In SEC v. Apuzzo, 2012 WL 3194303 (2d Cir. Aug. 8, 2012), the United States Court of Appeals for the Second Circuit clarified the standard for finding liability for aiding and abetting under Section 20(e) of the Securities Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. § 78t(e). Under Section 20(e), the Second Circuit held, the Securities and Exchange Commission (“SEC”) need not show that an aider and abettor “proximately caused” the harm on which the primary violation was predicated. Instead, the SEC need only show that the aider and abettor “in some sort associated himself with the venture, that he participated in it as in something he wished to bring about, and that he sought by his action to make it succeed.” In Appuzo, the Second Circuit has clarified that the SEC need only plead this level of participation — and not proximate causation — to adequately allege that an aider and abettor meets the “substantial assistance” prong of Section 20(e).
Apuzzo centered around a series of three-way transactions designed to allow the primary violators — United Rental, Inc. (“URI”), an equipment rental corporation, and its chief financial officer (“CFO”), Michael Nolan — to book sales improperly in violation of generally accepted accounting principles (“GAAP”). In order to facilitate this transaction, URI enlisted Terex Corporation (“Terex”), a construction equipment manufacturer, and, more specifically, Terex’s CFO, Apuzzo, to assist it in improperly booking revenue.
As structured, URI would sell equipment to General Electric Credit Corporation (“GECC”), a financing corporation, which would then lease back the same equipment to URI. GECC, however, would participate only if someone would guarantee that the equipment could be re-sold at a certain rate of return. Terex provided GECC with such a guaranty. Terex, in turn, was secretly indemnified by URI, which also promised to buy Terex’s products to improve Terex’s year-end sales. URI would disguise the indemnification payments by overpaying for Terex’s products. By arranging the transaction this way, URI would be able to immediately recognize revenue from the transaction, but in a way that violated GAAP.
The SEC brought a civil action against Apuzzo under Section 20(e) of the Exchange Act. Under Section 20(e), the SEC — but not private litigants — can bring a civil action against “aiders and abettors of securities fraud.” Any person who “knowingly provides substantial assistance to a primary violator” — the main actor(s) accused of perpetuating a securities fraud — can be liable under Section 20(e). To prove aiding and abetting liability the SEC must show: “(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.”
Apuzzo did not seriously challenge that he had had knowledge of the primary violation. Nevertheless, Apuzzo moved to dismiss the SEC’s civil complaint on this ground that he was not the proximate cause of the sale-leaseback scheme. In the absence of proximate cause, he argued, he could not be found to have “substantially assisted” the primary violation. The United States District Court for the District of Connecticut agreed, and granted the motion to dismiss. The SEC appealed.
The Second Circuit reversed. The Court held that the “substantial assistance” prong of Section 20(e) does not require the SEC to show proximate causation. Quoting Judge Learned Hand, the Second Circuit concluded that under Section 20(e), the SEC need only show that Apuzzo “in some sort associated himself with the venture, that the defendant participated in it as in something that he wished to bring about, and that he sought by his action to make it succeed.”
“Proximate cause,” the Court held, was “the language of private tort actions”; it did not apply to SEC actions where the purpose was “deterrence, not compensation.” Forcing the SEC to prove causation, the Second Circuit reasoned, would lead to “many if not most aiders and abettors” escaping liability because, “almost by definition, the activities of an aider and abettor are rarely the direct cause of the injury brought about by the fraud.”
Having rejected the “proximate cause” test, the Second Circuit concluded that Apuzzo had “provided substantial assistance to” URI in carrying out the fraud. Why? Apuzzo had agreed to participate in the fraudulent sale-leaseback transaction, had “negotiated the details of those transactions,” had profited from those transactions and had “approved and signed separate agreements with GECC and URI, which he knew were designed to hide URI’s continuing risks and financial obligations.”
In weighing whether this amounted to “substantial assistance” under Section 20(e), the Court concluded that Apuzzo’s high degree of knowledge of the transaction was highly relevant; “a high degree of knowledge may lessen the SEC’s burden in proving substantial assistance.” Having rejected the proximate cause analysis of the district court, the Second Circuit reversed and remanded the case for further proceedings before the district court.
Apuzzo greatly clarifies the standard for finding liability under Section 20(e) for aiders and abettors. Now, to prove the “substantial assistance” prong of 20(e), the SEC need not prove that the aider and abettor was the proximate cause of the fraudulent scheme. Instead, even if the aider and abettor’s role was incidental, the key inquiry in assessing “substantial assistance” is whether the aider and abettor “in some sort associated himself with the venture, that the defendant participated in it as in something that he wished to bring about, and that he sought by his action to make it succeed.” Courts in the Second Circuit will weigh the degree of the aider and abettor’s knowledge in making this inquiry.