String Of Recent Circuit Court Opinions Impact SEC Enforcement Program

Andy Weissman, Doug Davison and Ben Brown1 Four federal circuit courts recently issued a string of rulings that are likely to have an impact on the manner in which the Securities and Exchange Commission ("SEC") seeks to police the financial markets and penalize alleged misconduct. The Courts of Appeals for the Second, Fifth, Ninth and Eleventh Circuits released four opinions, two of which potentially enlarge the SEC's tool kit in seeking to punish wrongdoing, one that could pare back the SEC's reach, and finally one that is useful in addressing potential collateral consequences of SEC "neither admit nor deny" settlements in subsequent litigation. Each has the potential to influence litigated matters involving SEC investigations that are currently pending before federal courts, and may well have an impact even at the investigative stage.

Second Circuit Clarifies that SEC is Not Required to Plead Proximate Causation for Aiding & Abetting Claims

In a holding that some commentators have suggested eases the requirements for the SEC in charging secondary actors with securities law violations, SEC v. Apuzzo, the Second Circuit clarified that the SEC does not need to allege that a defendant proximately or directly caused a securities law violation to prove that the defendant "substantially assisted" the violation, one of the requisite elements of aiding and abetting liability.2 In its complaint, the SEC alleged that the defendant, Joseph Apuzzo, formerly the CFO of Terex Corp., aided and abetted violations involving a fraudulent accounting scheme allegedly orchestrated by the former CFO of United Rentals, Inc., one of Terex's customers. In the district court proceedings, Apuzzo moved to dismiss the complaint, arguing that it failed to allege two of the three required elements of an aiding and abetting violation: (i) that the defendant had knowledge of the fraud, and (ii) that the defendant substantially assisted the primary violator's misconduct.3

The district court found that the SEC met its pleading burden on the knowledge element, but failed to adequately allege substantial assistance and granted Apuzzo's motion to dismiss. The court explained 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."4 The court reasoned that, absent allegations of proximate causation, the complaint failed to adequately plead the required substantial assistance element. In reversing the district court's decision, Judge Rakoff, writing by designation of the Second Circuit, drew a distinction between private civil actions and SEC enforcement actions, observing that "'[p]roximate 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 a government enforcement action, civil or criminal, there is no requirement that the government prove injury, because the purpose of such actions is deterrence, not compensation."5Acknowledging that this distinction had been blurred in other decisions addressing this topic, Judge Rakoff took the opportunity to clarify that, in the Second Circuit, the SEC does not need to plead or prove proximate causation in connection with an aiding and abetting claim.6

The Second Circuit pointed to a test articulated by Judge Learned Hand in a 1938 criminal aiding and abetting prosecution, in which he stated that, in addition to establishing that the primary violation occurred and that the defendant had knowledge of it, the government also must prove that the defendant associated himself with the venture, participated in it as something that he wished to bring about, and sought by his action to make it succeed.7 The Apuzzo court found that the SEC satisfied this test.

Some commentators have asserted that the Apuzzo decision eases the SEC's burden in pleading aiding and abetting claims, arguing that the Learned Hand standard is less stringent than the standard required for showing proximate causation. This is not necessarily correct in light of the Second Circuit's application of the standard and discussion of the SEC's allegations, including the court's view that the complaint alleged a very high degree of knowledge of fraud on the defendant's part.8

While the Second Circuit's clarification of the pleading standard is noteworthy, in our view the more remarkable takeaway from the Apuzzo decision is the fact that the defendant, an outsider who merely did business with and was not employed by the reporting company where the alleged primary violations occurred, was targeted for aiding and abetting the violations of the reporting company. While such a claim by the SEC is not new, this opinion highlights the significant exposure an outside party potentially faces in entering into a transaction, especially in the context of a claim under Section 20(e) of the Securities Exchange Act of 1934 ("Exchange Act") post Dodd-Frank, under which the SEC is no longer required to...