The First Circuit Defines The Scope of Aiding And Abetting
The First Circuit Court of Appeals gave definition to aiding and abetting liability in an SEC enforcement action, requiring that the agency prove what specific acts each defendant performed which rendered substantial assistance to the primary fraud. In making its ruling, the Court rejected the SEC’s claim that aiding and abetting liability could be predicated on conduct that happened after the fraud was completed, even though that conduct arguably constituted a subsequent breach of fiduciary duty. SEC v. Papa, Case No 08-1172 (1st Cir. Decided Feb. 6, 2009).
The Commission’s complaint names as defendants 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, in a decision discussed here, dismissed the complaint as to Virginia Papa, then Director of Defined Contribution Plan Servicing, Kevin Crain, former head of the plan administration unit and Sandra Childs, previously responsible for overall compliance. The court concluded that the SEC failed to plead facts demonstrating that these three defendants were either primary violators or engaged in aiding and abetting because they did little more than attend meetings where the scheme was discussed. At the same time, the court declined to dismiss the claims as to defendants Karnig Durgarian, then Chief of Operations, Donald McCracken, former Head of Global Operations, and Ronald Hogan, then vice president in the new business implementation unit. The court found that the SEC alleged facts which, if established, demonstrated that these three defendants implemented the scheme.
In its appeal, the SEC abandoned its claim that Ms. Papa, Mr. Crain and Ms. Childs were primary violators. Rather, the SEC argued that each aided and abetted the scheme by executing internal audit letters in 2002 and 2003 which they knew were incorrect because of the backdated trades and accounting adjustments used to conceal the error. According to the SEC, the three defendants agreed to the overall scheme and, by executing these letters, breached their fiduciary duty to disclose it.
The Court rejected the SEC’s arguments. The test of aiding and abetting is whether the defendants rendered substantial assistance to the wrong committed. First, the court concluded that the execution of the audit letters did not render substantial assistance to the fraud. Rather, the letters were executed long after the fraud was committed. This is not aiding and abetting because “one can not aid and abet a fraudulent scheme that is already complete … .” If subsequent events such as the ones here were deemed part of the scheme it would never end – the scheme would be a continuing offense. The court rejected this theory.
The court also rejected the SEC’s breach of fiduciary duty argument. Under this theory, the SEC claimed that Putnam had an on-going duty to disclose accurate answers to the audit letters which would have revealed the fraud and that the failure to do so constituted a breach of duty and Section 10(b) fraud. This, the court concluded “would extend the supposed wrong indefinitely and until its disclosure – not just as a common law breach of duty, but as a federal securities violation. Then, through the aiding and abetting device, the SEC’s approach would create new liability under Section 10(b), long after the original transactions … . And it would do so based solely on general denials of knowledge of wrongdoing.” While the denials of knowledge by the defendants a year or more later may be wrongful, that conduct is not aiding and abetting an ongoing securities fraud “merely by dint of some other fiduciary to disclose its errors or wrongs,” the Court concluded.