Securities law - Eighth Circuit rejects knowledge requirement in assessing civil liability for corporate executives who deceive auditors.

Author:Bagley, Ian
Position:Case note

Securities Law--Eighth Circuit Rejects Knowledge Requirement in Assessing Civil Liability for Corporate Executives Who Deceive Auditors--SEC v. Das, 723 F.3d 943 (8th Cir. 2013)

When the United States Congress passed the Foreign Corrupt Practices Act (FCPA) in 1977, its chief concern was deterring off-the-books bribes of foreign officials by domestic corporations. (1) The FCPA authorized the Securities and Exchange Commission (SEC) to issue new rules, including Rule 13b2-2, which imposes civil liability on corporate officers who mislead accountants concerning the corporation's finances. (2) In SEC v. Das, (3) the Eighth Circuit Court of Appeals addressed the issue of whether civil liability is present in cases where the corporate officer did not knowingly mislead. (4) Splitting from the Ninth Circuit--the only other circuit court that addressed this issue directly--the Eighth Circuit rejected the proposed "knowingly" requirement, holding that a reasonableness standard shall apply in such cases. (5)

Das concerned info USA, Inc., a publicly traded, Nebraska-based corporation that sold databases to businesses and consumers. (6) More specifically, the case concerned events involving three corporate officers: Vinod Gupta, who served as chief executive officer and chairman until 2008; Rajnish Das, chief financial officer from 2003 to 2006; and Stormy Dean, chief financial officer from 2000 to 2003 and then again from 2006 to 2008. (7) The SEC claimed, in a 2010 civil enforcement action, that Dean violated provisions of the Securities Exchange Act of 1934. (8) The agency claimed, among other things, that both former chief financial officers, Das and Dean, deceived auditors concerning payments info USA had made to Aspen Leasing Services LLC and Annapurna Corporation--two companies owned by Gupta--to pay for Gupta's homes, yacht, and cars. (9) The SEC's complaint further alleged that Dean and Das had signed the company's management letters to external auditors, falsely representing that all related-party transactions had been properly disclosed. (10) At trial, the judge instructed the jury to find that Dean violated the law if he did not act "reasonably" regarding the false statements made to auditors. (11)

After only a few hours of deliberation, a jury returned a verdict in favor of the SEC on each of the seven claims brought against Das and Dean. (12) In Dean's subsequent appeal, he argued that the trial court abused its discretion in instructing the jury to find that Dean violated Rule 13b2-2(a) if he did not act "reasonably." (13) Dean argued that civil liability for deceiving auditors required a finding that Dean acted "knowingly." (14) He relied upon SEC v. Todd, (15) a Ninth Circuit decision holding that "'one must 'knowingly' make false statements'" to be liable under the rule. (16) Rejecting the Ninth Circuit's reasoning, the Eighth Circuit Court of Appeals affirmed the trial court's jury instruction applying a reasonableness standard. (17)

In 1977, Congress contemplated enacting a statute to prohibit corporate officials from making false or misleading statements to accountants--but did not do so. (18) To avoid debating the legality of the proposed "knowingly" requirement in light of a recent decision of the United States Supreme Court, Congress deliberately omitted the prohibition against making false or misleading statements to an accountant from the FCPA. (19) Two years later, however, the SEC, acting under the authority of the FCPA and the Securities Exchange Act, promulgated a rule to prohibit making false or misleading statements to accountants. (20) The SEC considered imposing a scienter, or knowledge, requirement but decided to leave it out. (21) The accounting provisions of the FCPA, and the new rules promulgated thereunder, broadened the scope of the SEC's authority beyond its traditional role of merely monitoring disclosures into the realm of regulating a corporation's internal management. (22) In 1988, Congress again amended section 13 of the Securities Exchange Act, providing that criminal liability for violating the Act's accounting provisions would arise only where the defendant acted "knowingly." (23) The SEC amended Rule 13b2-2 in 2003, pursuant to the enactment of the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley), but the substance of the rule remained the same, codified as Rule 13b2-2(a). (24)

The two decades following the enactment of the FCPA saw little federal action to enforce its provisions, in part because the SEC's authority to seek civil money penalties did not emerge until the Securities Enforcement Remedies and Penny Stock Reform Act of 1990. (25) In recent years, however, enforcement has skyrocketed, in terms of both the number of actions and the amount of fines. (26) Since the adoption of Rule 13b2-2(a), courts have applied the rule in cases where the defendant's mental state was not an issue because the false or misleading statements were made in connection with fraud. (27) In more recent cases, where the defendant's mental state was at issue, a number of courts concluded that scienter was not required. (28) The SEC has not deviated from its position that scienter is unnecessary, noting the absence of such a requirement in its announcement of an update of Rule 13b2-2 following passage of Sarbanes-Oxley. (29) Courts have expressed uncertainty, however, as to what standard should apply, if not scienter. (30)

In SEC v. McNulty, (31) the Second Circuit Court of Appeals determined that scienter is not an element of civil claims that are based on violations of provisions under section 13(b) of the Securities Exchange Act, including Rule 13b2-2. (32) The McNulty court deferred to the SEC's reasonable interpretation, and it relied upon legislative history indicating Congress had an opportunity to insert a scienter requirement, but chose not to do so. (33) In McConville v. SEC, (34) the Seventh Circuit followed suit, also relying on the SEC's interpretation. (35) Neither court, however, explicitly and directly addressed the issue of whether these general axioms applied to Rule 13b2-2 specifically. (36) The Ninth Circuit was the first court of appeals to specifically tackle this issue in SEC v. Todd, where it distinguished between "knowing" and "intent to mislead," and held that "to be liable, one must 'knowingly' make false statements." (37)

In SEC v. Das, the Eighth Circuit rejected the Ninth Circuit's reasoning in Todd, instead concluding the SEC need not prove the defendants acted knowingly to impose civil liability. (38) The court cited McNulty and McConville's general proposition that section 13(b) does not require knowledge, and echoed the Second and Seventh Circuits in noting that SEC interpretations of its own regulations are entitled to deference. (39) The court also stated that a knowledge requirement would be inconsistent with the plain meaning of section 13(b), which specifically requires knowledge for criminal liability. (40) The court noted that the Todd interpretation relied upon United States v. Goyal, which, unlike Todd, correctly required knowledge in a criminal case by applying section 13(b)(5) of the Securities Exchange Act. (41)

The strange fact that it took more than three decades for this particular issue to reach a circuit court of appeals can be attributed to a lack of SEC enforcement of Rule 13b2-2 in the decades following its promulgation. (42) This may be due to some officials' reluctance to enforce provisions in cases where bribery of foreign governments--the original target of the FCPA--was not an issue. (43) Although the accounting provisions of the FCPA emerged in the context of a legislative focus on widespread corporate...

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