Avoiding prison if convicted of securities fraud just became a lot more difficult after the Eighth Circuit’s decision in United States v. Behrens in April 2013. For years white collar defendants convicted of securities fraud could avoid prison altogether if they could establish that they had “no knowledge of such rule or regulation.” That defense is now unavailable to a defendant who was aware of the rules but claimed to have no knowledge that his or her conduct broke those rules.
In Behrens, the defendant owned and operated a life insurance agency and financial investment advising business. Later he became sole owner of National Investments, Inc. (NII). He promoted NII to clients as a safe and lucrative investment opportunity. He issued investors promissory notes. Instead of investing his clients’ money in NII, as promised, the defendant used the money to prop up his other business interests and support his extravagant lifestyle. Ultimately the defendant plead guilty to one count of securities fraud in violation of 15 U.S.C. Sections 78j(b), 78ff and 17 C.F.R. Section 240.10b-5 (Rule 10b-5). The district court sentenced him to five years imprisonment.
The defendant appealed his sentence arguing that he was ineligible for imprisonment under Section 78ff(a)’s “no knowledge” defense which imposes criminal liability for “willful violations” of securities laws or SEC rules but allows defendants who prove they had “no knowledge” of the rule or regulation they violated to avoid prison. The defendant claimed that, even if he knew about Rule 10b-5, he did not know that the promissory notes he issued through NII constituted “securities” within the scope of Rule 10b-5. In other words, defendant argued that he had “no knowledge” of Rule 10b-5 because he was ignorant that it applied to his admitted conduct.
The Eighth Circuit rejected defendant’s argument and affirmed his five year prison sentence. The Court reasoned that if Congress intended to allow defendants to avoid prison upon a showing that they did not know their conduct violated SEC laws, it would have written the law more broadly. According to the Court, the rule protects from imprisonment those individuals who “dabble in securities” and are truly “unaware of the substance of an SEC rule or regulation.” It does not, however, do away with the principle that “ignorance of the law is no defense.” The defendant in Behrens was no dabbler in securities. He held four securities licenses (Series 6, 26, 63 and 65) and a baseline understanding of SEC rules and regulations. The “no knowledge” safe harbor provision was, therefore, not available to him. And it will not be available to other individuals who, like the defendant in Behrens, are not average citizens but sophisticated business and securities players.
In summary, a white collar defendant convicted of violating the securities laws, who possesses a lengthy business resume, should no longer expect to avoid prison under the “no knowledge” defense so successfully employed by executives in the past. Those days are over. Today the defendant convicted of securities fraud should bring a toothbrush to the sentencing hearing.