Section 20(e) of the Securities Exchange Act of 1934 allows the SEC, but not private litigants, to bring civil actions against aiders and abettors of securities fraud. Under this section, the SEC may bring an enforcement action against “any person that knowingly provides substantial assistance” to a primary violator of the securities laws. On August 8, 2012, in SEC. v. Apuzzo, 689 F.3d 204 (2d Cir. 2012), the Second Circuit lowered the bar necessary to state a claim for aiding and abetting. Noting that prior case law may have been unclear, the Second Circuit rejected the argument that the SEC is required to plead or prove that an aider and abettor proximately caused the primary securities law violation. Instead, relying on a 75-year-old decision by Judge Learned Hand, the Court stated that once the government proves that a primary violation occurred and that the defendant had knowledge of it, the government need only prove that the defendant associated himself with the fraudulent scheme and sought to make it succeed. This relaxed standard will make it easier for the SEC to pursue enforcement actions against individuals who assist others in committing securities violations.
Joseph Apuzzo was the Chief Financial Officer of Terex Corporation, a manufacturer of mining equipment. The government alleged that, with Apuzzo’s assistance, United Rentals, Inc., one of the largest equipment rental companies in the world, and its Chief Financial Officer, Michael Nolan, carried out two fraudulent sales-leaseback transactions designed to allow United Rentals to recognize revenue prematurely and inflate the profit generated from sales. As part of this scheme, United Rentals sold used equipment to General Electric Credit Corporation (“GECC”) and leased the property back for a short period of time. In order to secure GECC’s participation in the sales-leaseback, United Rentals convinced Terex to agree to resell the equipment for GECC at the end of the lease period and to guarantee that GECC would receive no less than 96% of the purchase price that GECC paid United Rentals to acquire the equipment. To obtain Terex’s agreement, United Rentals secretly promised to indemnify Terex for any losses that Terex sustained and to make substantial equipment purchases from Terex in the future. Pursuant to Generally Accepted Accounting Principles, United Rentals could immediately recognize the revenue generated by the sale of equipment to GECC if it could demonstrate, among other things, that the risks and rewards of ownership had been fully transferred to GECC. However, because it had secretly agreed to indemnify Terex for any losses that Terex incurred, that requirement was not met, and therefore United Rentals could not properly record the revenue from the sales. The government alleged that Apuzzo knew that if the indemnification payments were disclosed, United Rentals would not be able to recognize the revenue. The government also claimed that Apuzzo executed various agreements and approved false invoices to conceal the indemnification payments.
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.” SEC v. DiBella, 587 F.3d 553, 566 (2d Cir. 2009) (quoting Bloor v. Carro, Spanbock, Londin, Rodman & Fass, 754 F.2d 57, 62 (2d Cir. 1985)). Relying on Bloor, the District Court found that although the complaint plausibly alleged that Apuzzo had actual knowledge of the primary violation, it did not adequately allege “substantial assistance” because the government did not allege that Apuzzo proximately caused the harm on which the primary violation was predicated. Specifically, the Court held that “the complaint 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.” SEC v. Apuzzo, 758 F. Supp. 2d 136, 148 (D. Conn 2010). Concluding that proximate causation was required to satisfy the “substantial assistance” component of aider and abettor liability, the District Court granted Apuzzo’s motion to dismiss.
The Second Circuit reversed and clarified the standard for determining the substantial assistance prong for aider and abettor liability. Relying on criminal case law for guidance, the Court reasoned that the conduct of an aider and abettor that was sufficient to impose criminal liability would also be sufficient to impose civil liability in an enforcement action. The Court then noted that in Peoni, Judge Hand set forth the classic formula for aider and abettor liability in criminal cases by stating that the government—in addition to proving that the primary violation occurred and that the defendant had knowledge of it—must prove “that he 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.” Apuzzo, 689 F.3d at 206. (quoting Peoni, 100 F.2d at 402.)
The Second Circuit concluded that this was likely the clearest definition possible and then rejected Apuzzo’s argument that substantial assistance should, instead, be defined as proximate cause. The Court determined that that argument ignored the difference between an SEC enforcement action and a private suit for damages. “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. Id. at 213.
Applying this new standard, the Second Circuit concluded that the complaint alleged that Apuzzo provided substantial assistance in carrying out the fraud because he negotiated the details of both transactions, extracted agreements for Terex, and signed inflated invoices to further the fraud. The Court thus reversed the District Court’s order and remanded the case for trial.
Because only the SEC may bring civil claims for aiding and abetting securities law violations, this decision will not affect private litigants. However, it will likely increase the number of enforcement actions brought against individuals who assist others in transactions designed to make financial statements seem more attractive. The SEC has long relied on theories of secondary liability to enforce the federal securities laws. In 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, which confirmed that knowing or reckless behavior can form the basis for liability for securities fraud. The Second Circuit’s decision in Apuzzo continues this recent trend in easing the SEC’s burden in secondary liability cases.