United States Court of Appeals
For the First Circuit
No. 08-1172
SECURITIES AND EXCHANGE COMMISSION,
Plaintiff, Appellant,
v.
VIRGINIA A. PAPA, KEVIN F. CRAIN, and SANDRA G. CHILDS,
Defendants, Appellees.
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. Nathaniel M. Gorton, U.S. District Judge]
Before
Boudin, Stahl and Howard,
Circuit Judges.
Tracey A. Hardin, Senior Counsel, Securities and Exchange
Commission, with whom Brian G. Cartwright, General Counsel, Andrew
N. Vollmer, Deputy General Counsel, Jacob H. Stillman, Solicitor,
and Katharine B. Gresham, Assistant General Counsel, were on brief
for appellant.
Anthony Mirenda, with whom Robert E. Toone, Jennifer A.
Cardello, Jennifer S. Behr and Foley Hoag LLP were on brief, for
appellee Kevin F. Crane.
Anthony Mirenda for appellees Virginia A. Papa and Sandra G.
Childs.
Kelley A. Jordan-Price, Michael J. Connolly, Laura B. Angelini
and Hinckley, Allen & Snyder LLP on brief for appellee Virginia A.
Papa.
John A. Sten, Jason C. Moreau and Greenberg Traurig, LLP on
brief for appellee Sandra G. Childs.
February 6, 2009
BOUDIN, Circuit Judge. This is an appeal by the
Securities and Exchange Commission ("SEC") from a judgment of the
district court dismissing with prejudice a civil complaint against
three individuals charging them with violations of the securities
laws. On the grant of a motion to dismiss, well-pleaded facts in
the complaint are taken as true, Tellabs, Inc. v. Makor Issues &
Rights, Ltd., 127 S. Ct. 2499, 2509 (2007), so our description of
events is largely drawn from the complaint.
Putnam is a well-known money management firm. One of its
entities, Putnam Fiduciary Trust Company ("PFTC"), acts as an
administrator of employee-defined contribution plans and Putnam
mutual funds. Cardinal Health, Inc., a PFTC client who utilized
PFTC to run its employee-defined contribution plans, decided to
merge with Allegiance Health, and in late 2000 the two companies
arranged to combine their defined contribution plans, creating a
trust with PFTC as the trustee and investment manager.
In this role, PFTC was responsible for investing the
merged plan's assets, making payments on its behalf, and carrying
out investment instructions. On January 2, 2001, the assets of the
Cardinal and Allegiance plans were combined into a single new
combined account; this was done by selling the assets of the old
Cardinal and Allegiance accounts and transferring the proceeds from
those sales to the new combined account. PFTC had been directed to
-2-
invest the combined assets in several mutual funds as soon as
possible.
In fact, PFTC did not make the investments until January
3, 2001, causing the combined plan to miss a sharp upswing in the
markets. Had the same funds been invested on January 2, the value
of the holdings of the combined plan would have been almost $4
million greater. Told on January 3 that the investments had been
made (but not told of the one-day delay), a Cardinal employee
rejoiced, saying that "[t]he market is up and we look great being
invested on the upswing."
PFTC officials took a set of steps designed to offset
much of the "loss" to the combined account resulting from the delay
and to conceal the misadventure and its repair. These activities
gave rise to the present law suit. According to the SEC's
complaint, at least six employees of PFTC were in some measure
responsible:
Karnig Durgarian, Jr., the highest ranking
executive of PFTC and of various Putnam mutual
funds, in several of which the combined plan
assets were invested on January 3;
Virginia A. Papa and Donald McCracken, two
senior officers of PFTC who reported directly
to Durgarian;
Kevin Crain and Sandra Childs, both unit heads
reporting to Papa; and
Ronald B. Hogan, an officer in Childs' unit
who reported to her.
-3-
According to the SEC, Crain, Childs, Hogan and perhaps
others met on January 3 or 4, 2001, and agreed that the combined
plan should be protected from losses resulting from the one-day
delay. On January 4 or 5, Hogan began to work out possible
transactions to achieve this end. On or about January 5, all six
defendants met and Hogan described a plan to cover the loss by
using "as-of" transactions--backdated purchases or sales of
securities that use the price from an earlier day rather than the
price current on the date the transaction occurred.
Such as-of trades can dilute the value of other shares in
a mutual fund, but (we are told) they are not necessarily illegal
and are used to correct trading errors. However, to prevent harm
to its mutual fund shareholders from dilution that may be caused by
as-of trades, PFTC had an internal policy, known as the penny-per-
share policy, requiring the party responsible for the error
necessitating the as-of trade to compensate mutual fund
shareholders for any dilution of value beyond a penny per share.
Each participant in the January 5, 2001, meeting, the SEC
asserts, knew that the transactions would harm the other mutual
fund investors and that the harm would exceed a penny per share.
Nevertheless, says the SEC, "[a]fter discussion, Defendants agreed
to execute Hogan's plan." Durgarian said that Cardinal should not
be informed about the delay in making the original investments and
that PFTC would not bear the cost of the shortfall.
-4-
Hogan thereafter executed several transactions involving
Putnam funds. The first, which serves as an example, involved
reversing on the books some January 2, 2001, sales by Cardinal
(made in liquidating its old account) and restating the sales as
occurring on January 3, crediting the new combined account with the
higher value that those shares had on the later date. This
generated $450,000 for the combined plan at the expense of the
Putnam funds' shareholders.
