In 2009, SEC enforcement actions reached an all-time high, doubling the number of formal investigations that took place in 2008. This rising tide of enforcement will undoubtedly grow larger given the newly-enacted Dodd-Frank Act’s whistleblower provisions, which provide significant monetary incentives to individuals willing to reveal certain types of financial misconduct. With this onslaught in mind, companies and individuals working in SEC regulated industries must clearly understand what behavior can place them in the government’s crosshairs.
The Security and Exchange Act of 1934 criminalizes “willful” violations of its provisions and certain SEC rules or regulations. While in some other contexts the term “willful” signals a requirement that the defendant “knowingly” violated federal law, several U.S. Courts of Appeal, including the Second and Ninth Circuits, have held that the government need only show that the defendant “intended to commit an act prohibited under the statute.” The Second Circuit reiterated this position as recently as July 1, 2010, when it upheld the trial court’s jury instruction defining the term “willful” under the Act with reference only to the defendant’s “intent to cause a deception, a falsification,” rather than requiring any knowledge of illegality. United States v. Kaiser, 609 F.3d 556, 567-68 (2nd Cir. 2010) (reversing conviction on other grounds). The Court reached this interpretation due in large part to the Act’s “unique statutory language,” which criminalizes willful violations, but shields defendants who violate a rule or regulation without knowledge of its existence from imprisonment. The Second Circuit had previously suggested that this safe harbor provision would be meaningless if the threshold for criminal liability in the first place was knowledge of illegality. United States v. Dixon, 536 F.2d 1388, 1396 (2nd. Cir. 1976). In other words, a person can “willfully” violate an SEC rule even if he does not know of the existence of the rule.
While Courts in other jurisdictions have yet to definitively interpret the “willful” requirement of the Act’s penalty provision, a number of decisions indicate that judges within those circuits may likely lean in the Second Circuit’s direction. The Fourth Circuit, for example, upheld a securities fraud conviction focused on the defendant’s intent to manipulate and deceive, making no indication that it required a knowing violation of the Act. See Bryan v. United States, 58 F.3d 933 (4th Cir. 1995). In United States. v. Johnson, 553 F. Supp. 2d 582 (E.D. Va. 2008), the District Court likewise focused on the defendant’s act of designing a scheme to defraud investors with no reference to his knowledge of securities laws.
With prior cases from Courts like the Fourth Circuit focusing on the defendant’s intent to commit wrongful acts, and the Second Circuit’s interpretation of the Securities and Exchange Act’s penalty provision, companies and individuals would do well to err on the side of caution and treat the Second Circuit’s view of the Act as prevailing law in any circuit that has not explicitly held otherwise. Despite the “willful” requirement under the Act, if an incident occurs that could give rise to an enforcement action, asserting lack of knowledge of securities laws and regulations is unlikely to make the government go away. Given the recent tenacity with which the Commission has pursued such actions, and its new ability to effectively provide bounties for a whistleblower’s information on criminal violations, companies’ and individuals’ potential exposure in this context will likely only increase in the future.