D&O and E&O carriers alike will want to keep a close eye on the US Supreme Court this term. On September 25, the court accepted the matter of Gabelli v. SEC, No. 11-1274. Another market-timing case against investment advisors, at issue in Gabelli is when a claim accrues under the 5-year statute of limitations for SEC enforcement actions. A copy of the court’s order granting certiorari is available here.
Marc Gabelli was the registered portfolio manager for his eponymous mutual fund, the Gabelli Global Growth Fund, which itself was registered under the Investment Company Act of 1940. At all times relevant to the SEC’s case, Bruce Alpert was the chief operating officer of both the mutual fund and several Gabelli-affiliated mutual funds; Mr. Alpert’s job responsibilities included overseeing the mutual fund’s “market timing police,” a group of employees that monitored trading in the mutual fund in order to restrict market timing.
The SEC’s complaint, filed in federal district court in Manhattan, alleged that Gabelli and Alpert permitted a favored client to engage in a form of market timing called “scalping” from 1999 until 2002. That favored client increased its market timing transactions markedly after April 2000; its transactions routinely involved between 4% and 15% of the mutual fund’s total assets. During that period, the favored client’s three accounts realized rates of return of 185%, 160%, and 73%, respectively. At best, the rate of return for all other shareholders in the mutual fund was -24.1%. According to the complaint, the favored client’s market timing caused annual dilution ranging from 1-4% of the fund’s total assets. In August 2002, Gabelli caused the client’s trading to cease.
The SEC filed suit against Gabelli in April 2008. In March 2010, the United States District Court for the Southern District of New York granted Gabelli’s motion to dismiss in substantial part, holding that the SEC’s claims under the Investment Advisers Act were time-barred. Gabelli argued that the SEC’s claims had first “accrued” as early as September 1999, and could not have further accrued after August 2002, when the market-timing conduct ceased. The district court agreed, noting that the relevant statute under which the SEC had sued (28 U.S.C. § 2462) did not incorporate a discovery rule, and further noting that the SEC could not avail itself of the doctrine of fraudulent concealment because it had failed to allege with particularity what acts Gabelli and the other named defendants had taken, beyond the alleged acts of wrongdoing themselves, to mask their actions.
The Second Circuit reversed, concluding that the SEC’s action was not untimely, and that the SEC’s complaint had adequately alleged both materiality and culpable intent on the part of Gabelli and Alpert. It also wrote that, at the motion-to-dismiss stage, neither Gabelli nor Alpert had demonstrated that a reasonably diligent plaintiff would have discovered the fraud prior to September 2003 – within five years of when the SEC had commenced its suit. Accordingly, the Second Circuit held that “the discovery rule defines when the claim accrues and, correlatively, that the SEC need not plead that the defendants took affirmative steps to conceal their fraud.”
A decision in the case is expected before the end of June 2013. If the Court upholds the Second Circuit’s decision, the result could be a vast expansion of the amount of time that the SEC might have in which to discover and pursue violations of the federal securities laws – and correspondingly greater potential exposure to defense costs for insurers who write D&O and E&O coverage.