Janus, Dodd-Frank, and the SEC; S.D.N.Y. Denies CFO's Motion to Dismiss
Susan M. Greenwood | Bloomberg Law
The U.S. District Court for the Southern District of New York denied a motion to dismiss by Steven Gould, the CFO of West End Financial Advisors LLC, West End Capital Management LLC, and Sentinal Investment Management Corporation (collectively, West End). The Securities and Exchange Commission (SEC) alleges violations of Section 17(a) of the Securities Act of 1933 (Securities Act), Section 10(b) of the Exchange Act of 1934 (Exchange Act), Rule 10b-5 under the Exchange Act, Sections 206(1), 206(2), and 206(4) of the Investment Advisers Act of 1940 (Advisers Act), and Rule 206(4)-8 under the Advisers Act against Gould, West End and other West End executives, including CEO William Landberg.
Private Fund Fraud
As the Court explained, West End was an unregistered investment adviser that accumulated $66.7 million from investors between 2003 and 2009. However, by 2009, the Court continued, West End’s two main investment funds allegedly failed to “generate adequate returns to satisfy their obligations.” Landberg purportedly addressed this deficiency by using “whatever assets were available to satisfy West End’s most impending obligations without regard to any representations made to the investors as to the use of those assets.” Gould allegedly knew about and participated in the fraud. According to the SEC, Gould, among other things, (1) “generated fraudulent account statements and other marketing materials that misrepresented the financial performance of West End;” (2) overvalued investments; (3) prepared a spreadsheet evidencing West End’s comingling of assets; (4) made unauthorized investments at Landberg’s direction; and (5) created “accounting mechanisms” to conceal West End’s actions.
Does Janus Apply to the SEC?
The Court assumed arguendo that Janus Capital Group, Inc. v. First Derivative Traders, 131 S. Ct. 2296 (2011) applies to SEC enforcement actions. However, the Court found no grounds under Janus to dismiss the SEC’s claims against Gould. It explained that Exchange Act Rule 10b-5 “provides additional bases for the SEC’s claim beyond the making of fraudulent statements.” Noting that Rule 10b-5 “prohibits employing ‘any device, scheme, or artifice to defraud’ or ‘engaging in ‘any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person’ in connection with a securities sale,” the Court concluded that the SEC adequately alleged that Gould “violated Rule 10b-5 beyond the making of a statement.” Moreover, the Court held that the SEC alleged “surrounding circumstances” that permit the conclusion that the alleged false statements “were implicitly attributed to Gould.” This, the Court said, “is ‘strong evidence’ that Gould was the ‘maker’ of those statements. . . .”
Detailed Facts Raise Inference of Scienter
Next, the Court held that the SEC adequately alleged scienter under Novak v. Kasaks, 216 F.3d 300 (2d Cir. 2000). The SEC’s allegations included references to false account statements and inaccurate West End financial results prepared and issued by Gould, emails from Gould to Landberg and other executives indicating his knowledge of West End’s cash flow problems, and conversations between Gould and other executives where he acknowledged that certain funds did not have sufficient assets to meet investor returns. The SEC also detailed Gould’s involvement in shifting assets among West End’s funds and disguising the use of assets from one fund to make investments on behalf of another fund. According to the Court, “[t]he SEC identifie[d] facts that would place a reasonable person on notice as to the falsity of representations being made and that suggest Gould was ignoring obvious signs of fraud.”
Dodd-Frank Comports with Second Circuit Aiding and Abetting Law
The SEC also adequately alleged that Gould aided and abetted violations of the Advisers Act. Gould argued that the SEC impermissibly relies on a recklessness standard for scienter that was adopted in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank). Instead, he contends that only actual knowledge suffices. The Court, however, observed that “[t]he scienter standard in this Circuit included recklessness prior to Dodd-Frank.” Further, the SEC did not retroactively apply civil penalties adopted in Dodd-Frank. Here too, the Second Circuit imposed penalties for aiding and abetting well before passage of Dodd-Frank.
Injunctive Relief under the Federal Securities Laws
Finally, the Court addressed injunctive relief under the Securities Act, Exchange Act, and Advisers Act. It noted that a finding of a propensity to engage in future violations is the prerequisite to enjoin future violations. Reviewing the SEC’s allegations, the Court determined that Gould’s purported repeated actions and concealment of West End’s conduct pleads “a reasonable likelihood of recurrence.”
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