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S.E.C. Vows More Use of a Little-Used Tool
By PETER J. HENNING
May 27, 2014 12:43 pm
It is rare that the Securities and Exchange Commission announces a new approach to pursuing violations. Mary Jo White, the agency’s chairwoman, did just that last week when she pointed to a seldom-used provision of the federal securities laws that the S.E.C. will employ against people who use others to do their ...bidding.
In a speech at a white-collar crime conference sponsored by the New York City Bar Association, Ms. White said that “One new approach to charging individuals is to use Section 20(b) of the Exchange Act,” which she said can be “potentially a very powerful tool” for pursuing violations. Before discussing the provision, she kindly told her audience filled with defense lawyers that “before you start reaching for your smartphones to look it up, let me save you the trouble” by describing the provision for them.
Section 20(b) provides that “It shall be unlawful for any person, directly or indirectly, to do any act or thing which it would be unlawful for such person to do under the provisions of this chapter or any rule or regulation thereunder through or by means of any other person.” Under the criminal law, this is known as the “innocent instrumentality” doctrine, which allows someone to be held responsible for using another person to engage in illegal conduct if that person did not intend to commit a crime.
For example, if I ask you to go into a neighbor’s house to retrieve my laptop computer, when in fact I do not own it, then you have not committed a crime if you get it for me because you did not have the intent to steal it. But by using you to commit the crime, the law treats me as the perpetrator even though I did not physically engage in the illegal conduct.
The securities laws give the S.E.C. different ways to hold one person responsible for another’s violation, even when they did not directly engage in the misconduct. One part of Section 20 creates liability for a “control person,” which requires showing a high degree of authority over the actions of the actual perpetrator.
The S.E.C. had notified the hedge fund firm SAC Capital Advisors, now called Point72 Asset Management, that it considered suing the firm as a control person for the conduct of its various employees who were convicted of trading on inside information. That approach was later dropped in favor of a guilty plea for violating the securities laws.
Another means to charge those who help contribute to a violation is for aiding and abetting the perpetrator. The Supreme Court rejected accomplice liability for securities fraud in 1994 in Central Bank of Denver v. First Interstate Bank. But Congress restored it the next year for S.E.C. enforcement actions — but not private claims — by providing for liability for anyone who “knowingly or recklessly provides substantial assistance to another person” in a violation.
Unlike control person and accomplice theories of liability, however, Section 20(b) has been rarely used by the S.E.C. because there was no real need for it, at least until recently. But that may have changed with the Supreme Court’s decision in 2011 in Janus Capital Group v. First Derivative Traders.
In that case, the court said that only “the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it” could be held responsible for a violation. In explaining how this limitation works, the court pointed to the relationship between a speechwriter and a public speaker, so that “even when a speechwriter drafts a speech, the content is entirely within the control of the person who delivers it. And it is the speaker who takes credit — or blame — for what is ultimately said.”
The approach in the Janus case makes it more difficult to reach those who contribute to a violation but are neither a controlling person nor an accomplice, but instead acted only as the unseen hand — think Tywin Lannister in “Game of Thrones” — behind the fraudulent conduct. It is not entirely clear whether the Supreme Court’s analysis applies to S.E.C. enforcement actions or just private securities fraud cases, and the lower courts have split on that issue.
But Ms. White is not taking any chances by pointing to Section 20(b) as a new avenue to reach those who use others to engage in wrongdoing without committing the violation themselves. Section 20(b) avoids the obstacle thrown up by the Janus opinion and, as Ms. White pointed out, lets the S.E.C. “reach those who have participated in disseminating false or misleading information to investors through offering materials, stock promotional materials, or earnings call transcripts.”
This provision may even allow the S.E.C. to go beyond just misleading disclosures to pursue individuals in other types of cases. Controversy has swirled lately around the conduct of activist investors who take large positions in companies and possibly leak information about their intentions to entice others to make similar trades. DealBook reported that the S.E.C. is investigating trades in Herbalife after William A. Ackman’s hedge fund, Pershing Square Capital Management, took a large short position and criticized the company as an illegal pyramid scheme. Pershing Square is among those asked to supply information, along with firms founded by Carl C. Icahn and George Soros that bought shares after Mr. Ackman’s arguments against the company became public.
It is not considered insider trading for a private investor to disclose the intention to buy or sell a stock or the reasons for it, even if that information might significantly affect the market price. But there are disclosure obligations for those who own 5 percent or more of a company, and restrictions on trading intended to manipulate a company’s stock price.
Encouraging others to buy or sell could be the basis for a securities violation even if the actual traders do not violate the law on their own because they did not have the requisite intent. Section 20(b) could be the basis to pursue an enforcement action if one person encourages another to trade to avoid making a required disclosure because the transaction technically falls outside the reporting rules. Using others to do your bidding is exactly what this provision is intended to reach if the government can show intent to violate the law by the person who orchestrated the trading.
In her speech, Ms. White described the use of Section 20(b) as “What Is Old Is New.” Her discussion is a warning that the S.E.C. is planning to dust off an overlooked provision to pursue conduct that skirts the edge of the securities laws by those who use intermediaries to do their bidding. The defense bar will have to figure out how to deal with this new push.
