The SEC prevailed in the Second Circuit Court of Appeals, securing the reversal of an order dismissing its claims against the portfolio manager of a mutual fund and the chief operating officer of the fund’s investment adviser. SEC v. Gabelli, Nos. 10-3581, 10-3628 and 10-3660 (2nd Cir. August 1, 2011).

The Commission’s action centered on claimed false statements made by Marc Gambelli, the portfolio manager of Gabelli Global Growth Fund, and Bruce Alpert, the COO of the Fund’s adviser, Gabelli Funds, LLC. The complaint alleged that each defendant failed to disclose, and made false statements concerning, the favorable treatment given to one fund investor. Specifically, the SEC’s complaint alleged that from 1999 until 2002 the defendants permitted trader Headstart to engage in “time zone arbitrage,” a form of market timing which takes advantage of pricing discrepancies across time zones. Under an agreement with the defendants Headstart was permitted to time millions of dollars in transactions. While permitting Headstart to time, the defendants banned at least 48 other accounts from market timing and rejected timing purchases of at least $23 million. Indeed, “market timing police” monitored and rejected timing trades.

According to the SEC, the defendants did not disclose to the Fund’s board of directors that Headstart was permitted to market time. As a result the board was misled into believing that all steps were being taken to preclude market timing. At one board meeting Mr. Alpert reported on the dangers of market timing and the steps being taken to eliminate the practice without mentioning that there was an agreement in place permitting Headstart to market time. Following this report Mr. Gabelli informed the board about the operations of the Fund without mentioning Headstart.

Even after Headstart stopped the practice the defendants continued to mislead the board and Fund investors, according to the complaint. A memo posted on the website of the parent company specifically stated that that market timers had been identified and restricted or banned, although it conceded that not all timers were eliminated. The complaint alleged violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1) and (2).

The district court dismissed the claims, concluding that the statement in the memorandum was literally true. The court also dismissed the Commission’s claim for a civil penalty concluding that it was time barred under the statute of limitations and, in any event, a penalty could not be assessed for aiding and abetting under the Advisers Act. Finally, the court concluded that the claim for injunctive relief should be dismissed because the complaint did not plausibly alleged that defendants are reasonably likely to engage in future violations. The SEC dismissed it only remaining claim for disgorgement and appealed.

The Second Circuit reversed. First, there is no doubt that the statement in the memorandum was literally true. This however does not mean it cannot be misleading as the district court concluded wrote Judge Rakoff, sitting by designation. In this regard “The law is well settled . . . that so-called ‘half-truths’ – literally true statements that create a materially misleading impression – will support claims for securities fraud.” Here reasonable investors reading the memorandum would plausibly believe that good faith efforts had been made to eliminate market timing. The fact that the memorandum conceded that not all timing had been eliminated did not save it in view of the fact that defendants knew of the agreement with Headstart.

Second, the law in the Second Circuit is settled that the SEC can seek a civil penalty for aiding and abetting a violation of Section 206 of the Advisers Act. In SEC v. DiBella, 587 F. 3d 553 (2nd Cir. 2009) the Court concluded that a violation of the Advisers Act includes aiding and abetting and primary violations.

Likewise, the claim for a civil penalty is not time barred. Section 2442 of title 28 requires that the claim for civil penalties be brought within five years. Here the SEC argues that its claim did not accrue until September 2003 when, as the complaint alleges, it discovered the claim. This is correct according to the Court. Defendants’ contention that the SEC cannot rely on this rule because there is no allegation of concealment confuses the discovery rule, which is applicable here, with the doctrine of fraudulent concealment. Under the former the statute of limitations does not accrue until the claim is discovered or could have been discovered with reasonable diligence by the plaintiff. The latter is an equitable tolling doctrine which provides that even when a claim has accrued a plaintiff may benefit from equitable tolling in the event that the defendant took specific steps to conceal the activities from the plaintiff.

Finally, the Court observed that it is most unusual at this stage of a case to dismiss a claim for injunctive relief. In fact no case could be located where this type of an order had been entered. In any event, here, where there are allegations which plausibly alleges that for almost three years the defendants aided and abetted the violations of the investment adviser the complaint sufficiently pleads a reasonable likelihood of future violations.

Two upcoming programs on the FCPA:

Program: Is FCPA Enforcement To Aggressive? August 5, 2011, ABA Annual Meeting Toronto. The program links are here and here.

Program: Current Trends in FCPA Enforcement, August 17, 2011, Live in Menlo Park, CA, and webcast nationally. The program link is here.

Tagged with: , , , , , ,