A Second Circuit panel reversed a district court judgment dismissing the SEC's complaint against a mutual fund's portfolio manager and the chief operating officer for the fund's adviser. According to the Commission, the manager and COO failed to disclose that the adviser secretly allowed an investor to market time the fund in exchange for an investment in another hedge fund managed by the adviser. While this was occurring, the fund banned other accounts from market timing and rejected other market timing purchases. The fund's board and investors were told about the efforts to combat market timing but were not informed of the advantage given to the one investor. The district court dismissed the Commission's fraud claims, finding no duty to fully disclose the investor's market timing, and barred all relief other than disgorgement.

The panel found that the district court erred in dismissing the fraud claims. While the COO's statement to the board that market timers were being restricted or banned was literally true, it was a "half-truth" that created a materially misleading impression. Regarding the materiality of the omissions, the court observed that it "borders on the frivolous" to suggest that a reasonable investor would find the failure to disclose a secret arrangement allowing market timing in exchange for an investment to be immaterial. The court also found that the COO knew, or was reckless in not knowing, that his statements were misleading because, among other indications, he had given the order to allow the market timing to continue.

The panel then determined that the district court erred in dismissing the SEC's motion for civil penalties under the Investment Advisers Act. The 2nd Circuit has previously held that civil penalties may be sought in connection with a claim for aiding and abetting violations of the Advisers Act. The claim was also timely under the discovery rule as applied to fraud claims because the fraudulent scheme was discovered in 2003, and the action was filed in 2008. Since the claim was timely, the panel concluded that the Commission’s motion for civil penalties must be reinstated. Finally, the panel found that the complaint sufficiently pleaded a reasonable likelihood of future violations and reversed the dismissal of the Commission's motion for injunctive relief.

□ SEC v. Gabelli (2nd Cir) is reported at ¶96,367.