Second Circuit Clarifies the Pleading Standard for “Substantial Assistance” in SEC Enforcement Cases Against Aiders and Abettors

In SEC v. Apuzzo, the Second Circuit Court of Appeals recently lowered the pleading standard for aiding and abetting of securities fraud in SEC enforcement actions by reversing the District Court’s finding that proximate causation of the ultimate harm was required to establish substantial assistance.

When evaluating aiding and abetting claims, courts previously extended the proximate cause requirement that applies in litigation between private parties to SEC enforcement proceedings. The SEC’s complaint in Apuzzo outlined the details of a complex, but calculated, fraud scheme. The defendant-appellee, Joseph Apuzzo, was the CFO of an equipment manufacturer — Terex Corporation. The SEC claimed that Apuzzo aided and abetted primary federal securities law violations which stemmed from a fraudulent accounting scheme involving Terex and an equipment rental company with which Terex did business — URI Rentals, Inc. (“URI”). In its Complaint, the SEC alleged that Apuzzo assisted Terex and URI with executing bogus sale-leaseback transactions through which URI prematurely recognized revenue and inflated profits from its sales, participated in discussions and negotiations and had control over the final terms of the agreements at issue.

While the District Court acknowledged that the SEC’s allegations established that Apuzzo knowingly participated in the fraudulent transactions, the Court found this “mere awareness and approval” to be insufficient to demonstrate that Apuzzo proximately caused harm to URI. The Second Circuit, however, found that this awareness and approval fit squarely within the scope of conduct that aiding and abetting claims are designed to capture. Consequently, the Second Circuit held that to satisfy the “substantial assistance” prong of an aiding and abetting claim, the SEC need only allege that the defendant in some way associated himself with a fraudulent scheme and knowingly participated in that scheme. Thus, the Court completely removed the proximate cause requirement from SEC enforcement cases against aiders and abettors, finding that it served to frustrate — rather than further — the SEC’s enforcement mandate.

As a policy matter, it is in the SEC’s best interests for courts to apply a lower pleading bar for aiding and abetting liability. Now that the Second Circuit has clarified the standard for substantial assistance, and adopted a more flexible formula, this lower burden of proof may pave the way for more enforcement cases against aiders and abettors in the future. It remains to be seen whether under this new standard, secondary actors who knowingly, but marginally, participate in a fraud will be the target of enforcement actions. Since the Second Circuit’s decision, Apuzzo has filed a petition for rehearing en banc.

A more comprehensive analysis of the subject is available in an article previously published in Securities Law 360.

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