Leasing Fraud

The terms of the transactions called for URI to sell used construction and mining equipment to GECC, which then leased the equipment back to URI for short periods. To induce GECC's participation in the arrangement, URI persuaded Terex to agree to resell the equipment on behalf of GECC at the end of each lease period. At URI's behest, Apuzzo agreed that Terex would provide GECC with a “residual value guarantee” that on resale, GECC would receive no less than 96% of the purchase price it initially paid for the equipment. According to the commission, in exchange for this guarantee Apuzzo and Nolan agreed, without GECC's knowledge, that URI would indemnify Terex for any losses it incurred as a result of the residual value guarantee. URI made these indemnification payments in advance and disguised them as premiums on its purchase of new equipment from Terex.

Under Generally Accepted Accounting Principles (“GAAP”), URI was permitted to immediately recognize revenue generated from its sale of equipment to GECC provided that the transactions satisfied certain criteria, including that the “risks and rewards of ownership” had been fully transferred to GECC, and there were no “unsettled commitments” related to the sale. The commission alleged that because Apuzzo and Nolan secretly agreed that URI would indemnify Terex for any losses arising from the residual value guarantees, these conditions were not satisfied and URI was not permitted under GAAP to immediately recognize the revenue from the sales. The commission further alleged that Apuzzo was aware of this at the time of the transactions and, in order to facilitate the scheme, executed various agreements that disguised URI's continuing obligations, and approved invoices that artificially inflated the price of URI's equipment purchases from Terex in order to conceal URI's indemnification payments.

The District Court Decision

Apuzzo moved to dismiss the complaint, arguing that the SEC failed to adequately plead the elements of aiding and abetting securities fraud. To prevail on an aiding and abetting claim in the Second Circuit, the SEC must plead and prove “(1) the existence of a securities law violation by the primary (as opposed to the aiding and abetting) party; (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.” See SEC v. DiBella, 587 F.3d 553, 566 (2d Cir. 2009) (quoting Bloor v. Carro, Spanbock, Londin, Rodman & Fass, 754 F.2d 57, 62 (2d Cir. 1985)).

Apuzzo argued that the commission had failed to adequately plead either that he had knowledge of Nolan's fraud, or that he substantially assisted it. [Note, Nolan separately settled the SEC charges against him and, in a parallel criminal proceeding, pled guilty to one count of making false filings with the Securities and Exchange. U.S. Securities and Exchange Commission, Litigation Release No. 20396 (Dec. 12, 2007), available at www.sec.gov/litigation/litreleases/2007/lr20396.htm.]

The district court granted Apuzzo's motion and dismissed the complaint. Although the court found that the commission adequately alleged Appuzo's knowledge of the accounting scheme, it concluded that the commission did not adequately allege that Apuzzo “substantially assisted” the scheme. Quoting the Second Circuit's decision in Bloor (DiBella, 587 F.3d at 566 n. iv), the district court explained that “[i]n alleging the requisite 'substantial assistance' by the aider and abettor, the complaint must allege that the acts of the aider and abettor proximately caused the harm to the corporation on which the primary liability is predicated.” SEC v. Apuzzo, 758 F.Supp.2d 136, 150 (D. Conn. 2010).

According to the district court, the complaint did not meet this standard because it failed to allege, for example, that Apuzzo exercised any direct control over accounting decisions at URI, that he concealed information from URI's auditors, or that he directly furnished URI's auditors with the falsely inflated invoices. Apuzzo, 758 F.Supp.2d at 153. Consequently, relying on Bloor, the court determined that “Apuzzo's 'mere awareness and approval of the primary violation' does not establish that he proximately caused the harm to URI and thus substantially assisted the primary violation.” 758 F.Supp.2d at 153 (quoting SEC v. Power, 525 F.Supp.2d 415 (S.D.N.Y. 2007).

The Second Circuit Decision

The SEC appealed and the Second Circuit overturned the district court's decision. The only issue on appeal was whether the commission plausibly alleged that Apuzzo substantially assisted the fraud. The court held that it had, rejecting the “proximate cause” test advanced by Apuzzo and relied on by the court below. [Note, on appeal, Apuzzo did not challenge the district court's finding that the commission had adequately alleged Apuzzo's knowledge of the fraud.]

Writing for a three-judge panel, U.S. District Judge Jed Rakoff, sitting by designation, emphasized that the concept of “proximate cause” is a creature of private tort actions, as opposed to SEC enforcement actions, and derives from the need for a private plaintiff to prove that a defendant's conduct proximately caused damages in order to obtain compensation. See 2012 WL 3194303 at *6. In contrast, the government need not prove injury in a civil enforcement action because the chief purpose of such actions is deterrence.

