Securities and Exchange Commission v. Fehn

Brief Fact Summary. Fehn (Defendant), an attorney representing CTI Technical, Inc. (CTI), had a suit brought against him, its founder, its officers and directors and its underwriter, by the Securities and Exchange Commission (SEC) (Plaintiff),  in an investigation of CTI’s initial public offering (IPO), and alleged Fehn of aiding and abetting violations of  §§ 10(b) and 15(d) of the Securities Exchange Act of 1934 by helping the preparation of fabricated and misleading Form 10-Qs for CTI.

Synopsis of Rule of Law. An attorney aids and abets a violation of the Securities Exchange Act of 1934 by editing and submittinga Form 10-Q that he is cognizant includes misrepresentations and omissions that constitute violations of the Securities Exchange Act to the SEC,under § 104 of the Private Securities LitigationAct of 1995.

Facts. CTI Technical, Inc., with Wheeler as the founder and CEO, had their initial public offering of securities (IPO) tainted by violations of state and federal securities laws. A formal investigation was launched by the SEC into the IPO, and a securities attorney, Fehn, was employed to represent CTI, Wheeler, CTI’s underwriter (Stoneridge Securities), and multiple CTI officers and directors. Fehn was alerted to CTI failing to comply with specific reporting requirements of the Securities Exchange Act of 1934 (Act) during the investigation. CTI did not file Form 10-Q quarterly reports and also did not disclose that a diet product it created, one of its central products, had been banned by the FDA with the current inventory of the product being impounded. CTI’s violations in connection with the IPO were also not disclosed by CTI. Wheeler was advised by Fehn that the ban needed to be revealed by CTI but there was no need to reveal the IPO violations. The Form 10-Qs, prepared by a non-lawyer, disclosed the FDA ban, but Wheeler’s actual role in CTI was mischaracterized and the form did not disclose the possible civil liability coming from Wheeler’s and CTI’s prior IPO violations. The Form 10-Qs were reviewed and edited by Fehn. Fehndenied that he made substantive changes to the Form 10-Qs but the SEC retained that Fehn had deleted information that was wronglyomitted. The SEC allegedFehnof aiding and abetting violations of§§ 10(b) and 15(d) of the Act by helping in the preparation of incorrect and misleading Form 10-Qs for CTI, and it hoped to ban him for life from future securities laws violations.  A judgment was entered against Fehn by the district court and entered an order banning him for life from future aiding and abetting violations.  The court of appeals granted review.

Issue. Does an attorney aids and abet a violation of the Securities Exchange Act of 1934 by editing and submitting a Form 10-Q that he is cognizant includes misrepresentations and omissions that constitute violations of the Securities Exchange Act to the SEC, under § 104 of the Private Securities Litigation Act of 1995?

Held. (Hawkins, J.) Yes.An attorney aids and abets a violation of the Securities Exchange Act of 1934 by editing and submitting a Form 10-Q that he is cognizant includes misrepresentations and omissions that constitute violations of the Securities Exchange Act to the SEC, under § 104 of the Private Securities Litigation Act of 1995. The SEC is authorized to pursue injunctive actions for aiding and abetting violations of certain securities laws against “any person that knowingly provides substantial assistance to another person in violation of a provision of this chapter…†by Section 104 of the Private Securities Litigation Act of 1995. In Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164 (1994), the U.S. Supreme Court held that a private plaintiff may not maintain an action for aiding and abetting violations of § 10(b) of the Act.Congress utilized language identical to that utilized by lower federal courts in expressing the components of aiding and abetting under § 10(b) before Central Bank eradicatedprivate causes of action like that in Section 104. Congress’ intention of Section 104 to preserve the definition of aiding and abetting as it existed prior to Central Bank is strongly indicated by the symmetry between the components of aiding and abetting previous to Central Bank but post Section 104. The first component must be an independent primary violation, in this case, the failure of the Form 10-Qs to list Wheeler as CTI’s promoter during the time of the IPO and to reveal the contingent liabilities coming from previous violations of securities laws is the primary violation. The next component is demonstrating substantial assistance in the primary violation. Participating in the editing of information for the purpose of marketing securities is included in the “substantial assistance†interpretation. In this case, Fehn stated that he reviewed the original drafts of the Form 10-Qs and altering those documents personally.  As a result of his participation in editing the forms and submitting them for filing to the SEC, Fehn fulfilled the requirement of “substantial assistance†to the primary violations. Fehn insisted the professional advice he gave to CTI and Wheeler was in good faith, however, Fehn’s attempts to stop violations of the law failed to be “reasonable†taking into consideration the obvious banned misrepresentations and omissions contained by the Form 10-Qs. The last component is knowledge that the purported aider and abettor of the primary violations and of his or her aide of it, also known as scienter. As showcased here, it is obvious that Fehn was aware of the primary violations and was aware that Wheeler did not desire any implicating information disclosed in the Form 10-Q reports.  So, Fehn must have been aware when he opted to edited those forms that permitted the misrepresentations and omissions to perpetuate would continue the primary violations. It is also to be noted that the district court was not erroneous in enforcing a lifetime ban on Fehn from future aiding and abetting violations of the Securities Act of 1934. Affirmed.

Discussion. Issuers who must register with the SEC must file supplementary and periodic information, documents, and reports as required by the SEC is provided under Section 15(d) of the Securities Exchange Act. § 15(d)’s disclosure provision is implemented by Rule 15d-13 in requiring quarterly 10-Q reports. In addition to the mandated reports, Rule 12b-20 further requires that issuers must add extra material information that may be needed to make the requisite statements no longer misleading, in the light of the situations under which they are made. Fehnwas adamant that the securities laws impose no duty to disclose in a Form 10-Q the reality that at the time of an IPO the company’s promoter was not identified or the presence of previous violations of securities laws. The court did not agree and so reasoned that against the evidence in this case, extra information was material and so required to be presented.