Second Circuit Clarifies Standard for SEC Claims Against Aiders and Abettors

August 10, 2012 Advisory
On Wednesday, August 8, 2012, the U.S. Court of Appeals for the Second Circuit issued a significant victory for the U.S. Securities and Exchange Commission ("SEC") in SEC v. Apuzzo, Case No. 11-696-cv (2d Cir. Aug. 8, 2012). In that case, the Second Circuit ruled that the SEC can bring aiding and abetting claims against defendants without pleading or proving that the defendants proximately caused a securities law violation. This ruling, which in effect lowers the bar for claims against secondary actors, is likely to lead to more enforcement cases against executives and other individuals.

The Second Circuit's ruling reversed a 2010 decision by the U.S. District Court of Connecticut, which had dismissed the SEC's 2007 complaint against Joseph F. Apuzzo, the former CFO of Terex Corporation. According to the SEC's complaint, Apuzzo aided and abetted United Rentals, Inc. in artificially inflating United Rentals' profits. Specifically, the SEC alleged that Apuzzo aided and abetted United Rentals' fraudulent scheme by, among other things, signing sale-leaseback agreements and submitting false invoices that allowed United Rentals to prematurely recognize revenue on transactions.

In order for a defendant to be liable as an aider and abettor in a civil enforcement action, the SEC must prove, among other things, that the aider and abettor had knowledge of a primary violation and that the aider and abettor provided "substantial assistance" in the primary violation. According to the lower court, the SEC adequately alleged that Apuzzo had actual knowledge of the scheme, but failed to allege substantial assistance, holding that the test for substantial assistance required that the aider and abettor proximately cause the harm on which the primary violation was predicated. According to the lower court, the SEC failed to adequately plead that Apuzzo -- who did not structure the agreements or the scheme, was not responsible for United Rentals' accounting, and did not mislead United Rentals' auditors - proximately caused United Rentals' accounting violations.

On appeal, the Second Circuit rejected the lower court's interpretation of the substantial assistance test. Instead, drawing from a 1938 opinion by Judge Learned Hand, the Second Circuit held that the test for substantial assistance in an SEC enforcement action is that the aider and abettor "in some sort associate[d] himself with the venture, that he participate[d] in it as in something that he wishe[d] to bring about [and] that he [sought] by his action to make succeed." Applying this test, the Second Circuit found that the SEC had plausibly alleged that Apuzzo had provided substantial assistance, and reinstated the complaint.

In rejecting the lower court's decision, the Second Circuit clarified that proximate cause is not part of the test for aiding and abetting liability in SEC enforcement actions. According to the Second Circuit, the concept of proximate cause is only applicable to private litigation, as it "derives from the need of a private plaintiff, seeking compensation, to show that his injury was proximately caused by the defendants' actions." 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." This distinction, which the Second Circuit admitted has "not always been made...with clarity," has always presented a potential hurdle to straightforward enforcement actions against secondary actors where unambiguous proof of substantial assistance was lacking. With the lowering (or clarification) of the test for substantial assistance, the SEC may begin bringing enforcement actions that were previously viewed as difficult to win.