The court distinguished the circumstances underlying Bloor, on which the district court relied, noting that although that case addressed allegations of aiding and abetting securities fraud, it involved a private plaintiff's claims for damages. Judge Rakoff also noted that the decision in Bloor preceded the Supreme Court's decision in Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164 (1994), which prohibited private claims for aider and abettor liability under federal securities laws.

Moreover, Bloor merely explained that the plaintiff in that case failed to properly plead that the primary securities law violation proximately caused any injury to the plaintiff; contrary to the district court's reading, it did not hold that a plaintiff is required to plead that the alleged aider and abettor proximately caused the harm resulting from the primary violation. According to the court, imposing such a requirement would undercut the purpose of ' 20(e), which was passed to allow the SEC to pursue aiders and abettors, because “the activities of an aider and abettor are rarely the direct cause of the injury brought about by the fraud[.]” 2012 WL 3194303 at *7.

Having rejected the district court's formulation of “substantial assistance” as unsuitable for civil enforcement actions, the court turned to the “well-developed law of aiding and abetting liability” in criminal cases for further guidance. See 2012 WL 3194303 at *6. Reaching back into the annals of Second Circuit precedent, the court landed squarely on the formula for aider and abettor liability articulated by Judge Learned Hand almost 75 years ago in United States v. Peoni, 100 F.2d 401 (2d Cir. 1938) and subsequently adopted by the Supreme Court in Nye & Nissen v. United States, 336 U.S. 613 (1949).

The Peoni court held that in order for a defendant to be liable as an aider and abettor the government must prove the occurrence of the primary violation and the defendant's knowledge of it, and that the defendant “in some sort associate[d] himself with the venture, that [the defendant] participate[d] in it as something that he wishe[d] to bring about, [and] that he [sought] by his action to make it succeed.” 100 F.2d at 402. Describing this formulation as “clear, concise, and workable,” the Apuzzo court adopted it as “the appropriate standard for determining the substantial assistance component of aider and abettor liability in an SEC civil enforcement action.” 2012 WL 3194303 at *6-*7.

Finally, the court held that under that standard, the complaint sufficiently alleged that Apuzzo substantially assisted the fraud. Specifically, Apuzzo agreed to participate in the sale-leaseback transactions; negotiated the terms of those transactions, through which Terex extracted certain agreements in exchange for its participation; approved and signed separate agreements with URI and GECC, which he understood were designed to hide URI's continuing risks and obligations under the transactions; and approved or knew about Terex's issuance of inflated invoices for URI's equipment purchases, which he knew were designed to further the scheme. The court also noted that the SEC's burden in alleging substantial assistance is lessened where, as in this case, it has alleged that the aider and abettor has a high degree of knowledge of the primary violation: “[A] high degree of knowledge may lessen the SEC's burden in proving substantial assistance, just as a high degree of assistance may lessen the SEC's burden in proving scienter.” Id. at *8.

Discussion

The Second Circuit's articulation of a new standard for pleading and proving “substantial assistance” is significant. For years, district courts within the Second Circuit have relied on the now-defunct “proximate cause” standard in aiding and abetting cases. See, e.g., SEC v. Boock, No. 09 Civ. 826, 2011 WL 3792819, *16 (S.D.N.Y. Aug. 25, 2011); SEC v. Espuelas, 698 F.Supp.2d 415, 433 (S.D.N.Y. 2010); SEC v. Treadway, 430 F.Supp.2d 293, 339 (S.D.N.Y. 2006); SEC v. Militano, 773 F.Supp. 589 (S.D.N.Y. 1991).

Apuzzo's relaxation of that standard likely will make it easier for the SEC to plead and prove aiding and abetting liability in securities fraud cases, and may result in the SEC bringing more aiding and abetting cases. This is particularly important because only the SEC may bring civil claims for aiding and abetting securities fraud; private litigants are prohibited from bringing such claims.

The impact of Apuzzo likely will be amplified by the fact that courts within the Second Circuit serve as the venue for the majority of securities fraud actions filed by the SEC. The high volume of securities fraud cases brought here necessarily generates a substantial body of related case law, to which courts outside of this circuit routinely look for guidance. Indeed, many courts have adopted the “proximate cause” standard in aiding and abetting cases, in some cases explicitly relying on Second Circuit precedent. See, e.g., SEC v. Benger, 697 F.Supp.2d 932, 942 (N.D. Ill. 2011); SEC v. Lucent Technologies, 363 F.Supp.2d 708 (D.N.J. 2005). Going forward, as the Apuzzo standard is applied by district courts within the Second Circuit, it is likely that the resulting precedent will be examined and widely adopted by courts elsewhere.

