Opinion for the Court filed by Circuit Judge RANDOLPH.
Opinion concurring in the judgment filed by Circuit Judge HENDERSON.
RANDOLPH, Circuit Judge:
Nicholas P. Howard petitions for review of a Securities and Exchange Commission order imposing sanctions on him for aiding and abetting alleged securities laws violations committed in the course of closing two private placement offerings of common stock in 1991 and 1992. The SEC's opinion holding Howard liable is confused and confusing. The SEC first held that "awareness of wrongdoing" is a necessary element of aiding and abetting, but it marshaled no evidence to show that Howard had any such awareness. The SEC then stated — inconsistently — that alleged aiders and abettors who act "recklessly" may be liable, but it never explained what it thought "recklessly" meant in this context; it disregarded evidence tending to show that Howard did not act recklessly as this court has defined the term; and it wound up applying a "should have known" negligence standard that we have rejected. Under a correct scienter standard the evidence is insufficient to sustain most of the charges against Howard. The record is unclear with respect to two others, which we remand to the SEC for reconsideration.
In the early 1990's Howard served as a senior vice president of James Capel, Inc. ("JCI"), a registered broker-dealer based in New York. JCI was a subsidiary of James Capel & Company, Ltd., a securities brokerage firm in London, which together with another affiliate, made up the Capel Group. Howard's job was to market European equity securities to American and Canadian institutional investors. In 1990, his customers became interested in investment opportunities created by the fall of communism in Eastern Europe.
The initial offering of 5,000,000 shares of common stock occurred in late 1990 and early 1991. JCI was the exclusive marketer of New Europe Hotels stock in the United States; its affiliates were the underwriters overseas. The law firm of Rogers & Wells prepared the offering documents for use in this country. Rogers & Wells began drafting the documents in the fall of 1990. Howard was not involved in the drafting process although he was apprised of developments. Matcovsky and the corporate finance department served as the liaison between JCI and Rogers & Wells.
The final placement documents — which Howard skimmed through but did not read closely — offered the stock on a "best efforts, part or none" basis. Under SEC Rule 10b-9, 17 C.F.R. § 240.10b-9, a part-or-none offering requires prompt refunds to investors if the minimum number of shares set forth in the offering is not sold, or full payment is not received, by the date specified. The first offering made closing contingent on the sale of at least 2,000,000 shares at 20 Deutsche Marks per share by January 2, 1991.
JCI began marketing the United States placement in late 1990. Howard headed the marketing effort here, telephoning potential investors and arranging road shows. Sales were not up to expectations. With concern growing that the minimum might not be met by the deadline, three transactions were undertaken, each of which eventually led to an alleged violation of the securities laws.
On December 20, 1990, the Capel Group — at the behest of its co-chairmen — obtained for itself enough shares to close the offering. It did this by taking 100,000 shares in lieu of the fee it would have received for serving as the worldwide selling agent and by purchasing an additional 55,650 shares. Howard told the subscribers in this country, and potential investors, that the Capel Group had purchased these shares, viewing this as a "marketing plus." In making this representation, he did not say whether the shares would count toward the subscription minimum. Howard did not believe there were any legal problems with the Capel Group's purchases because he understood that Matcovsky had cleared the transactions with Rogers & Wells. Howard was on vacation during the week of the closing and played no role in determining which shares would be counted toward the minimum.
The next questioned transaction was a purchase by JCI. During the offering period Howard received an indication of interest for 30,000 New Europe Hotels shares from Julius Baer Securities on behalf of the European Warrant Fund, a closed-end investment company that Howard participated in creating. Baer served as the fund's investment adviser, and JCI served as a "subadviser." Howard was aware of these relationships. In the days before the closing, Howard was unable to reach Baer for confirmation. Howard checked with his supervisor, JCI's president Mark Green, who told him that JCI should itself purchase the stock. Before
The third transaction involved the real estate developer, IDG Development Corporation. As disclosed in offering documents, IDG was to receive 75,000 shares free of charge as "founders shares" and had agreed to purchase another 75,000 shares on its own. The offer of free shares was rescinded after another investor objected. Unhappy with losing the free shares, IDG asked if New Europe Hotels would advance IDG's managerial fees to ease a cash flow burden. Although a director of New Europe Hotels, Howard was on vacation at the time and did not participate in these discussions. In his absence, New Europe Hotels' board of directors approved a plan whereby the company would deposit an amount equal to IDG's fees in a bank that in turn would use the deposit as collateral for a loan to IDG. Matcovsky, who was also a director and participated in the meetings, called Howard, told him of the board's resolution, and represented that Rogers & Wells had been consulted and approved the transaction. Only then did Howard vote in favor of the plan. New Europe Hotels thus assisted IDG in obtaining two loans, which IDG used to buy the shares it was originally supposed to receive free of charge. These shares were counted toward the minimum.
