This week the U.S. Court of Appeals for the Second Circuit “lowered the bar” for the U.S. Securities and Exchange Commission to successfully bring enforcement actions against “aiders and abettors” of securities fraud. In SEC v. Apuzzo, a three-judge panel ruled that the SEC “is not required to plead or prove that an aider and abettor proximately caused the primary securities law violation.” The new, more lax standard, says Reuters, “could help the regulator bring more enforcement cases against individuals.”
In Apuzzo, the SEC charged Joseph F. Apuzzo, former Chief Financial Officer of a global manufacturing company, with aiding and abetting the purported securities laws violations of a third-party equipment rental company through his role in an alleged fraudulent accounting scheme. The SEC alleged that Apuzzo aided and abetted the scheme by signing leaseback agreements that he knew were designed to allow United Rental to improperly recognize revenue in order to meet earnings forecasts.
Section 20(e) of the Securities Exchange Act of 1934 allows the SEC, but not private plaintiffs, to bring civil actions against purported “aiders and abettors” of securities fraud. The Second Circuit explained that “[i]n order for a defendant to be liable as an aider and abettor in a civil enforcement action, the SEC must prove: (1) the existence of a securities law violation by the primary (as opposed to the aiding and abetting) party; (2) ‘knowledge’ of this violation on the part of the aider and abettor; and (3) ‘substantial assistance’ by the aider and abettor in the achievement of the primary violation.”
In Apuzzo, the existence of a securities law violation was not in doubt and, the trial court concluded, it was clear that Apuzzo had “actual knowledge” of the violation. The district court found, however, that the SEC had not adequately alleged the third element: “substantial assistance.” In dismissing the complaint, the district court held that the Commission failed to adequately plead that Apuzzo “proximately caused” the harm arising from the third party's allegedly fraudulent scheme – that is, “that there was a ‘but for’ causal relationship between Apuzzo’s conduct and the primary violation.” The court found instead that the fraud was accomplished principally through transactions orchestrated by United Rentals’ executives.
The Second Circuit disagreed with the district court’s ruling. Relying heavily on “well-developed law of aiding and abetting liability in criminal cases,” the Court ruled that the proper test for gauging “substantial assistance” in SEC civil enforcement actions is whether the aider and abettor “in some sort associated himself with the venture, that he participated in it as in something that he wished to bring about, and that he sought by his action to make it succeed.”
The Second Circuit’s new “substantial assistance” test for securities fraud cases mirrors the standard formulated by Judge Learned Hand in United States v. Peoni (1938) for assessing criminal aider and abettor liability. The Court regards Judge Hand’s test as “clear, concise, and workable.” Simply put, “a defendant is liable as an aider and abettor if, in addition to knowing of the primary violation, he consciously assisted the commission of the specific crime in some way.” Under the new test, rather than focusing on whether the purported aider and abettor caused the securities law violation, “[i]t is particularly appropriate to consider the degree of scienter in evaluating substantial assistance.”
The Court forcefully rejected Apuzzo’s contention that it should define “substantial assistance” as “proximate cause.” The Court reasoned that Apuzzo’s argument “ignores the difference between an SEC enforcement action and a private suit for damages.” The Court explained
‘Proximate cause’ is the language of private tort actions; it derives from the need of a private plaintiff, seeking compensation, to show that his injury was proximately caused by the defendants’ actions. But, in an enforcement action, civil or criminal, there is no requirement that the government prove injury, because the purpose of such actions is deterrence, not compensation.
The distinction between the causation requirements in private tort actions and enforcement actions “is already implicit in some of the case law,” said the Court, and there is no reason to carry the “proximate cause” requirement over to a regulatory context.
Moreover, the Court reasoned, “many if not most aiders and abettors would escape all liability if such a proximate cause requirement were imposed, since, almost by definition, the activities of an aider and abettor are rarely the direct cause of the injury brought about by the fraud, however much they contribute to the success of the scheme.”
The decision eases the SEC’s burden in bringing enforcement actions against purported aiders and abettors of securities law violations. The potential impact of the decision is particularly acute because many publicly traded companies are subject to the jurisdiction of New York federal courts, where Apuzzo is now the law of the land.