The U.S. Supreme Court on Wednesday limited the authority of the federal government's top securities regulator to seek civil penalties over conduct that occurred more than five years before investigators took action.
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The nine-member court held on a unanimous vote that the five-year clock for the government to act on fraud begins to tick when the fraud occurs, not when it is discovered.
The case was a victory for mutual fund manager Marc Gabelli and colleague Bruce Alpert, whom the U.S. Securities and Exchange Commission claimed allowed a firm now known as Headstart Advisers Ltd to conduct hundreds of "market-timing" trades. Such trades involve rapid trading to exploit market or price inefficiencies.
The practice, while not illegal, is considered improper.
Gabelli and Alpert, who deny any wrongdoing, said the clock for enforcement action starts to tick when the alleged act occurred. The SEC said it starts when the agency is reasonably able to detect fraud.
The SEC claimed that Gabelli and Alpert violated the law from 1999 to 2002. But the agency did not sue Gabelli and Alpert until April 2008, nearly five years later, and more than five years after it said the last market-timing trade occurred.
SEC spokesman John Nester said the agency was reviewing the decision.
Allowing the SEC to bring a case so late, without Congress having explicitly given the SEC the power to do so, poses challenges, Chief Justice John Roberts wrote for the court.
"Determining when the government, as opposed to an individual, knew or reasonably should have known of a fraud presents particular challenges for the courts," Roberts wrote.
"Agencies often have hundreds of employees, dozens of offices and several levels of leadership. In such a case, when does 'the government' know of a violation?" he asked.
The SEC had won before the 2nd U.S. Circuit Court of Appeals in August 2011. Judge Jed Rakoff wrote for the court that the regulator could not have reasonably uncovered the market timing until a high-profile investigation by then-New York Attorney General Eliot Spitzer brought it to prominence.
The case is Gabelli v. SEC, U.S. Supreme Court, No. 11-1274.