On August 8, 2012, the Second Circuit issued an important clarification regarding the statutory authority of the U.S. Securities and Exchange Commission ("SEC") to charge aiding and abetting liability in civil enforcement actions in U.S. Securities and Exchange Commission v. Apuzzo.1 Specifically, the Second Circuit held that the SEC is not required to plead or prove that the alleged aider and abetter's actions proximately caused the primary violation. Instead, the test for "substantial assistance," one of three elements that the SEC must plead in order to properly allege that an individual aided or abetted a violation of federal securities laws, is satisfied by pleading that the defendant (1) associated himself with the primary violation, (2) participated in it as something he wished to bring about, and (3) sought to make it succeed. This holding is significant because of its effect on the SEC's authority to charge an expanded range of conduct by individuals who did not engage in a primary violation of the securities laws.
The SEC's Case Against Joseph Apuzzo
On December 27, 2007, the SEC charged Joseph Apuzzo ("Apuzzo"), former CFO of mining equipment manufacturer Terex Corp. ("Terex"), for purportedly assisting in a fraudulent accounting scheme. United Rentals, Inc. ("URI"), a publicly-traded equipment leasing company, and its CFO Michael Nolan were among those charged as the actual perpetrators of the scheme. The SEC alleged that on two separate occasions URI -- with Apuzzo's assistance -- carried out fraudulent "sale-leaseback" transactions designed to prematurely realize revenue and improve year-end financial results for URI.2
The SEC alleged that URI agreed to sell used equipment to a third party and simultaneously leased back the equipment for a set period of time. The third party agreed to engage in the transactions only after obtaining guarantees from Apuzzo that Terex would resell the equipment at no less than 96% of the third party's initial purchase price. In order to induce Terex to resell the used equipment, URI agreed to indemnify Terex for any losses it suffered by selling the equipment for less than 96% of the third-party's initial purchase price. In addition, URI agreed to purchase $20 million worth of new equipment from Terex to help it meet its own announced financial projections.
According to generally accepted accounting principles ("GAAP"), each of the sale-leaseback transactions allowed URI to immediately record revenue from the deal only if the "risks and rewards of ownership" were fully transferred to the third-party and there were no "unsettled commitments" associated with the sale once it was completed. The SEC alleged that in order to make these transactions appear to conform to GAAP requirements and to avoid being questioned by URI's auditors, URI and Terex, with the knowledge and assistance of Apuzzo, agreed to conceal the existence of the indemnification agreement, inflated invoices, and mischaracterized indemnification payments as pre-payments for future purchases, all in furtherance of URI's scheme.
In 2010, Apuzzo moved to dismiss the allegations on several grounds. The District Court of Connecticut sided with Apuzzo and dismissed the complaint after finding that the SEC failed to satisfy all the elements required to show Apuzzo aided and abetted the accounting fraud. Specifically, the district court concluded that the "substantial assistance" test was not satisfied because the SEC lacked proof that Apuzzo proximately caused any of the acts committed.
Aiding and Abetting Liability and the "Substantial Assistance" Test
The Second Circuit reversed the district court and remanded for further proceedings after holding that proximate causation was not a requirement of the "substantial assistance" test. Although there is no private right of action for aiding and abetting, the SEC is authorized to charge "any person that knowingly provides substantial assistance" to a primary violator of federal securities laws.3 The SEC must plead the following elements to allege a claim for aiding and abetting liability: (1) the existence of a primary violation, (2) knowledge of the primary violation on the part of the aider and abettor, and (3) "substantial assistance" provided by the aider and abettor in furtherance of the primary violation.4
On appeal, Apuzzo did not contest that the SEC satisfied its burden to plead that there was a primary violation of the federal securities laws and that Apuzzo had actual knowledge of the fraud. The only contested issue was whether the SEC properly plead that Apuzzo provided "substantial assistance" to the alleged fraud. The circuit court rejected Apuzzo's proximate cause argument5 because "there is no requirement that the government prove injury, because the purpose of such actions is deterrence, not compensation."6 Instead, borrowing from federal criminal precedent, the Second Circuit held that the SEC satisfies the "substantial assistance" test when pleading that the defendant "in some sort associate[d] himself with the venture, that [the defendant] participate[d] in it as in something that he wishe[d] to bring about, [and] that he [sought] by his action to make it succeed."7
The Second Circuit made clear that substantial assistance is but one of the three required factors in pleading aiding and abetting, and that these factors cannot be examined in isolation. The court hypothesized that a strong showing by the SEC of actual knowledge might lessen the SEC's burden in proving substantial assistance, or vice-versa.8
Over the past two years, aider and abettor liability has undergone critical changes. As noted by the Second Circuit, the passing of the Dodd Frank Act expanded the scope of aider and abettor liability in securities prosecutions to those that knowingly or recklessly act in furtherance of the primary fraud. This expansion, in conjunction with the Second Circuit's clarification of "substantial assistance," provides the SEC with enhanced powers to charge an increasing number of individuals with violations of federal securities laws. Potentially, individuals facing charges may not have benefitted from the violation in any way, but nonetheless may have "wished it to succeed" by their associated actions. In light of these developments, corporate officers and executives are encouraged to continue scrupulously adopting and implementing stringent compliance policies, taking appropriate actions at the first signs of possible misconduct.