By Rodney F. Tonkovic and N. Peter Rasmussen
The 2nd Circuit discussed what the SEC* must prove in order to establish aiding and abetting liability. In order 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. The 2nd Circuit rejected the lower court’s holding that an aider and abettor must have proximately caused the harm on which the primary violation was predicated, holding that “to satisfy the `substantial assistance’ component of aiding and abetting, the SEC must show that the defendant in some sort associated himself with the venture, that he participated in it as in something that he wished to bring about, and that he sought by his action to make it succeed” (internal citations omitted). SEC v. Apuzzo.
The U.S. District Court for the District of Connecticut had previously dismissed SEC charges of aiding and abetting against Joseph F. Apuzzo, the chief financial officer of Terex Corp., a heavy equipment manufacturer. As alleged, Apuzzo aided and abetted the violation of securities laws by Michael J. Nolan, the former CFO of United Rentals, Inc. Nolan allegedly committed securities fraud by inflating profits and by prematurely recognizing revenue from the sale of used equipment.
According to the SEC, the sales were structured in a way that took advantage of favorable accounting treatment. However, URI had made a series of interlocking agreements, among which was an agreement to assume the Terex's remarketing obligations and to indemnify it for any losses. The SEC argued that under GAAP, URI could not record revenue during the period at issue because it was under a continuing obligation to Terex. The SEC alleged that Apuzzo CFO substantially assisted Nolan and URI in concealing the nature of the agreements and in concealing the indemnification payments, which allegedly allowed URI company to inflate its profits from the transactions.
While finding that Apuzzo plausibly knew of a primary violation of the securities laws, the trial court found that the SEC failed to allege substantial assistance by Apuzzo. The lower court noted that Nolan structured the transactions and brought the parties together. Apuzzo was also not responsible for URI’s accounting decisions. While there was a “but for” causal relationship between Apuzzo’s conduct and the primary violation, the court concluded that the allegations did not “support a conclusion that Apuzzo’s conduct proximately caused the primary violation.”
The 2nd Circuit, in an opinion authored by U.S. District Judge Jed Rakoff (sitting by designation), observed that Apuzzo’s proximate cause construction of substantial assistance “ignores the difference between an SEC enforcement action and a private suit for damages. Private plaintiffs need to show proximate cause to connect their injuries to the defendant’s conduct. However, “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.” Under Apuzzo’s definition, according to the 2nd Circuit, many aiders and abettors would escape liability since "the activities of an aider and abettor are rarely the direct cause of the injury brought about by the fraud, however much they may contribute to the success of the scheme."
Applying the standard defined by Judge Learned Hand in a 1938 case, U.S. v. Peoni, the appeals court concluded that “it is clear that the [c]omplaint plausibly alleges that Apuzzo provided substantial assistance to the primary violator in carrying out the fraud.
* The SEC may bring enforcement actions for aiding and abetting liability. The Supreme Court’s Central Bank decision precludes such actions by private plaintiffs.