd Circuit held in SEC v. Gabelli that the discovery rule applies to 28 U.S.C. § 2462 (the statute governing the statute of limitations for civil penalty actions brought by the SEC). The discovery rule is an exception to the general rule that a claim accrues when a plaintiff has a right to commence it—i.e., when the violation is complete. The exception arose in the 18th century as a solution to crimes of fraud, which are not always susceptible to immediate discovery by the victim (even with due diligence). When the discovery rule applies, a claim accrues from the point when the plaintiff could have discovered it with reasonable diligence.

The statute at issue in Gabelli requires the SEC to commence civil penalty actions within five years of accrual. The SEC brought a civil enforcement action against petitioners Bruce Alpert and Mark Gabelli in 2008—six years after the last alleged “market timing” transaction. (Market timing, which takes advantage of the valuation lag in mutual funds, is legal, but the SEC alleged that the defendants secretly allowed only one investor to market time.) The 2nd Circuit concluded that the discovery rule applied, because the underlying violations “sounded in fraud.”

The Supreme Court disagreed, and held that the SEC has five years from when a fraud occurs to seek civil penalties—not from when the SEC discovers the fraud. Chief Justice Roberts gave several reasons for the holding in his opinion. First, nothing in the statute suggests that Congress intended the discovery rule to apply to civil penalty actions. Second, the Court has never applied the discovery rule where the plaintiff was the government seeking civil penalties, not a victim seeking compensation. Extending the discovery rule to this scenario would be particularly inappropriate, the Court noted, given that the SEC’s avowed raison d’être is to “investigat[e] potential violations of the federal securities laws.” Lastly, a practical and undesirable consequence of granting the SEC’s wish would have been to burden courts with determining when the government knew or reasonably should have known of a fraud.