Ultimately, however, the Apuzzo decision represents a sensible outcome and provides a clear test for district courts to apply. As the court noted, “proximate cause” is a concept more germane to damages calculations in tort actions, and there is no basis for incorporating it into enforcement actions where the SEC is not obliged to allege or prove damages. Indeed, not requiring the commission to plead and prove proximate cause in aiding and abetting cases is consistent with the law surrounding the calculation of disgorgement in enforcement actions, where the SEC is not required to prove proximate cause. See SEC v. Seibald, No. 95 CV 2081, 1997 WL 605114 (S.D.N.Y. Sept. 30, 1997).

Conclusion

The Second Circuit's decision in Apuzzo should enhance the SEC's ability to bring aiding and abetting claims in securities fraud cases by relaxing the pleading and proof requirements. At the same time, however, even under the discarded “proximate cause” standard, district courts in this circuit (and other circuits) routinely denied motions to dismiss predicated on the theory that the commission failed to adequately allege proximate cause. Thus, while the potential impact of Apuzzo appears to be significant, particularly in this era of heightened SEC enforcement activity, and may lead to an increase in stand-alone aiding and abetting cases, its ultimate effect ' including whether the SEC will bring more cases, and whether more of those cases will survive motions to dismiss ' will only become apparent over time.

This article first appeared in the New York Law Journal, a sister publication of this newsletter.

Barbara L. Trencher is a partner at Morvillo, Abramowitz, Grand, Iason, Anello & Bohrer, P.C.. Niall O'Hegarty is an associate at the firm.

In its recent decision in SEC v. Apuzzo, No. 11-696-CV, 2012 WL 3194303 (2d Cir. Aug. 8, 2012), the U.S. Court of Appeals for the Second Circuit held that to prevail on a claim of aiding and abetting securities fraud under ' 20(e) of the Securities and Exchange Act of 1934, 15 U.S.C. ' 78t(e), the Securities and Exchange Commission (“SEC”) need not demonstrate that the defendant's conduct proximately caused the primary violation. The decision clarifies the “substantial assistance” requirement underlying ' 20(e) claims in a manner that significantly bolsters the SEC's ability to bring successful enforcement actions against those charged with playing a supporting role in securities law violations.

Background

In December 2007, the SEC filed a complaint in the U.S. District Court for the District of Connecticut against Joseph Apuzzo, the former chief financial officer of Terex Corporation, a construction and mining equipment manufacturer, alleging that Apuzzo aided and abetted securities laws violations through his role in a fraudulent accounting scheme. The commission's claims stemmed from a pair of fraudulent “sale-leaseback” transactions involving
Terex, United Rentals, Inc. (“URI”), a heavy equipment rental company and Terex customer, and General Electric Credit Corporation (“GECC”). Specifically, the commission alleged that Apuzzo knowingly assisted URI's CFO, Michael Nolan, structure the transactions so that URI could prematurely recognize revenue and thereby meet its earnings guidance.

The terms of the transactions called for URI to sell used construction and mining equipment to GECC, which then leased the equipment back to URI for short periods. To induce GECC's participation in the arrangement, URI persuaded Terex to agree to resell the equipment on behalf of GECC at the end of each lease period. At URI's behest, Apuzzo agreed that Terex would provide GECC with a “residual value guarantee” that on resale, GECC would receive no less than 96% of the purchase price it initially paid for the equipment. According to the commission, in exchange for this guarantee Apuzzo and Nolan agreed, without GECC's knowledge, that URI would indemnify Terex for any losses it incurred as a result of the residual value guarantee. URI made these indemnification payments in advance and disguised them as premiums on its purchase of new equipment from Terex.

Under Generally Accepted Accounting Principles (“GAAP”), URI was permitted to immediately recognize revenue generated from its sale of equipment to GECC provided that the transactions satisfied certain criteria, including that the “risks and rewards of ownership” had been fully transferred to GECC, and there were no “unsettled commitments” related to the sale. The commission alleged that because Apuzzo and Nolan secretly agreed that URI would indemnify Terex for any losses arising from the residual value guarantees, these conditions were not satisfied and URI was not permitted under GAAP to immediately recognize the revenue from the sales. The commission further alleged that Apuzzo was aware of this at the time of the transactions and, in order to facilitate the scheme, executed various agreements that disguised URI's continuing obligations, and approved invoices that artificially inflated the price of URI's equipment purchases from Terex in order to conceal URI's indemnification payments.

