Ruling Increases SEC Authority to Prosecute Directors and Officers

A new ruling by the 2nd U.S. Court of Appeals should make it easier for the Securities and Exchange Commission (SEC) to charge senior executives with aiding and abetting, according to a former senior SEC enforcement official. The Aug. 8, 2011 decision reversed a Connecticut federal court ruling that disallowed evidence of aiding and abetting in an accounting fraud case. The appeals court ruled that the lower court set the standard of evidence too high.

The case alleges that in 2001 directors and officers of two companies with a standing business relationship executed a "sale-leaseback" scheme. One company manufactured heavy equipment. The other, its customer, was a rental company. This alleged scheme artificially increased profits, and brought the client early revenue. The charges came in 2007, and the client company officer admitted to a criminal count of making a false SEC filing, and entered a guilty plea. The directors and officers of both companies settled associated civil SEC cases, paying a total of $22 million but admitting no guilt.

However, the lower court ruled that the SEC had to show that the actions of the manufacturing company officer constituted a "proximate cause" of damage resulting from the alleged fraud. That would have required proving a more active rather than a passive role for that officer in the scrutinized transactions. The appeals court considered this standard too high, asserting that aiding and abetting by its nature is very often not a proximate cause of damages. The more restrictive standard, the court ruled, might make it impossible to convict anyone of aiding and abetting.

Attorneys for the defendant are considering how to proceed from here, as they expect this ruling to affect the whole legal landscape. Since courts under the 2nd Circuit, because of its jurisdiction, hears most SEC enforcement cases, this is expected to affect how other circuit courts rule in the future as well.

Source: Reuters, "U.S. court eases SEC burden to show defendant aided fraud," Jonathan Stempel, August 8, 2012

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