Source: https://www.wilmerhale.com/insights/publications/string-of-recent-circuit-court-opinions-impact-sec
Timestamp: 2019-04-22 04:02:33+00:00

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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.
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.”4The court reasoned that, absent allegations of proximate causation, the complaint failed to adequately plead the required substantial assistance element.
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.
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 plead and prove “knowing” substantial assistance to another, but instead may simply allege “recklessness.”9 The new legal standard should not reach a commercial counterparty engaged in a legitimate business transaction – we believe that an important factor in this case was the nature of the alleged misconduct of the defendant – but the case highlights that, as a matter of prudence and risk control, all transacting parties should take steps to enter into accurately documented and appropriate business relationships.
The potential exposure of outside parties like Apuzzo is particularly acute in the current political environment, where there continues to be unwavering pressure on the SEC to seek to hold individuals accountable. See, for example, Senator Reed’s recent comment: “A lot of people on the street, they’re wondering how a company can commit serious violations of securities laws and yet no individuals seem to be involved and no individual responsibility was assessed.”10 In this environment, and in light of recent opinions like Janus Capital Group that have made it potentially more difficult for the SEC to pursue individuals for violations of Rule 10b-5 of the Exchange Act,11 it is possible that the agency will more aggressively pursue aiding abetting claims like those in Apuzzo.
In an unpublished per curium opinion, the Eleventh Circuit disagreed, finding that the lower court did not abuse its discretion in considering the defendants’ salaries in setting disgorgement. The court explained that the SEC may seek disgorgement after producing a reasonable approximation of the defendant’s ill-gotten gain, and that the burden is on the defendant to show that the SEC’s estimate is not reasonable.17The court found that the defendants failed to meet that burden, and explained that it was not aware of any authority supporting the argument that a wrongdoer’s salary should not be subject to disgorgement if modest and/or reasonable. “The purpose of disgorgement is to deprive the wrongdoer of his ill-gotten gain . . . and there is no reason why salaries earned cannot be used to determine disgorgement. Here it is undisputed that the amount of disgorgement ordered by the district court was a reasonable approximation of the salaries received by Messrs. Wyer and Beasley from Merchant Capital.”18 The court reasoned that the defendants’ salaries were derived from fees earned in connection with the alleged misconduct, and therefore constituted ill-gotten gains appropriately subject to disgorgement.
This ruling represents a potentially worrisome expansion of the SEC’s authority to seek remedial relief. Traditionally, the disgorgement remedy has been used as a means of recovering profits derived from illegal activity, funds misappropriated from customers or employers, and other illicit windfalls realized in connection with the alleged misconduct. Although the appellate court noted a linkage between the defendants’ salaries and the underlying violations, the manner in which the Eleventh Circuit designated routine compensation as a viable source of disgorgement in this case potentially expands the SEC’s reach in seeking remedial relief from defendants.
This ruling, which the SEC likely would argue represents a substantial departure from precedent in at least three other circuits (First, Ninth, and Eleventh), is a blow to the SEC’s ability to seek remedial relief. In our view, it appropriately recognizes the punitive nature of two of the sanctions that are the lifeblood of the SEC Enforcement program – injunctions and officer and director bars – and puts reasonable limits on the SEC’s ability to pursue such relief years and years after the alleged misconduct occurred. It serves as an important reminder of the need to conduct and conclude investigations in a timely fashion, even in the wake of a number of changes implemented in recent years aimed at making the Enforcement process more efficient.27The ruling also is notable in that it could serve as a basis for future arguments that another form of remedial relief commonly imposed in enforcement cases – disgorgement – likewise should be subject to the limitations period in § 2462.
The defendant and his company were sued by the SEC for alleged violations of the Securities Act of 1933 (“Securities Act”) involving allegations of misconduct in the distribution of securities. The defendant and the SEC settled the matter before trial, on a neither admit nor deny basis. The defendant was criminally charged a year later. While the criminal charges were based on different facts, the charges included allegations that the defendants violated the same provisions of the Securities Act that the defendant was alleged to have violated in the previous SEC complaint. At trial, the district court allowed the prosecution to introduce the prior SEC complaint as evidence that the defendant knew his conduct was unlawful and that he was required to comply with the applicable securities laws.29 After the complaint was introduced into evidence, the prosecution also argued that it supported a showing of the defendant’s intent to commit the alleged violations.30 The jury found the defendant guilty and he was sentenced to thirty months in jail.
Although U.S. v. Bailey involved a criminal proceeding, the decision is an important one that could be relied upon by defendants litigating with the SEC or private plaintiffs to keep settled complaints filed by the agency in other litigation out of evidence. In our view, the Ninth Circuit arrived at the right conclusion. By definition, a complaint is a collection of unproven allegations, not findings of fact, drafted by the plaintiff to put the defendant in the most unfavorable light and to advance the complaining party’s position. Although there is some precedent for introducing into evidence SEC findings of fact for limited purposes,35 allowing SEC complaints into evidence would encourage exactly the type of negative inference the Ninth Circuit found to be impermissible, and would give a plaintiff an unfair and inappropriate advantage in litigation, particularly if a jury is the finder of fact. Moreover, because findings of fact or agreements to not dispute, contest, or contradict facts typically occur only in connection with certain types of SEC proceedings (e.g., administrative proceedings and proceedings resolved with non-prosecution or deferred prosecution agreements), the potential difference in treating those findings or statements of fact, on the one hand, and allegations in a federal court complaint, on the other hand, could be a factor in deciding which form of settlement might be preferred by a potential defendant in an SEC proceeding.