The District Court Decision

Apuzzo moved to dismiss the complaint, arguing that the SEC failed to adequately plead the elements of aiding and abetting securities fraud. To prevail on an aiding and abetting claim in the Second Circuit, the SEC must plead and prove “(1) the existence of a securities law violation by the primary (as opposed to the aiding and abetting) party; (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.” See SEC v. DiBella , 587 F.3d 553, 566 (2d Cir. 2009) (quoting Bloor v. Carro, Spanbock, Londin, Rodman & Fass , 754 F.2d 57, 62 (2d Cir. 1985)).

Apuzzo argued that the commission had failed to adequately plead either that he had knowledge of Nolan's fraud, or that he substantially assisted it. [Note, Nolan separately settled the SEC charges against him and, in a parallel criminal proceeding, pled guilty to one count of making false filings with the Securities and Exchange. U.S. Securities and Exchange Commission, Litigation Release No. 20396 (Dec. 12, 2007), available at www.sec.gov/litigation/litreleases/2007/lr20396.htm.]

The district court granted Apuzzo's motion and dismissed the complaint. Although the court found that the commission adequately alleged Appuzo's knowledge of the accounting scheme, it concluded that the commission did not adequately allege that Apuzzo “substantially assisted” the scheme. Quoting the Second Circuit's decision in Bloor ( DiBella , 587 F.3d at 566 n. iv), the district court explained that “[i]n alleging the requisite 'substantial assistance' by the aider and abettor, the complaint must allege that the acts of the aider and abettor proximately caused the harm to the corporation on which the primary liability is predicated.” SEC v. Apuzzo , 758 F.Supp.2d 136, 150 (D. Conn. 2010).

According to the district court, the complaint did not meet this standard because it failed to allege, for example, that Apuzzo exercised any direct control over accounting decisions at URI, that he concealed information from URI's auditors, or that he directly furnished URI's auditors with the falsely inflated invoices. Apuzzo, 758 F.Supp.2d at 153. Consequently, relying on Bloor , the court determined that “Apuzzo's 'mere awareness and approval of the primary violation' does not establish that he proximately caused the harm to URI and thus substantially assisted the primary violation.” 758 F.Supp.2d at 153 (quoting SEC v. Power , 525 F.Supp.2d 415 (S.D.N.Y. 2007).

The Second Circuit Decision

The SEC appealed and the Second Circuit overturned the district court's decision. The only issue on appeal was whether the commission plausibly alleged that Apuzzo substantially assisted the fraud. The court held that it had, rejecting the “proximate cause” test advanced by Apuzzo and relied on by the court below. [Note, on appeal, Apuzzo did not challenge the district court's finding that the commission had adequately alleged Apuzzo's knowledge of the fraud.]

Writing for a three-judge panel, U.S. District Judge Jed Rakoff, sitting by designation, emphasized that the concept of “proximate cause” is a creature of private tort actions, as opposed to SEC enforcement actions, and derives from the need for a private plaintiff to prove that a defendant's conduct proximately caused damages in order to obtain compensation. See 2012 WL 3194303 at *6. In contrast, the government need not prove injury in a civil enforcement action because the chief purpose of such actions is deterrence.

The court distinguished the circumstances underlying Bloor, on which the district court relied, noting that although that case addressed allegations of aiding and abetting securities fraud, it involved a private plaintiff's claims for damages. Judge Rakoff also noted that the decision in Bloor preceded the Supreme Court's decision in Central Bank of Denver v. First Interstate Bank of Denver , 511 U.S. 164 (1994), which prohibited private claims for aider and abettor liability under federal securities laws.

Moreover, Bloor merely explained that the plaintiff in that case failed to properly plead that the primary securities law violation proximately caused any injury to the plaintiff; contrary to the district court's reading, it did not hold that a plaintiff is required to plead that the alleged aider and abettor proximately caused the harm resulting from the primary violation. According to the court, imposing such a requirement would undercut the purpose of ' 20(e), which was passed to allow the SEC to pursue aiders and abettors, because “the activities of an aider and abettor are rarely the direct cause of the injury brought about by the fraud[.]” 2012 WL 3194303 at *7.

Having rejected the district court's formulation of “substantial assistance” as unsuitable for civil enforcement actions, the court turned to the “well-developed law of aiding and abetting liability” in criminal cases for further guidance. See 2012 WL 3194303 at *6. Reaching back into the annals of Second Circuit precedent, the court landed squarely on the formula for aider and abettor liability articulated by Judge Learned Hand almost 75 years ago in United States v. Peoni , 100 F.2d 401 (2d Cir. 1938) and subsequently adopted by the Supreme Court in Nye & Nissen v. United States , 336 U.S. 613 (1949).