Although the closing took place on January 2, 1991, it was not until several weeks later that full payment was made for up to a third of the shares, including those sold to IDG Development Corporation. In part this was due to conflicting instructions about where to wire payment. Howard learned of these problems when he returned from vacation on January 4 and assisted JCI's efforts to account for and collect the missing funds.
JCI initiated a second private placement offering of NEH securities in October and November 1991. As with the first offering, the corporate finance department coordinated the drafting of documents by Rogers & Wells. Howard relied on its work product and believed the offering materials contained all the necessary disclosures. The second offering closed on November 27, 1991.
The SEC charged Howard with willfully aiding and abetting and causing the securities violations committed by JCI and New Europe Hotels. In the SEC's view, the minimum subscription of 2,000,000 shares in the part-or-none offering was reached by improperly counting (1) shares the Capel Group purchased for itself, (2) shares JCI purchased for an aftermarket sale to the European Warrant Fund, and (3) shares IDG purchased with bank loans using as collateral the fees New Europe Hotels advanced. These transactions were not, according to the SEC, "bona fide" under Rule 10b-9.
After an evidentiary hearing an Administrative Law Judge found that Howard had aided and abetted and caused these violations. The SEC agreed and suspended Howard from associating with any broker or dealer for three months, ordered him to cease and desist from committing any future violations, and assessed a civil penalty of $50,000.
Of the three sanctions imposed on Howard, one — the cease and desist order — stands apart. The SEC's authority to issue such orders against secondary actors rests on § 21C(a) of the Securities Exchange Act, 15 U.S.C. § 78u-3(a). This section states that if the SEC finds that any person has violated the Act or any rule or regulation thereunder, it may issue a cease and desist order against "any other person that ... was ... a cause of the violation, due to an act or omission the person knew or should have known would contribute to such violation...." Although we held in KPMG, LLP v. SEC, 289 F.3d 109, 120 (D.C.Cir.2002), that the "knew or should have known" language in § 21C embodied a negligence standard for purposes of that case, it does not necessarily follow that negligence is the standard here. The SEC's opinion in KPMG, which we sustained, held that "negligence is sufficient to establish `causing' liability under Exchange Act Section 21C(a), at least in cases in which a person is alleged to `cause' a primary violation that does not require scienter." In re KPMG Peat Marwick LLP, Exchange Act, Release No. 43862, 2001 WL 47245 *19 (Jan. 19, 2001).
The SEC's authority to impose the other two sanctions — suspending Howard for three months and ordering him to pay a penalty of $50,000 — rested on Exchange Act provisions other than § 21C. Under § 15(b)(6) and § 15(b)(4) the SEC may suspend for up to twelve months any person associated with a broker or dealer who "has willfully aided, [and] abetted" any violation of the securities laws. 15 U.S.C. §§ 78o(b)(6)(A), 78o(b)(4)(E). Under § 21B, the SEC may impose money penalties against persons who have "willfully aided, [and] abetted" another's violation of the securities laws. 15 U.S.C. § 78u-2(a)(2).