The decision also is noteworthy because it highlights the ongoing debate over the propriety of SEC settlements made on a “neither admit nor deny” basis.36 Here, as is typical in SEC settlements, the defendant settled the civil litigation without admitting or denying the factual allegations, as well as liability, so there were no findings of fact or admissions that could be introduced at the criminal trial. Instead, the prosecution attempted to rely on the SEC complaint as evidence of the defendant’s knowledge and intent, but was denied by the Ninth Circuit. As the debate over the appropriateness of neither admit nor deny settlements continues,37 this decision is likely to be cited by those who favor requiring admissions from settling defendants.
Each of the decisions is important and no doubt had an important impact in the particular matter in which they arose. Beyond these individual matters, however, these decisions reflect significant developments in the areas of the legal standards for seeking to charge, try, and sanction those who are alleged to have violated the federal securities laws.
1 Andy Weissman and Doug Davison are partners and Ben Brown is a counsel at Wilmer Cutler Pickering Hale and Dorr, LLP (“WilmerHale”) in Washington, DC. Questions about this article may be directed to any of the authors, whose contact information is available at www.wilmerhale.comor by calling 202/663-6000. This material is for general informational purposes only and does not represent legal advice of WilmerHale or any of the authors as to any particular set of facts; nor does it represent any undertaking to keep recipients advised of all relevant legal developments. The views expressed herein are not necessarily those of WilmerHale or any of WilmerHale’s clients.
2 SEC v. Apuzzo, No. 11-cv-696 (2d Cir. August 8, 2012).
4 SEC v. Apuzzo, 758 F. Supp. 2d 136, 152 (D. Conn. 2010).
5 Supra note 2 at 13.
7 Id . at 12.
8 Id . at 15-18.
9 15 USC § 78t(e) (“[A]ny person that knowingly or recklessly provides substantial assistance to another person in violation of a provision of this chapter, or of any rule or regulation issued under this chapter, shall be deemed to be in violation of such provision to the same extent as the person to whom such assistance is provided”.).
10 Corporate Fraud Cases Often Spare Individuals, NEW YORK TIMES (Aug. 7, 2012), available at http://www.nytimes.com/2012/08/08/business/more-fraud-settlements-for-companies-but-rarely-individuals.html.
11 See Douglas Davison et al., Lower Courts Interpret the Supreme Court’s Decision in Janus Capital Group, Inc. v. First Derivative Traders (Apr. 2, 2012), available at http://www.wilmerhale.com/publications/whPubsDetail.aspx?publication=10109.
12 U.S. Court Eases SEC Burden to Show Defendant Aided Fraud, CHICAGO TRIBUNE (Aug. 8, 2012), available at http://articles.chicagotribune.com/2012-08-08/news/sns-rt-sec-fraudrulingl2e8j85zt-20120808_1_sec-enforcement-sec-civil-case-appeals-court.
13 SEC v. Merchant Capital LLC, No. 11-cv-14908 (11th Cir. Aug. 7, 2012).
14 SEC v. Merchant Capital LLC, No. 02-cv-2984 (N.D. Ga. Apr. 25, 2011).
15 Supra note 13 at 6.
19 SEC v. Bartek, No. 11-cv-10594 (5th Cir. Aug. 7, 2012).
25 See, e.g., Merck & Co. v. Reynolds , 130 S. Ct. 1784 (2010); S.E.C. v. Koenig, 557 F.3d 736 (7th Cir. 2009); and S.E.C. v. Gabelli, 653 F.3d 49 (2d Cir. 2011).
26 Supra note 19 at 8-10.
27 Douglas Davison, Ben Brown, et al., SEC Director of Enforcement Outlines Significant Changes Signaling Tougher, More Efficient Enforcement Environment (Aug. 14, 2009), available at http://www.wilmerhale.com/publications/whPubsDetail.aspx?publication=9231.
28 U.S. v. Bailey, 09-cv-00327 (9th Cir. Aug. 27, 2012).
31 Federal Rule of Evidence § 404(a)(1).
32 Federal Rule of Evidence § 404(b)(2).
33 Supra note 28 at 9735.
35 See, e.g., Option Resource Group v. Chambers Dev. Co., Inc., 967 F. Supp. 846, 850 (W.D. Pa. 1996) (finding the SEC’s opinions, conclusions, and findings of fact contained in settlement materials admissible for summary judgment, but not addressing whether admissible at trial); SEC v. Pentagon Capital Mgmt. PLC, 2010 WL 985205 *2 (S.D.N.Y. Mar. 17, 2010) (allowing SEC findings of fact in administrative proceeding into evidence where defendant was seeking to use the findings as a “shield” in his defense); but see Carpenters Health & Welfare Fund v. The Coca-Cola Co., No. 00-CV-2838, Slip Op. (N.D. Ga. Apr. 23, 2008) (refusing to allow SEC finding of facts into evidence, reasoning that doing so would have a chilling effect on the settlement process); Lipsky v. Commonwealth United Corp., 551 F.2d 887, 893 (2d Cir. 1976) (refusing to admit a consent judgment and complaint in an SEC civil action, finding that they were not true adjudications of the underlying issues).
36 See, e.g., William McLucas, Douglas Davison, and Ben Brown, Public Interests and ‘Neither Admit Nor Deny’ Settlements, Law 360 (Mar. 29, 2012), available at http://www.law360.com/articles/321782/public-interests-and-neither-admit-nor-deny-settlements.
37 See, e.g., SEC Enforcement: Pitt, Academics Urge 2d Cir. to Affirm Rakoff Rejection, Corporate Counsel Weekly (Aug. 29, 1012) (reporting on amicus brief filed by legal scholars encouraging Second Circuit to affirm Judge Rakoff’s rejection of the settlement in SEC v. Citigroup Global Markets as contrary to public policy).

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