Part IX: SEC Enforcement Trends And Priorities, 2009 — Key Legal Issues
Last year, there were important circuit court decisions regarding the scope of aiding and abetting liability in SEC enforcement actions and parallel SEC and DOJ investigations. Each decision is likely to have a significant impact on SEC enforcement in the future.
Following the Supreme Court’s decision in Central Bank of Denver v. First Interstate, 511 U.S. 164 (1994), Congress, in the Private Securities Litigation Reform Act of 1995, restored aiding and abetting liability in SEC enforcement actions. Congress did not extend aiding and abetting liability to private securities actions.
In SEC v. Papa, Case No. 08-1172 (1st Cir. Feb. 6, 2009), the court gave definition to the scope of liability for aiding and abetting in an SEC enforcement action. The complaint named six former employees of Putnam Fiduciary Trust Company. According to the SEC, the six executives engaged in a scheme to defraud Putnam client Cardinal Health, Inc. The misconduct centered on the cover-up of a one-day delay in investing certain assets of Cardinal in a defined benefit plan in 2001. The delay caused Cardinal to miss out on about $4 million of market gains. Following the error, the defendants chose not to inform Cardinal. Rather, they took steps to conceal the error by improperly shifting about $3 million of the costs to the shareholders of other Putnam mutual funds through backdated accounting entries and various accounting mechanisms. Cardinal bore about $1 million in losses.
The district court, on a motion to dismiss, concluded that three of the defendants were primarily violators, having directly participated in the scheme. Three others, however, only attended meetings about the cover-up and one year later executed what are effectively internal audit confirmations stating that all accounts were accurately stated. The district court concluded that this conduct was not sufficient to constitute aiding and abetting liability. Accordingly, the case was dismissed as to these three defendants.
On the SEC’s appeal, the court affirmed. The test of aiding and abetting liability is whether each defendant rendered substantial assistance in furtherance of the wrong committed. First, the execution of the audit letters did not render substantial assistance because the fraudulent scheme was already complete. Second, the SEC’s claim that the three defendants breached their fiduciary duty in executing the audit confirmations, because if they had been answered truthfully, the fraud would have been revealed which would have turned the scheme into a continuing and never ending one. The court rejected this notion of aiding and abetting.
Another key court ruling involved parallel proceedings. Frequently, SEC investigations are conducted at the same time as those by the Department of Justice and other regulators and self-regulatory organizations. Parallel proceedings offer certain efficiencies for both the government and a potential defendant. Their use has repeatedly been upheld by the courts. They do, however, present certain pitfalls.
U.S. v. Stringer, 521 F.3d 499 (9th Cir. 2008) is a key decision involving parallel SEC and DOJ investigations. The district court dismissed a criminal indictment based on misconduct by the U.S. Attorney’s Office and the SEC. The court concluded that the USAO and the SEC violated the constitutional rights of defendants by merging their investigation and concealing the criminal inquiry behind the SEC civil investigations which was used to collect evidence for the USAO. U.S. v. Stringer, 408 F. Supp. 2d. 1083 (D. Or. 2006).
The Ninth Circuit reversed. The court concluded that the government fully disclosed the possibility that information received in the course of the civil investigation could be used for criminal proceedings by furnishing witnesses SEC Standard Form 1662. The decision is predicated on the court’s determination that the SEC did not make any affirmative misrepresentations. Reliance on Form 1662 was argued by the SEC in an amicus brief. The decision in Stringer, as well as the ruling in Papa, are likely to have a significant impact on SEC enforcement actions in the future.