Eighth Circuit Limits Safe Harbor - Allowing Securities Fraud Violators To Avoid Jail If They Have 'No Knowledge' Of Pertinent Sec Rule -- To Those Who Prove Lack Of Knowledge Of Rule's Substance

Under 15 U.S.C. § 78ff (a), a defendant who willfully violates any SEC rule or regulation is subject to imprisonment for up to 20 years, unless "he proves that he had no knowledge of such rule or regulation." This provision has been characterized as a safeguard implemented by Congress to ensure that severe criminal punishments fall only on those who have acted with scienter. United States v. O'Hagan, 521 U.S. 642, 665 (1997).

But what exactly does it mean to have "no knowledge" of the relevant rule or regulation? Must a defendant establish to the sentencing judge's satisfaction that he was unaware entirely of the existence of the particular rule or regulation which he has been convicted of violating? That would be a very high bar indeed for a defendant to prove. Or is it sufficient for him to show that, although aware of the existence of the provision, he did not know that it was applicable to his specific conduct? The latter interpretation would bring Section 78ff(a) very close in meaning to the "willfulness" required to be proven by the government in tax prosecutions, i.e., that only a taxpayer who knew of, and specifically intended to violate, a particular tax provision with his conduct could be punished. See Cheek v. United States, 498 U.S. 192, 200-02 (1991).

The Eighth Circuit recently addressed this fairly novel question in United States v. Behrens, 2013 WL 1760325 (8th Cir., April 25, 2013). Behrens, who held multiple securities licenses, pled guilty to violating Rule 10b-5 by issuing worthless promissory notes to investors in his company. At sentencing, he argued that the safe harbor provision of Section 78ff allowed him to avoid jail because he did not know that the Rule was applicable to promissory notes which he contended were not "securities" under its terms. The Court of Appeals, however, upheld the conviction.

Addressing for the first time the meaning of the safe harbor provision, the Court of Appeals rejected the alternative constructions placed on the language by the defendant and the government. The defendant's preferred construction, that the safe harbor applied in any situation where a defendant did not understand his specific conduct to violate a rule of which he was admittedly aware, was too great a departure from the general principle that ignorance of the law is no defense. The court saw no reason to import from the criminal tax area the requirement that prosecution, and exposure to jail...