How does one decide whether a person willfully aided and abetted a securities violation? The "rules for determining aiding and abetting [securities violations] are unclear, in an area that demands certainty and predictability." Central Bank of Denver, 511 U.S. at 188, 114 S.Ct. at 1453-54 (internal quotations and citation omitted). Rather than bringing clarity to the subject, the SEC in this case muddied the waters. According to its opinion, an element "necessary to find that a respondent aided and abetted [the primary] violations" is "a general awareness by the aider and abettor that his role was part of an activity that was improper." In re Nicholas P. Howard, Exchange Act Release No. 47357, 2003 WL 297382, *4 (Feb. 12, 2003) ("Comm'n Op."). The "general awareness" language comes from this court's holding in Investors Research Corp. v. SEC, 628 F.2d 168, 178 (D.C.Cir.1980),
Awareness of wrongdoing means knowledge of wrongdoing. See id. at 178 & n. 61; Central Bank of Denver, 511 U.S. at 181, 114 S.Ct. at 1450; Halberstam v. Welch, 705 F.2d 472, 478 & n. 8 (D.C.Cir.1983). Despite its holding that this was a "necessary" element of aiding and abetting liability,
In short, the evidence showed that Howard was not aware, generally or otherwise, of any wrongdoing. To the extent the SEC explained itself, its point was the opposite — Howard's fault was in not being aware. In the sentence after it set forth the elements of aiding and abetting, the SEC added that "[r]ecklessness is sufficient to satisfy the scienter requirement for aiding and abetting liability." Comm'n Op., 2003 WL 297382, *4. The quotation is an accurate statement of the law of this circuit, but it is inconsistent with the idea that knowledge of wrongdoing must be proven. A secondary violator may act recklessly, and thus aid and abet an offense, even if he is unaware that he is assisting illegal conduct. Two of our decisions, rendered after Investors Research, make this point. Graham v. SEC, 222 F.3d 994 (D.C.Cir.2000); SEC v. Steadman, 967 F.2d 636 (D.C.Cir.1992). Both hold that "extreme recklessness" may support aiding and abetting liability. Graham, 222 F.3d at 1004; Steadman, 967 F.2d at 641. "Extreme recklessness" — or as many courts of appeals put it, "severe recklessness"
Nothing in the SEC's confusing opinion suggests that it had any of this in mind when it found that Howard acted recklessly. We are willing to assume that the SEC thought — incorrectly — that reckless conduct amounted to a form of awareness of wrongdoing. But we are unwilling to assume that it properly evaluated Howard's conduct under an extreme recklessness standard.
The SEC adopted Rule 10b-9 in 1962. It is quoted in full in the margin.
Counsel for the SEC argues that the bona fide requirement is simply "common sense," Brief of the SEC at 29, and the SEC's opinion claimed that "[i]t is well established that purchases by underwriters or their affiliates arranged for the undisclosed purpose of closing an unsuccessful part-or-none offering are fraudulent." Comm'n Op., 2003 WL 297382, *4. In support, the SEC directed our attention to a practitioners' guide to Rule 10b-9.
While Howard does not question the SEC's finding that primary violations of Rule 10b-9 occurred through non-bona fide transactions, he does dispute the SEC's claim that there were danger signals or red flags so obvious that he should have noticed them. His point is well-taken. As we understand the SEC's position, the purchases by the Capel Group and JCI were not in themselves illegal. The illegality arose in counting these shares toward the 2,000,000 minimum and closing the offering on that basis without informing the investors that these shares would be counted toward the minimum. Nothing on the face of Rule 10b-9 deals with transactions of this sort. While the SEC's 1975 release spoke of the need for "bona fide" sales, the non-bona fide transactions it mentioned — purchases by the issuer through nominee accounts or purchases by persons whom the issuer guarantees against loss, see 1975 WL 163128, at *1 — do not appear to be of the sort facing us here. And the Robbins article states that there are "many cases in which it is permissible for the sponsor or affiliates to purchase unsold interests in an all-or-none offering," as when the sponsor or affiliates buy "the securities on the same terms as other investors," "take the risk of the investment," and the purchases do not "affect the financial condition of the issuer." Robbins, supra, at 312 & n. 30.
In light of the uncertainties about the meaning of Rule 10b-9,
The ALJ made the following finding: Howard "believed that Matcovsky, higher management in the Capel Group, and outside counsel had approved actions that violated the antifraud provisions and Rule 10b-9." ALJ Dec., 1999 WL 156333, 15.
In its brief, the SEC offers two other rationales for disregarding this evidence: one, Howard, never claimed the defense of reliance of counsel; and two, even if he had, he failed to qualify for the defense because he did not make full disclosure to counsel, did not request counsel's advice, did not receive advice, and did not rely in good faith on that advice. The SEC's opinion relied on neither rationale, see SEC v. Chenery Corp., 332 U.S. 194, 200, 67 S.Ct. 1575, 91 L.Ed. 1995 (1947), and it would have been error for it to do so.
Despite dicta in SEC v. Savoy, 665 F.2d 1310, 1314 n. 28 (D.C.Cir.1981), reliance on the advice of counsel need not be a formal defense; it is simply evidence of good faith, a relevant consideration in evaluating a defendant's scienter. See Bisno v. United States, 299 F.2d 711, 719 (9th Cir.1961). As a former SEC commissioner put it, the "reliance defense ... is not really a defense at all but simply some evidence tending to support a defense based on due care or good faith." Bevis Longstreth, Reliance on Advice of Counsel as a Defense to Securities Law Violations, 37 BUS. LAW. 1185, 1187 (1982).
