by T. GormanPosted on Posted in SECActions

The SEC frequently brings its enforcement actions years after the conduct occurred. In some instances this happens because the agency did not initiate its investigation until long after the events in question. In others it stems from the nature of the conduct involved can be very complex and difficult to unravel transactions. While these delays can have statute of limitations implications under Section 2462 of Tile 28 which applies a five year statute of limitations to obtaining a penalty, traditionally the Commission has successfully argued that at least its equitable remedies are not impacted. A recent ruling by the Fifth Circuit Court of Appeals holds otherwise however. SEC v. Bartek, No. 11-10594 (5th Cir. Decided Aug. 7, 2012).

Bartek is an option backdating case against Douglas Bartek and Nancy Richardson, respectively, the CEO and CFO of Microtune. The complaint, filed June 30, 2008, alleges that from 2000 to 2003 the defendants backdated millions of dollars worth of options for which the proper accounting charges were not taken. It alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(b)(5) and 14(a) and sought remedies which include an injunction and an officer and director bar.

The district court granted the defendants’ motion for summary judgment, concluding that the action was barred by the statute of limitations under Section 2462. In making this ruling the court concluded that the remedies sought by the SEC were penalties within the meaning of the statute. The district court rejected the Commission’s cross motion for summary judgment.

The Fifth Circuit affirmed, concluding that the Commission’s action and the remedies it sought were time barred by the statute of limitations. The SEC argued that it did not have notice of the backdating practices until its 2003 investigation of the revenue recognition practices of Microtune. Since the cause of action was not discovered until then, the action is not time barred, according to the agency. Defendants disputed this point claiming that the Commission should have known of its practices when the company conducted its 2000 IPO and the agency reviewed its registration statement.

The Court rejected the Commission’s contention that the statute of limitations in Section 2462 does not commence until the cause of action is discovered rather than when it occurs. Examining the text of the statute, the Court held that “A plain reading of §2462 reveals no discovery rule exception. Congress specified the exceptions it wanted to adopt by stating at the beginning of the statute: ‘Except as otherwise provided by Act of Congress . . . “ Since it failed to incorporate a discovery exception into the statute, there is none. SEC v. Gabelli, 653 F. 3d 49 (2nd Cir. 2011), cited by the Commission, is not to the contrary. There the court found that the discovery rule does not govern the accrual of most claims because they do not involve conduct that is inherently self-concealing as in that case. Here there is no such conduct.

Finally, the Court rejected the SEC’s claim that the permanent injunctions and the officer director bars sought here are equitable remedies and not penalties barred by Section 2462. The test for what constitutes a penalty is an objective one. In this context the D.C. Circuit, in a case cited by the SEC in the district court but rejected by the agency on appeal, held that a “’penalty,’ as the term is used in §2462, is a form of punishment imposed by the government for unlawful or proscribed conduct, which goes beyond remedying the damage caused to the harmed parties by the defendant’s actions,’” quoting Johnson v. SEC, 87 F. 3d 484, 487 (D.C. Cir. 1996).

Here, determining whether the injunctions sought are a penalty or are remedial requires an examination of their nature or characteristics. In this case the injunctions would have a “stigmatizing effect and long-lasting repercussions.” Other courts have held that excluding a person from their profession is a penalty. Neither remedy addresses the past harm alleged here. Accordingly, the lifetime bans sought here are penalties and time barred. The district court’s grant of summary judgment in favor of the defendants was affirmed.

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by T. GormanPosted on Posted in SECActions

The opinions written by Judge Rakoff have not always been favorable to the SEC. In recent years he has accused the agency of conducting a sham investigation before finally, and reluctantly, approving the revised proposed settlement in its market crisis case with Bank of America. Later he rejected the Commission’s settlement in another market crisis case with Citigroup in an order which is now on appeal and pending before the Second Circuit Court of Appeals.

