Supreme Court Sharply Questions Hedge Fund Market-Timing Case

Jan 10 2013 | 1:26am ET

The U.S. Supreme Court seems inclined to throw out a Securities and Exchange Commission lawsuit over a hedge fund's mutual-fund market timing.

The hedge fund in question, the former Folkes Asset Management—now known as Headstart Advisors—is not involved in the case before the High Court. But two executives from the company that manages the mutual funds it market-timed, Gabelli Fund, have fought the fraud charges, arguing that the SEC sued it after the five-year statute of limitations expired.

Justices from all corners of the Supreme Court's ideological spectrum, questioning the government's lawyer, seemed likely to agree. Justice Antonin Scalia, mainstay of the Court's right, called the SEC's argument that the clock doesn't begin ticking until a fraud is discovered, or should have been, "a brand new assertion by the government."

"What's extraordinary is that the government has never asserted this, except in the 19th century, when it was rebuffed and repudiated its position."

Perhaps less extraordinary, Justices Ruth Bader Ginsburg and Elena Kagan, two of the more left-leaning members of the court, seemed to agree. Ginsburg called the five-year statute of limitations "generous" and Kagan wondered whether the federal government hadn't been "embarrassed" into pursuing mutual-fund market-timing by former New York Attorney General Eliot Spitzer, who led the charge against the practice prior to his short tenure as the Empire State's governor.

Another member of the court's left, Stephen Breyer, feared that the SEC's reasoning could apply to "all government actions."

"The reason I brought up Social Security, Veterans Affairs, Medicare is it seems to me to have enormous consequences for the government suddenly to try to asset a quasi-criminal penalty and abolish the statute of limitations, I mean, in a vast set of cases," he said.

Jeffrey Wall, the U.S. assistant solicitor general and the hapless defender of the government's position, could only muster that the court should not allow "feverish hypotheticals" to prevent the SEC from bringing cases in which it is difficult to determine when a fraud took place.

In the Gabelli case, the fraud allegedly occurred until August 2002, when the last allegedly improper trade took place. But the SEC did not sue until April 2008, when it accused Marc Gabelli and Gabelli Funds chief operating officer Bruce Alpert of approving Folkes' market-timing of one of their funds, without disclosing it to the fund's board or its investors, and while at the same time denying requests to market-time from other investors.

"This case concerns the statute dealing exclusively with penalty claims brought by government agencies to punish conduct made unlawful by statute," Lewis Liman, the lawyer for Gabelli and Alpert, told the court. "Congress provided a clear and easily administered statutory time limitation on the government's power to punish: five years."

Folkes and Gabelli Funds settled the SEC allegations, the former for $17 million and the latter for $16 million.


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