On February 27, 2013, in Gabelli v. Securities and Exchange Commission,1 a unanimous Supreme Court rebuffed an effort by the Securities and Exchange Commission to expand the limitations period for civil penalty claims beyond the five-year period set by statute. The SEC argued that its penalty claim accrued when it discovered the misconduct, and not when the misconduct occurred. The Court disagreed, holding that such a "discovery rule," used in private actions for damages, does not apply to Government actions for penalties.

While the Gabelli decision could increase the number of SEC cases brought this year that relate to the nearly five-year-old financial crisis, the holding will probably not impact the SEC’s enforcement agenda significantly since it does not squarely apply to claims for equitable relief, such as injunctions and disgorgement. In addition, while the SEC will still be able to obtain penalties in settled actions based on older conduct, Gabelli may work to reduce such penalties. More significant for the SEC is that the broad reasoning of Gabelli suggests that the Court may not endorse the SEC’s view that there is no statute of limitations for equitable relief.


In April 2008, the SEC brought two actions charging that an investor in a Gabelli mutual fund had received favorable treatment that was not disclosed to other investors: (1) a settled administrative proceeding against Gabelli Funds, LLC, an investment advisor headed by Mario Gabelli; and (2) a contested action filed in the Southern District of New York against a portfolio manager, Mario Gabelli’s son, as well as the chief operating officer of Gabelli Funds, LLC. These matters were among the last of many SEC actions in the last decade involving active buying and selling of shares in mutual funds to allegedly exploit short-term pricing inefficiencies, a practice often referred to as "market timing" that was brought to light by then Attorney General Eliot Spitzer on September 3, 2003. The SEC alleged that the Gabelli defendants had permitted one of the mutual fund’s investors to engage in active trading in the fund’s shares as a quid pro quo for the investor’s agreement to keep money in a hedge fund run by one of the defendants. According to the SEC, this favored treatment was highly profitable to the investor, but was secret, and not disclosed to other shareholders or the fund’s board, so the SEC did not discover the fraud until late 2003.2

In the federal court action, the SEC sought to enjoin the individual defendants from future violations, and to obtain disgorgement of their allegedly ill-gotten gains (plus prejudgment interest) and a civil monetary penalty under Section 209(e) of the Investment Advisers Act. As to one of the individual defendants, the SEC also charged a violation of the Securities Act of 1933 and the Securities Exchange Act of 1934, and sought a monetary penalty under those statutes as well.3

The defendants moved to dismiss the complaint on various bases, including that the claim for civil penalties was barred by the five-year statute of limitations in 28 U.S.C. § 2462, which states that, unless Congress provides otherwise, "an action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture" must be "commenced within five years from the date when the claim first accrued."

In March 2010, District Judge Deborah Batts dismissed most of the SEC’s claims, including the claim for penalties on the ground that it was time-barred.4 She also dismissed the injunctive claims, finding that there was no reasonable basis for anticipating future violations by the two individuals, both then former employees of Gabelli Funds, LLC. She left standing the SEC’s claim for disgorgement of any unlawful profits, determining that it was not time-barred. (This was a Pyrrhic victory for the SEC, however, given that Gabelli Funds, LLC had already disgorged the profits relating to market timing, and any "profit" made by the individual defendants as a result of the alleged conduct was small.)

Both sides appealed to the United States Court of Appeals for the Second Circuit: the SEC challenged, among other things, the holding as to penalties and injunctive relief, and the defendants challenged the holding as to disgorgement.5 District Court Judge Jed Rakoff, sitting by designation, authored an opinion that handed the SEC a complete victory. The Second Circuit, relying on Merck & Co. v. Reynolds,6 held that the penalty claim accrued only when the SEC discovered it; it also held that it was improper to rule out injunctive relief as a matter of law at the motion-to-dismiss stage. The defendants appealed the Second Circuit’s holding on the penalty (but not the other relief) to the Supreme Court, which agreed, in September 2012, to hear the case.