The facts that Rogers & Wells oversaw the closing of the first offering at its law offices, that it drafted the documents for the second offering and that Matcovsky conveyed to Howard his and the law firm's approval of the Capel Group's purchases and the IDG Development Corporation transaction constituted powerful evidence that Howard's actions did not amount to "an extreme departure from the standards of ordinary care" "so obvious that the actor must have been aware of it." Steadman, 967 F.2d at 641-42, quoting Sundstrand, 553 F.2d at 1045.
In Graham, what made the defendant's actions reckless, and not merely negligent, was an "abundance" of "red flags and suggestions of irregularities [that] demand[ed] inquiry as well as adequate follow-up and review." 222 F.3d at 1006 (internal quotations and citation omitted); see also Wonsover, 205 F.3d at 411 (noting existence of "several `red flags'"). On this record, the SEC is unable to identify any such unusual circumstances with regard to the non-bona fide purchases — the focus of the SEC's attention in this case. All the SEC can say is that Howard should have known what the legal requirements of Rule 10b-9 were and that he violated the disclosure laws by failing to reveal what he should have found out, but did not. At best this amounts to a finding of negligence; at worst it is liability without fault. Given the record in this case, there is no substantial evidence that Howard had the requisite scienter to aid and abet the violations, caused by JCI's counting of non-bona fide purchases towards the minimum of the part-or-none offering, of § 17(a) of the Securities Act, § 10(b) of the Exchange Act, and Rules 10b-5 and 10b-9 thereunder.
We are left with two loose ends for the SEC to address on remand. The first deals with the apparent fact that in the first offering — in the words of Rule 10b-9(a)(2)(ii) — "the total amount due to the seller [was not] received by him by a specified date."
The second matter we are remanding deals with Howard's aiding and abetting a violation of the Investment Company Act. Section 17(a), in conjunction with § 2(a)(3)(E), prohibited JCI from selling securities to the European Warrant Fund, an investment company it was advising, after the closing. 15 U.S.C. §§ 80a-17(a)(1), 80a-2(a)(3)(E). See supra note 3. As the SEC acknowledged, Howard did not know the transaction was unlawful. We have discovered no evidence to indicate that he received legal advice from either Matcovsky directly or Rogers & Wells indirectly. He claimed he relied on JCI's president, and on JCI's compliance department. While the SEC did not find that Howard had knowledge of wrongdoing, it did find that he acted recklessly in assisting in this transaction. His recklessness, according to the SEC, was in not being aware of the requirements of § 17(a)(1). As we have discussed, the SEC's version of recklessness with respect to the Rule 10b charges was erroneous. Nothing persuades us that it applied a different version to this charge. But unlike the Rule 10b violations, we cannot determine whether the evidence of Howard's aiding and abetting the violation of § 17(a)(1) would be insufficient if the SEC evaluated it in light of the correct standard of recklessness.
* * *
The SEC's order imposing sanctions against Howard is vacated and the case is remanded for reconsideration only with respect to the charges that he aided and abetted the violations of Rule 10b-9(a)(2)(ii) and § 17(a)(1) of the Investment Company Act.
KAREN LeCRAFT HENDERSON, Circuit Judge, concurring in the judgment:
I agree with my colleagues that the SEC's order cannot stand because Howard did not act, or fail to act, with the requisite scienter of an aider and abettor. I do not agree with the majority's formulation of the requisite scienter, however, and I therefore concur in the judgment.