The Peoni court held that in order for a defendant to be liable as an aider and abettor the government must prove the occurrence of the primary violation and the defendant's knowledge of it, and that the defendant “in some sort associate[d] himself with the venture, that [the defendant] participate[d] in it as something that he wishe[d] to bring about, [and] that he [sought] by his action to make it succeed.” 100 F.2d at 402. Describing this formulation as “clear, concise, and workable,” the Apuzzo court adopted it as “the appropriate standard for determining the substantial assistance component of aider and abettor liability in an SEC civil enforcement action.” 2012 WL 3194303 at *6-*7.

Finally, the court held that under that standard, the complaint sufficiently alleged that Apuzzo substantially assisted the fraud. Specifically, Apuzzo agreed to participate in the sale-leaseback transactions; negotiated the terms of those transactions, through which Terex extracted certain agreements in exchange for its participation; approved and signed separate agreements with URI and GECC, which he understood were designed to hide URI's continuing risks and obligations under the transactions; and approved or knew about Terex's issuance of inflated invoices for URI's equipment purchases, which he knew were designed to further the scheme. The court also noted that the SEC's burden in alleging substantial assistance is lessened where, as in this case, it has alleged that the aider and abettor has a high degree of knowledge of the primary violation: “[A] high degree of knowledge may lessen the SEC's burden in proving substantial assistance, just as a high degree of assistance may lessen the SEC's burden in proving scienter.” Id. at *8.

Discussion

The Second Circuit's articulation of a new standard for pleading and proving “substantial assistance” is significant. For years, district courts within the Second Circuit have relied on the now-defunct “proximate cause” standard in aiding and abetting cases. See, e.g., SEC v. Boock, No. 09 Civ. 826, 2011 WL 3792819, *16 (S.D.N.Y. Aug. 25, 2011); SEC v. Espuelas , 698 F.Supp.2d 415, 433 (S.D.N.Y. 2010); SEC v. Treadway , 430 F.Supp.2d 293, 339 (S.D.N.Y. 2006); SEC v. Militano , 773 F.Supp. 589 (S.D.N.Y. 1991).

Apuzzo's relaxation of that standard likely will make it easier for the SEC to plead and prove aiding and abetting liability in securities fraud cases, and may result in the SEC bringing more aiding and abetting cases. This is particularly important because only the SEC may bring civil claims for aiding and abetting securities fraud; private litigants are prohibited from bringing such claims.

The impact of Apuzzo likely will be amplified by the fact that courts within the Second Circuit serve as the venue for the majority of securities fraud actions filed by the SEC. The high volume of securities fraud cases brought here necessarily generates a substantial body of related case law, to which courts outside of this circuit routinely look for guidance. Indeed, many courts have adopted the “proximate cause” standard in aiding and abetting cases, in some cases explicitly relying on Second Circuit precedent. See, e.g., SEC v. Benger , 697 F.Supp.2d 932, 942 (N.D. Ill. 2011); SEC v. Lucent Technologies, 363 F.Supp.2d 708 (D.N.J. 2005). Going forward, as the Apuzzo standard is applied by district courts within the Second Circuit, it is likely that the resulting precedent will be examined and widely adopted by courts elsewhere.

Ultimately, however, the Apuzzo decision represents a sensible outcome and provides a clear test for district courts to apply. As the court noted, “proximate cause” is a concept more germane to damages calculations in tort actions, and there is no basis for incorporating it into enforcement actions where the SEC is not obliged to allege or prove damages. Indeed, not requiring the commission to plead and prove proximate cause in aiding and abetting cases is consistent with the law surrounding the calculation of disgorgement in enforcement actions, where the SEC is not required to prove proximate cause. See SEC v. Seibald, No. 95 CV 2081, 1997 WL 605114 (S.D.N.Y. Sept. 30, 1997).

Conclusion

The Second Circuit's decision in Apuzzo should enhance the SEC's ability to bring aiding and abetting claims in securities fraud cases by relaxing the pleading and proof requirements. At the same time, however, even under the discarded “proximate cause” standard, district courts in this circuit (and other circuits) routinely denied motions to dismiss predicated on the theory that the commission failed to adequately allege proximate cause. Thus, while the potential impact of Apuzzo appears to be significant, particularly in this era of heightened SEC enforcement activity, and may lead to an increase in stand-alone aiding and abetting cases, its ultimate effect ' including whether the SEC will bring more cases, and whether more of those cases will survive motions to dismiss ' will only become apparent over time.

This article first appeared in the New York Law Journal, a sister publication of this newsletter.

Barbara L. Trencher is a partner at Morvillo, Abramowitz, Grand, Iason, Anello & Bohrer, P.C.. Niall O'Hegarty is an associate at the firm.