By: James W. Kraus
September 2, 2012
On August 8, 2012, a panel of the U.S. Court of Appeals for the Second Circuit reversed the District Court’s dismissal of an SEC claim against former Terex CFO, Joseph Apuzzo, wherein the SEC had alleged that Mr. Apuzzo aided and abetted securities law violations to his role in a fraudulent accounting scheme.
Apuzzo’s employer, Terex Corporation, manufactures equipment for use in the construction, infrastructure and service to mining industries. United Rentals, Inc. is one of the largest equipment rental companies in the world. Michael J. Nolan was United Rentals’ Chief Financial Officer from 1997 until December of 2002. According to the SEC, United Rentals and Nolan, with Apuzzo’s assistance, carried out two fraudulent “sale – lease back”transactions. These transactions were designed to allow United Rentals to recognize revenue prematurely and to inflate the profit generated from United Rentals’ sales. Here’s how it worked:
URI sought to immediately recognize the revenue generated by the sale of equipment to General Electric Credit. However, under Generally Accepted Accounting Principles (GAAP) it could only do so if it met certain criteria, including (1) that the “risks and rewards of ownership” had been fully transferred to General Electric Credit and (2) that the sale price was “fixed and determinable,” or, in other words, that there were no unsettled commitments related to the sale. The problem was that United Rentals had secretly agreed to indemnify Terex for any losses that Terex would incur, and that in doing so, it had not fully transferred the risks and rewards of ownership and there were unsettled commitments associated with the sale. Therefore, recording it as revenue was not permitted under GAAP, and Apuzzo knew that if the full extent of three party transactions was transparent, United Rentals would not be able to claim the increased revenue. Apuzzo, therefore, executed various agreements that disguised United Rentals’continuing risks and financial obligations, and he also approved inflated invoices from Terex that were designed to conceal United Rentals Indemnification Payments to Terex.
The SEC asserted that in order for a defendant (Apuzzo) to be liable as an aider and abettor in a civil enforcement action, the SEC must 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 achievement of the primary violation,” citing SEC v. Debella, 587 F.3d 553, 566 (2nd Cir. 2009) (quoting Bloor v. Carro, Spanbock, Londin, Rodman & Fass, 754 F.2d 57, 62 (2nd Cir. 1985)).
Although the District Court found that the complaint filed by the SEC plausibly alleged that Apuzzo had actual knowledge of the primary violation, it concluded that the complaint did not adequately allege“substantial assistance,” and dismissed the SEC’s complaint. Specifically, the District Court held that the “substantial assistance” component required that the aider and abettor proximally cause the harm on which the primary violation was predicated, and that the Complaint did not plausibly allege such proximate causation. The Second Circuit, however, reversed holding that to satisfy the “substantial assistance” component of aiding and abetting, the SEC must show that the defendant “in some sort associate[d] himself with the venture, and that he participate[d] in it as in something that he wish[ed] to bring about [and] that he [sought] by his action to make it succeed,” citing United States v. Peoni, 100 F.2d 401, 402 (2nd Cir. 1938). The Court rejected Apuzzo’s argument that substantial assistance should be defined as proximate cause, noting that such an argument ignored the difference between an SEC enforcement action and a private suit for damages.
The Court further indicated that “proximate cause” is the language of private tort actions, but that in an enforcement action, civil or criminal, there is no requirement that the government prove injury, because the purpose of such actions is deterrence, not compensation. The Court went on to affirmatively clarify that, in enforcement actions brought under 15 U.S.C. §78(t)(e), the SEC is not required to plead or prove that an aider and abettor proximally caused the primary securities law violation.
Applying this test, the Second Circuit found that the complaint by the SEC plausibly alleged that Apuzzo provided substantial assistance to the primary violator in carrying out the fraud and, therefore, the judgment of the district court was reversed. The Court explained that Apuzzo associated himself with the venture, participated in it as something that he wished to bring about, and sought by his action to make it succeed. It noted specifically that Apuzzo agreed to participate in the transactions; negotiated the details of those transactions, through which he extracted certain agreements from United Rentals in exchange for Terex’s participation; approved and signed separate agreements with General Electric Credit and United Rentals, which he knew were designed to hide United Rentals’ continuing risks and financial obligations relating to the sale-lease back transactions in furtherance of the fraud; and approved or knew about the issuance of Terex’s inflated invoices, which he knew were designed to further the fraud.