The Supreme Court Decision

The Court unanimously reversed the Second Circuit’s decision. In the opinion, Chief Justice Roberts framed the issue simply: "whether the five-year clock begins to tick when the fraud is complete or when the fraud is discovered." The Court found that the "most natural reading" of 28 U.S.C. § 2462 is that "a claim based on fraud accrues—and the five-year clock begins to tick—when a defendant’s allegedly fraudulent conduct occurs." It also noted that "we have never applied the discovery rule in this context, where the plaintiff is not a defrauded victim seeking recompense, but is instead the Government bringing an enforcement action for civil penalties."

But rather than resolve the question based solely on the plain reading of the statute, the Court also pointed to the policy favoring sharp clarity in the reading of statutes of repose, which are "intended to ‘promote justice by preventing surprises through the revival of claims that have been allowed to slumber until evidence has been lost, memories have faded, and witnesses have disappeared.’" The Court found such an approach to be "vital to the welfare of society," adding that "even wrongdoers are entitled to assume that their sins may be forgotten."

The Court distinguished Merck v. Reynolds and an earlier case in which the Government was itself the victim of fraud, Exploration Co. v. United States,7 explaining that in an enforcement action the Government is in a very different posture from "the defrauded victim the discovery rule evolved to protect." The difference, the Court reasoned, stems from the Government’s role in detecting fraud and its superior ability to do so. Unlike private citizens, who "do not live in a state of constant investigation," and "do not typically spend [their] days looking for evidence that we were . . . defrauded," the SEC’s "central mission" is to root out fraud, and it has many tools to do so.

The Court also explained that the monetary penalties sought by the SEC are different in kind from monetary damages sought by private plaintiffs. Penalties are intended to punish culpable individuals, the Court held, "not to extract compensation and restore the status quo." Quoting Chief Justice John Marshall, Chief Justice Roberts wrote that it "would be utterly repugnant to the genius of our laws" if actions for penalties could "be brought at any distance of time." He added that, as a practical matter, it would be extremely difficult to determine precisely when "the government" came to learn of something.


The Court’s rejection of the "discovery rule" for monetary penalties in SEC enforcement actions is obviously a favorable development for many would-be defendants, particularly financial institutions and public companies as to whom the SEC seeks ever increasing penalties. Had the Court adopted the SEC’s position, for example, the SEC could have sought penalties against the Gabelli defendants based on trades dating all the way back to 1999. Nonetheless, the SEC seems to be downplaying the significance of the decision, recently noting that "we do not expect an immediate impact on our ability to successfully hold violators accountable for their misconduct."8

While the Court’s decision in Gabelli on statutes of limitation was limited to interpreting 28 U.S.C. § 2462, it could have wider application should the Court also decide that SEC injunctions and/or disgorgement are effectively "penalties," and thus subject to the same time bar. Two weeks before Gabelli was decided, the SEC sought Supreme Court review of the Fifth Circuit’s decision in SEC v. Bartek,9 a case involving options back-dating.10 In Bartek, the appeals court had ruled against the SEC on the same issue that was appealed to the Court in Gabelli, as well as on the important question left open by the Court in Gabelli: whether injunctions, including officer-and-director bars, are subject to the same time bar as actions for penalties. In an unpublished opinion, the Fifth Circuit affirmed a district court summary judgment decision in favor of the defendants, holding that SEC claims for equitable relief were effectively penal in view of their "severity and permanent nature." Given the Court’s decision in Gabelli—that actions for penalties are time-barred if brought more than five years after the conduct—the SEC has even more reason to seek reversal of the Bartek decision. But the broad language in Gabelli on the virtues of repose and the SEC’s duty to investigate may cause the SEC to rethink their appeal in Bartek, since an adverse decision from the Court on the penal nature of injunctions and disgorgement would change a long-standing SEC practice of reaching back well beyond five years in injunctive actions seeking disgorgement.


The holding in Gabelli could well reduce the penalty amounts sought by the SEC in settlement discussions involving older conduct, by confining the bases for penalties to conduct that occurred within the five years prior to the filing of an action, and/or five years prior to the execution of a tolling agreement, to the extent that an action has not yet been filed. This will affect not only new cases, but currently pending actions and investigations, as the SEC will no longer be able to recover such penalties in litigated matters and may thus be willing to restart settlement talks at new, lower levels for the penalty portion of the settlement.