Second Circuit Eases Aiding and Abetting Standard for SEC

To prove an aiding and abetting claim against a defendant, the SEC has to prove three things: (1) a securities law violation by a primary party; (2) knowledge of the violation by the aider and abettor; and (3) “substantial assistance” by the aider and abettor in the achievement of the primary violation.  It is a fairly straightforward test, but as with all legal standards, this one has room for interpretation.

Time was, the SEC tended not to make aiding and abetting claims if it could help it.  Better, if possible, to charge a direct violation of Section 10(b) of the Exchange Act and Rule 10b-5.  The elements of direct violations are better known and more standard in the different federal circuits, while the “knowledge” standard for aiding and abetting varied around the country, at least until recently.

Two things in as many years have changed the Enforcement Division’s position on aiding and abetting claims.  First, the Dodd-Frank Act in 2010 dropped the knowledge standard for them from “knowing” to “reckless”.  A number of federal circuits already allowed aiding and abetting claims to proceed against reckless conduct; Dodd-Frank just made that level of awareness standard throughout the country.  Second, the Supreme Court’s 2011 decision in Janus Capital Group limited Rule 10b-5 claims based on misrepresentations to those who “make” the statement.  That is, “the maker of a statement is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it. 

Without control, a person or entity can merely suggest what to say, not ‘make’ a statement in its own right.” It may seem unremarkable that a rule making it unlawful to “make an untrue statement of a material fact” could only be enforced against the “maker” of that statement.  But it is not always clear who is doing the making and who is doing the suggesting, and for a long time the SEC brought cases alleging primary violations of Rule 10b-5 against defendants who were arguably only “suggestors”.

The two developments have pushed the Enforcement Division to make claims of aiding and abetting and control person liability more frequently: Dodd- Frank because the knowledge element has been standardized and slightly relaxed, and Janus because the threat of dismissal hangs over complaints against defendants who are not clearly the “makers” of allegedly fraudulent statements about securities.

All of which is why the SEC likely breathed a sigh of relief last Wednesday when the Second Circuit handed down its decision in SEC v. Apuzzo. In that case, Joseph Apuzzo, the former CFO of the Terex Corporation, allegedly assisted in carrying out two fraudulent “sale-leaseback” transactions. These deals were purportedly designed to allow another company, United Rentals, Inc., to “recognize revenue prematurely and to inflate the profit generated from URI’s sales.” The SEC charged Apuzzo in late 2007 with aiding and abetting URI’s securities fraud. Apuzzo moved to dismiss the claim, and the district court granted the motion. The district court found that the SEC had not adequately alleged the substantial assistance prong of the aiding and abetting inquiry. Specifically, the district held that to demonstrate substantial assistance, the SEC was required to show that Apuzzo had proximately caused the primary violation. And the SEC hadn’t shown that, the district court said.

The Second Circuit disagreed and said a showing of proximate cause was not required at all. Instead, the Court of Appeals continued to adhere to the construction of aiding and abetting formulated by Judge Learned Hand nearly 75 years ago. That is, in addition to a primary violation and the defendant’s knowledge of it, the government must prove:

that he in some sort associate[d] himself with the venture, that [he] participate[d] in it as something that he wishe[d] to bring about, [and] that he [sought] by his action to make it succeed. United States v. Peoni, 100 F.2d 401, 402 (2d Cir. 1938).

The court noted that a contrary result could mean that “aiders and abettors would escape all liability,” as their activities “are rarely the direct cause of the injury brought about by the fraud, however much they may contribute to the success of the scheme.” Rest assured that this is a most welcome result for the SEC. Forced by the Supreme Court’s Janus decision to bring more aiding and abetting claims, it would have been a near disaster for its enforcement program to be forced to show proximate cause on those claims.

Update:  Sept. 21, 2015 -- The SEC just settled with Apuzzo.