Securities Fraud: Understanding Aiding and Abetting Liability Risks
Contents
Securities Fraud: Understanding Aiding and Abetting Liability Risks
Securities fraud is a complex area of law that aims to protect investors by requiring transparency and accountability in financial markets. One aspect of securities fraud law that is important to understand is aiding and abetting liability. This refers to the liability of third parties who were not the main perpetrators of fraud, but who substantially assisted the fraud in some way.
What is Aiding and Abetting Liability?
Aiding and abetting liability allows regulators and private plaintiffs to pursue legal action against third parties that were not the primary violators of securities laws, but assisted in fraudulent activities in a substantial way.
To be liable under an aiding and abetting theory, a third party generally must meet three elements:
- There was a primary violation of securities laws by another party
- The third party provided substantial assistance to the primary violator
- The third party had general awareness of their role in the overall illegal activity
If these elements are met, the aiding and abetting party can face civil penalties and fines even if they did not directly commit fraud themselves.
Why is Aiding and Abetting Liability Important?
Aiding and abetting liability is an important tool for deterring securities fraud and providing legal recourse to victims. Without it, third parties could provide essential support to fraudulent schemes with limited legal risk.
For example, accountants and lawyers often play a crucial role in helping companies prepare disclosures, financial statements, and other documents that may be used to mislead investors. Holding these gatekeepers liable for enabling fraud creates incentives for them to more closely scrutinize potential misconduct by their clients.
Similarly, banks and brokerages that facilitate manipulative trading or knowingly process illicit funds derived from fraud may be liable as aiders and abettors. This encourages financial institutions to establish and enforce robust anti-fraud and anti-money laundering controls.
By extending liability to enablers of fraud, regulators can cast a wider net to deter illegal behavior in capital markets. And investors have another avenue to potentially recover losses from parties that allowed fraud to occur.
Key Aiding and Abetting Cases
There have been several high-profile cases focused on aiding and abetting liability over the past two decades:
Enron and Arthur Andersen
In one of the most notorious accounting scandals ever, energy giant Enron collapsed into bankruptcy in 2001 after years of cooking the books and deceiving investors . Enron’s longtime auditor, Arthur Andersen, was accused of actively participating in and facilitating Enron’s accounting maneuverings.
The Department of Justice pursued criminal charges against both Enron and Arthur Andersen. Enron executives were found guilty of fraud, while Andersen was convicted of obstructing justice by shredding reams of Enron-related documents.
The scandal led to the dissolution of Arthur Andersen and was a catalyst for reforms like the Sarbanes-Oxley Act aimed at improving auditor independence and accountability.
Investment Banks and the 2008 Financial Crisis
In the wake of the 2008 financial crisis, major investment banks like Goldman Sachs faced allegations that they misled clients who invested in toxic mortgage-backed securities.
Banks were accused of aiding and abetting fraud by knowingly packaging and selling poor-quality loans while keeping the risks to themselves. In 2010, Goldman paid $550 million to settle Securities and Exchange Commission (SEC) charges over one such deal, known as Abacus. The SEC said Goldman failed to disclose key information to investors about the role of a hedge fund that was betting against the Abacus securities.
While Goldman did not admit wrongdoing in the settlement, it marked an important application of aiding and abetting liability to help hold Wall Street accountable for crisis-era misconduct.
Purdue Pharma and the Opioid Crisis
More recently, prosecutors have pursued novel aiding and abetting arguments against companies involved in the US opioid epidemic. Numerous states, cities and counties filed lawsuits accusing opioid makers like Purdue Pharma of downplaying addiction risks when marketing prescription painkillers to doctors and patients.
But many cases also named pharmacies, consulting firms and even tech companies as defendants under aiding and abetting and conspiracy claims. Plaintiffs allege these corporate enablers helped drive overprescribing of opioids and should share responsibility for the public health crisis. The cases underscore the breadth of secondary liability theories in emerging areas like opioid litigation.
Key Defenses Against Aiding and Abetting Claims
Given the potentially severe penalties imposed in aiding and abetting securities fraud cases, defendants have incentives to fight allegations aggressively. Some potential defenses include:
Lack of awareness – Defendants may claim they did not know about the underlying illegal conduct or believe their actions would assist fraud. But willful blindness is not exonerating – the awareness element can be met if a third party consciously avoided learning the truth.
Ordinary business activities – Enablers sometimes argue they were carrying out normal business duties like legal representation, auditing, or transaction processing. However, assistance crosses into aiding and abetting when it goes beyond typical activities and provides special support for misconduct.
No substantial assistance – Defendants can defeat claims by showing their involvement did not matter to the success of fraud or was insignificant. But courts set a fairly low bar for what constitutes substantial assistance. Even just creating additional opportunities for illegal acts may qualify.
Good faith reliance on professionals – Auditors, consultants and other gatekeepers might assert a good faith defense – arguing they reasonably relied on false information or assurances from primary violators. However, red flags often undermine claims of blissful ignorance.The outcome often turns on the specific facts and the egregiousness of the defendant’s conduct. While defenses can sometimes prevail, regulators and private plaintiffs now routinely consider adding aiding and abetting charges to strengthen securities fraud cases.
Looking Ahead at Aiding and Abetting Risks
The scope of liability for aiding and abetting securities fraud may continue expanding in the years ahead thanks to two key trends:
Novel applications of liability theories – As seen in opioid litigation, plaintiffs are testing the boundaries of secondary liability claims against new types of defendants not previously viewed as key fraud enablers. Similar theories could emerge in areas like climate change disclosures or human rights violations.
Use of technology and data analytics – Digitization creates more supporting evidence and paper trails documenting relationships between third parties and primary fraudsters. Data mining can help establish connections, communication and awareness. For instance, email traffic and phone records may show accounting partners discussing misstatements with executives.As a result, a wider range of companies should be aware of potential aiding and abetting risks in today’s interconnected markets. Understanding liability theories is key to mitigating legal exposure.
Conclusion
Aiding and abetting liability is a vital tool for deterring fraud by reaching beyond the primary malefactors to third parties that enable misconduct. Recent cases show regulators and plaintiffs pursuing novel applications of liability theories against gatekeepers, financial institutions and even peripheral business partners.
With the support of technology, the web of liability will likely continue growing wider. As a result, all market participants should be cognizant of risks and establish rigorous controls to avoid assisting securities fraud, whether knowingly or unwittingly. The stakes for enablers are rising.