In the usual aiding and abetting scenario, we ask three questions: whether "1) another party has committed a securities law violation; 2) the accused aider and abetter had a general awareness that his role was part of an overall activity that was improper; and 3) the accused aider and abetter knowingly and substantially assisted the principal violation." Investors Research Corp. v. SEC, 628 F.2d 168, 178 (D.C.Cir.1980); see also Dirks v. SEC, 681 F.2d 824, 844 (D.C.Cir.1982), rev'd on other grounds, 463 U.S. 646, 103 S.Ct. 3255, 77 L.Ed.2d 911 (1983). As the majority opinion notes, Maj. Op. at 1143, here the SEC found that Howard's unawareness that his role was part of improper activity fulfilled the second Investors Research element. I believe the SEC's finding in this respect is not supported by substantial evidence, see 15 U.S.C. § 78y(a)(4), because Howard was not "recklessly" ignorant and therefore, under our precedent, including Graham v. SEC, 222 F.3d 994 (D.C.Cir.2000), inter alia, we must vacate the SEC's order. Where I part company with the majority is in its apparent use of two distinct lines of authority regarding recklessness — one applying to a securities violation, whether committed by a primary actor or by an aider and abettor, the other applying to the second Investors Research element of "general awareness of wrongdoing" —
We have held in the securities area that willfulness can support a primary violation, Wonsover v. SEC, 205 F.3d 408, 416 (D.C.Cir.2000) (concluding that "substantial evidence supports the [SEC]'s determination that Wonsover failed to conduct reasonable inquiry into the sources of the unregistered shares he sold and that his inadequate inquiry in the face of several `red flags' justified a finding of willfulness" (emphasis added)), as can "extreme" recklessness. SEC v. Steadman, 967 F.2d 636, 641 (D.C.Cir.1992). In Steadman, we considered both primary violations of section 10(b) of the Securities Exchange Act and Rule 10b-5, inter alia, allegedly committed by Steadman and others, and Steadman's separate liability as an aider and abettor in the defendant corporation's violations of certain SEC regulations. Relying on Investors Research, we stated that an aider and abettor must "`knowingly and substantially assist[ ]' in the commission of a securities violation, with at least `a general awareness that his role was part of an overall activity that was improper.'" Steadman, 967 F.2d at 647 (quoting Investors Research, 628 F.2d at 178 (alteration in original)).
More recently, in Graham v. SEC, supra, the court articulated the test for aiding and abetting liability as follows:
222 F.3d at 1000. Graham's third element "that [the aider and abettor] rendered such assistance knowingly or recklessly" can only be a reformulation of the Investors Research "general awareness of wrongdoing" element, both because Graham expressly relies on Investors Research in its articulation and because the other two parts of the Investors Research test are covered in Graham's first and second elements. Graham later focuses on the "third element" of aiding and abetting liability:
222 F.3d at 1004. Graham's use of "extreme" recklessness here and elsewhere, see id. at 1006 ("Given the abundance of red flags here, it would be very hard to characterize Graham's conduct as anything but extremely reckless, regardless of the approvals she received...."), describes the extent of Graham's recklessness; it does not impose a requirement of extreme recklessness to support the "third element" (Investors Research's second element) of aiding and abetting liability. This reading is plain, most notably from Graham's own recognition that "recklessness is sufficient" as well as its express reliance on Dirks. See supra n. 1.
The majority opinion, however, misreads both Steadman and Graham to "hold that `extreme recklessness' may support [the second Investors Research element of] aiding and aiding liability." Maj. Op. at 1143 (emphasis added). That "may" means "must" in the majority's view — and that the majority is in fact addressing the second Investors Research element — is apparent from its subsequent discussion, particularly the following passage: "We are willing to assume that the SEC thought — incorrectly — that reckless conduct amounted to a form of awareness of wrongdoing. But we are unwilling to assume that it properly evaluated Howard's under an extreme recklessness standard." Maj. Op. at 1143. It ultimately concludes that the SEC improperly evaluated Howard's conduct because it used "recklessness" rather than "extreme recklessness" as the requisite level of scienter. Maj. Op. at 1147. I believe its application of an "extreme" recklessness standard is wrong.
While I characterized the majority's error as using two "distinct" lines of authority regarding recklessness, supra at 1150, one line is, at least to me, not altogether clear. Although we said in Steadman that "extreme" recklessness satisfies the intent requirement, we relied on Circuit precedent that held that recklessness suffices. Supra n. 1.
Some states protect directors from liability when they reasonably rely on counsel or other experts. See, e.g., N.Y. Bus. Corp. Law § 717 (McKinney 2004) ("director shall be entitled to rely on information, opinions, reports or statements... prepared or presented by ... counsel, public accountants or other persons as to matters which the director believes to be within such person's professional or expert competence"); Del.Code Ann. tit. 8, § 141(e) (2003) (similar language); Model Bus. Corp. Act § 8.30(e)(2) (2002); see also Buffalo Forge Co. v. Ogden Corp., 555 F.Supp. 892, 904 (W.D.N.Y.1983); Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1134, 1142 (Del.Ch.1994).
ALJ Dec., 1999 WL 156333, at *11 n. 17. The SEC's brief devotes hardly any attention to the matter.