Peter J. Henning, a professor at Wayne State University Law School, is a co-author of “Securities Crimes (2d edition).” Twitter: @peterjhenning
https://www.facebook.com/#!/creativeedgenutrition
S.E.C. Vows More Use of a Little-Used Tool
By PETER J. HENNING
May 27, 2014 12:43 pm
It is rare that the Securities and Exchange Commission announces a new approach to pursuing violations. Mary Jo White, the agency’s chairwoman, did just that last week when she pointed to a seldom-used provision of the federal securities laws that the S.E.C. will employ against people who use others to do their ...bidding.
In a speech at a white-collar crime conference sponsored by the New York City Bar Association, Ms. White said that “One new approach to charging individuals is to use Section 20(b) of the Exchange Act,” which she said can be “potentially a very powerful tool” for pursuing violations. Before discussing the provision, she kindly told her audience filled with defense lawyers that “before you start reaching for your smartphones to look it up, let me save you the trouble” by describing the provision for them.
Section 20(b) provides that “It shall be unlawful for any person, directly or indirectly, to do any act or thing which it would be unlawful for such person to do under the provisions of this chapter or any rule or regulation thereunder through or by means of any other person.” Under the criminal law, this is known as the “innocent instrumentality” doctrine, which allows someone to be held responsible for using another person to engage in illegal conduct if that person did not intend to commit a crime.
For example, if I ask you to go into a neighbor’s house to retrieve my laptop computer, when in fact I do not own it, then you have not committed a crime if you get it for me because you did not have the intent to steal it. But by using you to commit the crime, the law treats me as the perpetrator even though I did not physically engage in the illegal conduct.
The securities laws give the S.E.C. different ways to hold one person responsible for another’s violation, even when they did not directly engage in the misconduct. One part of Section 20 creates liability for a “control person,” which requires showing a high degree of authority over the actions of the actual perpetrator.
The S.E.C. had notified the hedge fund firm SAC Capital Advisors, now called Point72 Asset Management, that it considered suing the firm as a control person for the conduct of its various employees who were convicted of trading on inside information. That approach was later dropped in favor of a guilty plea for violating the securities laws.
Another means to charge those who help contribute to a violation is for aiding and abetting the perpetrator. The Supreme Court rejected accomplice liability for securities fraud in 1994 in Central Bank of Denver v. First Interstate Bank. But Congress restored it the next year for S.E.C. enforcement actions — but not private claims — by providing for liability for anyone who “knowingly or recklessly provides substantial assistance to another person” in a violation.
Unlike control person and accomplice theories of liability, however, Section 20(b) has been rarely used by the S.E.C. because there was no real need for it, at least until recently. But that may have changed with the Supreme Court’s decision in 2011 in Janus Capital Group v. First Derivative Traders.
In that case, the court said that only “the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it” could be held responsible for a violation. In explaining how this limitation works, the court pointed to the relationship between a speechwriter and a public speaker, so that “even when a speechwriter drafts a speech, the content is entirely within the control of the person who delivers it. And it is the speaker who takes credit — or blame — for what is ultimately said.”
The approach in the Janus case makes it more difficult to reach those who contribute to a violation but are neither a controlling person nor an accomplice, but instead acted only as the unseen hand — think Tywin Lannister in “Game of Thrones” — behind the fraudulent conduct. It is not entirely clear whether the Supreme Court’s analysis applies to S.E.C. enforcement actions or just private securities fraud cases, and the lower courts have split on that issue.
But Ms. White is not taking any chances by pointing to Section 20(b) as a new avenue to reach those who use others to engage in wrongdoing without committing the violation themselves. Section 20(b) avoids the obstacle thrown up by the Janus opinion and, as Ms. White pointed out, lets the S.E.C. “reach those who have participated in disseminating false or misleading information to investors through offering materials, stock promotional materials, or earnings call transcripts.”
This provision may even allow the S.E.C. to go beyond just misleading disclosures to pursue individuals in other types of cases. Controversy has swirled lately around the conduct of activist investors who take large positions in companies and possibly leak information about their intentions to entice others to make similar trades. DealBook reported that the S.E.C. is investigating trades in Herbalife after William A. Ackman’s hedge fund, Pershing Square Capital Management, took a large short position and criticized the company as an illegal pyramid scheme. Pershing Square is among those asked to supply information, along with firms founded by Carl C. Icahn and George Soros that bought shares after Mr. Ackman’s arguments against the company became public.
It is not considered insider trading for a private investor to disclose the intention to buy or sell a stock or the reasons for it, even if that information might significantly affect the market price. But there are disclosure obligations for those who own 5 percent or more of a company, and restrictions on trading intended to manipulate a company’s stock price.
Encouraging others to buy or sell could be the basis for a securities violation even if the actual traders do not violate the law on their own because they did not have the requisite intent. Section 20(b) could be the basis to pursue an enforcement action if one person encourages another to trade to avoid making a required disclosure because the transaction technically falls outside the reporting rules. Using others to do your bidding is exactly what this provision is intended to reach if the government can show intent to violate the law by the person who orchestrated the trading.
In her speech, Ms. White described the use of Section 20(b) as “What Is Old Is New.” Her discussion is a warning that the S.E.C. is planning to dust off an overlooked provision to pursue conduct that skirts the edge of the securities laws by those who use intermediaries to do their bidding. The defense bar will have to figure out how to deal with this new push.
Peter J. Henning, a professor at Wayne State University Law School, is a co-author of “Securities Crimes (2d edition).” Twitter: @peterjhenning
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