On August 8, 2012, the U.S. Circuit Court for the Second Circuit issued an important decision that clarified the pleading threshold for aiding and abetting liability and potentially eased the burden on the Securities and Exchange Commission (the SEC) to bring aiding-and-abetting claims against individuals who substantially assist in securities fraud.
In SEC v. Apuzzo, 2012 WL 3194303 (2d Cir. Aug. 8, 2012), the Second Circuit reversed the district court’s dismissal of a complaint filed by the SEC against Joseph Apuzzo (Apuzzo), the former Chief Financial Officer of Terex Corporation (Terex), an equipment manufacturer.
The SEC alleged that, between December 2000 and December 2001, United Rentals, Inc. (URI), one of the world’s largest equipment rental companies, and Michael J. Nolan (Nolan), its Chief Financial Officer, carried out two fraudulent “sale-leaseback” transactions with the assistance of Apuzzo. According to the SEC, Apuzzo assisted URI and Nolan in conducting a scheme designed to permit URI to recognize revenue prematurely and to inflate profits generated from URI’s sales.
The alleged scheme worked as follows: URI would sell used equipment to a financing company, and lease the equipment back from that financing company for a short period of time. To obtain the financing company’s agreement to participate in these sale-leaseback transactions, URI convinced Terex to agree to resell the equipment for the financing company at the end of the lease periods. Terex and URI also allegedly agreed that Terex would provide a residual-value guarantee to the financing company which provided that, after the equipment was resold, the financing company would receive no less than 96% of the purchase price that the financing company had paid URI for the equipment. In order to secure Terex’s participation in these transactions, URI secretly agreed with Terex to indemnify Terex for any losses incurred by Terex under the residual-value guarantee. URI also agreed to make substantial purchases of new equipment from Terex in order to improve Terex’s year-end sales.
Under applicable accounting guidance, URI could immediately recognize the revenue generated by the sale of equipment if (i) the “risks and rewards of ownership” were fully transferred to the buyer and (ii) the sale price was “fixed and determinable.” According to the SEC, because of URI’s secret indemnification agreement with Terex, URI did not fully transfer the risks and rewards of ownership to the financing company and was thus prohibited from recording the revenue from the sales. The SEC alleged that Apuzzo know that if the full extent of these transactions was transparent, URI would be prohibited from claiming the increased revenue. The Complaint alleged that Apuzzo executed various agreements and approved inflated invoices that were designed to conceal the indemnification payments from URI to Terex.
Apuzzo moved to dismiss the Complaint, arguing that the Complaint failed to adequately allege the second and third elements of aiding and abetting securities fraud—namely, that Apuzzo had actual knowledge of URI’s fraud and that Apuzzo rendered substantial assistance to URI. The district court found that the SEC had adequately alleged actual knowledge of the violation. See SEC v. Apuzzo, 758 F. Supp. 2d 136, 148 (D. Conn. 2010). The court further found, however, that the SEC failed to sufficiently allege the “substantial assistance” element of the claim. Specifically, the district court found that “the [C]omplaint contains factual allegations which taken as true support a conclusion that there was a ‘but for’ causal relationship between Apuzzo’s conduct and the primary violation, but do not support a conclusion that Apuzzo’s conduct proximately caused the primary violation.”1 at 152. The court thus dismissed the Complaint with prejudice, concluding that proximate causation was required to satisfy the “substantial assistance” element of aiding and abetting liability.2
Under Section 20(e) of the Securities Exchange Act of 1934, the SEC is permitted to bring civil actions against aiders and abettors of securities fraud. 15 U.S.C. § 78t(e) (the SEC may bring a claim for aiding and abetting securities fraud against “any person that knowingly provides substantial assistance” to a primary violator of the securities laws). In SEC v. DiBella, 587 F.3d 553, 566 (2d Cir. 2009), the Second Circuit articulated that, in order to state a claim for aiding and abetting liability, the SEC must allege: “(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.”
Previously, in Bloor v. Carro, Spanbock, Londin, Rodman & Fass, 754 F.2d 57, 62 (2d Cir. 1985),3 the Second Circuit stated that the complaint “must allege that the acts of the aider and abettor proximately caused the harm to the corporation on which the primary liability is predicated.” Thus, Apuzzo argued that “substantial assistance” should be defined as proximate cause. In rejecting this argument, the Second Circuit stated that:
Proximate cause is the language of private tort actions; it derives from the need of 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.
Indeed, the court found no reason to carry the proximate-cause requirement set out in Bloor over to the context of an SEC enforcement action. Rather, the court looked to the well-developed body of law on criminal aiding and abetting. Drawing from Judge Learned Hand in a case decided nearly 75 years ago, the Second Circuit noted that, in order for a criminal defendant to be liable for aiding and abetting, the government must prove “that he in some sort associate[d] himself with the venture, that [defendant] participate[d] in it as something that he wishe[d] to bring about, [and] that he [sought] by his action to make it succeed.” U.S. v. Peoni, 100 F.2d 401, 401 (2d Cir. 1938). The court further noted that Judge Hand’s standard has “survived the test of time, is clear, concise, and workable, and governs the determination of aider and abettor liability in securities fraud cases.”
Applying Judge Hand’s standard to the SEC’s Complaint against Apuzzo, the Second Circuit found that the Complaint plausibly alleged that Apuzzo provided substantial assistance to URI in carrying out the securities fraud. Specifically, the court held that the Complaint alleged that Apuzzo associated himself with the venture by agreeing to participate in the sale-leaseback transactions, participated in it as something he wished to bring about by negotiating the details and approving and signing agreements that he knew were designed to conceal URI’s continuing risks and financial obligations in furtherance of the fraud, and sought by his actions to make it succeed by approving the issuance of Terex’s inflated invoices.
Further, the court held that, in evaluating whether Apuzzo substantially assisted the fraud, it must consider his high degree of actual knowledge of the primary violation. Thus, where the SEC plausibly alleges a high degree of actual knowledge, it lessens the burden the SEC must meet in alleging substantial assistance. In this case, the district court found that the Complaint alleged, in detail, a very high degree of knowledge of the fraud on the part of Apuzzo. In light of those detailed allegations, the allegations of substantial assistance could be viewed only as an effort by Apuzzo to intentionally assist the fraud and help it succeed, and dismissal of the Complaint was inappropriate.
It remains to be seen whether federal courts in other circuits will adopt the pleading standard for aiding and abetting liability in the securities fraud context set forth in the Apuzzo case. As noted by the Second Circuit, however, other circuits, such as the Seventh Circuit, have recognized Judge Hand’s standard as “[t]he classic formula for aider and abettor liability.” U.S. v. Irwin, 149 F.3d 565, 569 (7th Cir. 1998). Thus, the SEC will likely rely on the Apuzzo case as the applicable standard when faced with motions to dismiss an aiding-and-abetting claim based on failure to sufficiently allege proximate cause.