The Judge is not always on the opposite side of the SEC however. To the contrary, in SEC v. Apuzzo, Docket No. 11-696-cv (2nd Cir. Decided Aug. 8, 2012) Judge Rakoff, sitting by designation, penned a unanimous opinion rejecting a district court decision which, if upheld, would have imposed additional proof requirements on the SEC to establish aiding and abetting under Exchange Act Section 20(e).

Joseph Apuzzo was the Chief Financial Officer of Terex Corporation, according to the Commission’s complaint. In December of 2000, and again the following year, Terex entered into two fraudulent sale-leaseback transactions with United Rentals, Inc. or URI. Briefly stated, the transactions were designed to allow URI to prematurely recognize revenue and inflate the profit generated from the sales. The Court summarized the key allegations from the Commission’s complaint as alleging that “Apuzzo 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. Specifically, Apuzzo agreed to participate in the . . . transactions; negotiated the details of those transactions, through which he extracted certain agreements from URI in exchange for Terex’s participation; approved and signed separate agreements with GECC [General Electric Credit Corp.] and URI, which he knew were designed to hide URI’s continuing risk and financial obligations . . . in furtherance of the fraud; and approved or knew about the issuance of Terex’s inflated invoices, which he also knew were designed to further the fraud.”

The district court granted Mr. Apuzzo’s motion to dismiss the complaint. That court rejected his claim that the Commission’s complaint failed to adequately plead the knowledge component of an aiding and abetting claim. It found, howeve,r that the SEC failed to adequately allege “substantial assistance” which requires “that the aider and abettor proximately cause the harm on which the primary violation was predicated . . . “ The complaint was dismissed with prejudice, although the Commission had requested leave to replead.

The Second Circuit reversed, finding that the complaint “plausibly alleged that Apuzzo aided and abetted the primary violation . . . “ Under Section 20(e) of the Exchange Act the Commission is authorized to bring an action for aiding and abetting if three elements are plausibly pleaded: 1) the existence of a securities law violation by a primary violator; 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, Here, the first element is conceded as is the second which is not impacted by Section 929 of the Dodd-Frank Act (adding the concept of reckless conduct to the knowledge component). The sole question before the Court was “substantial assistance.”

Quoting Judge Learned Hand in U.S. v. Peoni, 100 F. 2d 401, 402 (2nd Cir. 1938), the Court defined substantial assistance as meaning that “he in some sort associate[d] himself with the venture, that [the defendant] participate[d] in it as in something that he wishe[d] to bring about, [and] that he [sought] by his action to make succeed.” This formulation was later adopted by the Supreme Court in Nye & Nessen v. U.S., 336 U.S. 613, 619 (1949).

Despite Judge Hand’s classic formulation of the element, Mr. Apuzzo contended that substantial assistance requires that proximate cause be pleaded. This argument fails to distinguish between a private suit and an SEC enforcement action, Judge Rakoff wrote. Proximate cause is a tort concept which ties to the requirement to link the injury to the damages. Stated differently, it is loss causation as discussed in Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 341-342 (2005). There is no such requirement in an SEC enforcement action. In reaching this conclusion, the Court noted that in the past its opinions had not always been clear on the point.

In this case the SEC’s complaint meets the test, the Court held. It specifically pleads more than a simple routine transaction. Rather, the complaint specifies that the transactions were “designed” to hide the fraud and that Mr. Apuzzo “knew” that the transactions were crafted to inflate revenue. Where, as here, the SEC plausibly alleges a high degree of actual knowledge, it lessens the burden in alleging substantial assistance. Conversely, a high degree of substantial assistance may lessen the burden in proving scienter.

Finally, while the SEC need not allege and prove proximate cause, it may elect to do so as a way to establish substantial assistance. As the Court stated: “One who proximately causes a primary violation with actual knowledge of the primary violation will inherently meet the test we have set forth above.” Accordingly, the order of the district court dismissing the complaint with prejudice was reversed.

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