The SEC alleged that defendants Simpson Capital Management Inc., its Chief Investment Officer and its head trader violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 by designing and implementing a fraudulent scheme whereby they engaged five separate broker-dealers to place more than 10,700 trades in over 375 mutual funds after the 4:00 p.m. Eastern Time market close and falsely represented the trades to have been made prior to the close. By concealing the true nature of the trades, defendants were able to gain important information not available prior to the close of trading.
The defendants moved to dismiss the complaint, arguing that only the broker-dealers who actually placed the late trades and violated the applicable rules could be primary violators and that, at most, “the complaint supported an inference that the defendants had knowledge of the regulatory violations of others, obtained an economic advantage from those violations, and did nothing to reveal or prevent those violations.” Defendants claimed that the complaint must be dismissed because they were not charged with aiding and abetting liability and could not be held liable as “primary violators.”
Although acknowledging that the Second Circuit has not definitively described the bounds of primary liability, the court noted that the Second Circuit has recognized that merely participating in a fraudulent scheme, even without directly performing the violating actions, is enough to establish primary liability. With that background, the court ruled that defendants could be charged as primary violators of Section 10(b) and Rule 10b-5 if they participated in the alleged fraud and, in doing so, employed a deceptive device or engaged in a fraudulent practice. Based upon the SEC’s allegations that the defendants devised the late trading scheme and identified and worked exclusively with broker-dealers who agreed to participate in the scheme, the court held that the SEC had sufficiently pled defendants’ primary liability. (S.E.C. v. Simpson Management, Inc., et al., 2008 WL 4093046 (S.D.N.Y. Sept. 3, 2008))