This first set of transactions were followed by two more
transactions, differently designed but also at the expense of other
Putnam funds' shareholders. The result was to offset about $3
million of the $4 million loss. The remaining $1 million in loss,
which was due to delayed investment in the Franklin Small Cap Fund-
-a non-Putnam mutual fund--went uncompensated. Hogan and Durgarian
both contacted Franklin and attempted to persuade it to execute
similar as-of trades, but Franklin refused.
At a later meeting or meetings attended by all six of the
officials identified above, Durgarian told McCracken to use various
accounting adjustments so as to increase recorded expenses for
certain of the adversely affected Putnam funds. The purpose was to
mask the apparent effect of the as-of transactions. The
adjustments were designed to appear on the books at the same time
as the as-of trades themselves.
-5-
On January 18, 2002, and February 7, 2003, PFTC's outside
auditor conducted audits of PFTC's internal controls in the defined
contribution plan servicing unit for the years 2001 and 2002. As
part of the audit, certain senior managers were required to sign
statements (the "audit letters") stating that they were "unaware of
any uncorrected errors, frauds or illegal acts attributable to"
PFTC that had affected its clients. Crain, Childs and Papa all
signed these statements for both audits.
These events came to light in early 2004 when Crain,
having been fired by PFTC for other reasons, told PFTC's internal
auditor that the January 5, 2001, events had the "fingerprints" of
"financial fraud." Ultimately PFTC terminated Durgarian, Papa and
Hogan and converted McCracken's 2002 resignation into a termination
for cause. PFTC made compensatory payments to the affected Putnam
mutual funds and to others who had redeemed shares or withdrawn
from the Putnam funds or combined plan.
On December 30, 2005, the SEC filed a civil complaint in
the district court alleging that all six of the PFTC officers had
violated section 17(a) of the Securities Act, 15 U.S.C. § 77q(a)
(2006), section 10(b) of the Exchange Act, id. § 78j, and its
implementing regulation, Rule 10b-5, 17 C.F.R. § 240.10b-5 (2008),
and that each had aided and abetted PFTC's uncharged primary
violations of section 10(b) and Rule 10b-5, thus violating section
20(e) of the Exchange Act, 15 U.S.C. § 78t(e).
-6-
Section 10(b) of the Exchange Act, which is central to
this case, makes it unlawful "[t]o use or employ, in connection
with the purchase or sale of any security . . . any manipulative or
deceptive device or contrivance in contravention of such rules and
regulations as the Commission may prescribe as necessary or
appropriate." Id. § 78j. Rule 10b-5 identifies false, misleading
or incomplete statements as violations and proscribes the use of
devices, schemes, or artifices to defraud. 17 C.F.R. § 240.10b-5.
On motions by the defendants to dismiss for failure to
state a claim, the district court denied the motions as to
Durgarian, McCracken, and Hogan in light of their actions in
ordering or carrying out the pertinent transactions. SEC v.
Durgarian, 477 F. Supp. 2d 342, 350, 353-54 (D. Mass. 2007). By
contrast, the district court found that none of the counts stated
a claim against Papa, Crain, and Childs, id. at 360, and entered
final judgment in favor of each, Fed. R. Civ. P. 54(b), permitting
an immediate separate appeal by the SEC, Fed. R. App. P. 4(a).
The district court, in dismissing claims against the
appellees as primary violators, stressed that Papa, Crain, and
Childs were not charged with ordering or executing any of the
wrongful transactions in January 2001; the complaint merely
asserted in general terms that they had "agreed" on January 5,
2001, to the overall plan. This, the district court said, was
insufficient to make them "substantial" participants in a
-7-
potentially wrongful scheme directed by Durgarian and carried out
by Hogan and McCracken.
The appellees' signing of the audit letters over a year
after the transactions (and then again a year after that) were
affirmative acts but, as to them, the district court said:
[T]he alleged false [audit letters] bearing
their signatures are too attenuated to link
them to the fraudulent scheme. The SEC
provides no allegation linking the signatures
to the fraud other than its general assertion
that the defendants attended the meeting. The
referenced certification letters are the only
overt acts alleged in the Complaint against
these defendants and, therefore, the only
basis on which their substantial participation
in the scheme, and thus their liability as
primary violators, is predicated.
Durgarian, 477 F. Supp. 2d at 355. For similar reasons, the
district court also found inadequate the aiding and abetting claims
against Papa, Crain and Childs. Id. at 357.1
On appeal, the dispute has been narrowed. The SEC no
longer asserts that Papa, Crain, and Childs are liable as primary
violators under sections 10(b) and 17(a). It claims only that they
aided and abetted PFTC's uncharged primary violations of section
10(b), as implemented by Rule 10b-5, by signing the 2002 and 2003
1
In addition, the district court said that the complaint
failed to plead facts sufficient to create a strong inference that
Papa, Crain and Childs acted with scienter in signing the audit
letters. Id. at 355. However, the "strong inference" requirement
relied on by the court has recently been held inapplicable to SEC
actions, SEC v. Tambone, 550 F.3d 106, 119-20 (1st Cir. 2008),
petition for reh'g filed, so we bypass this alternative holding.
-8-
audit letters while knowing that the allegedly wrongful as-of
transactions and accounting adjustments had occurred and not been
disclosed.
Appellees say that this is a theory that the SEC never
squarely presented to the district court and so cannot be argued on
appeal as a basis for reversal. The SEC's theory of appellees'
liability in the district court rested on the alleged agreement by
the Papa, Crain and Childs to the overall scheme, and their later
signatures on the audit letters were treated merely as acts in
furtherance of that scheme. Thus, the SEC's emphasis in the
district court was different than its emphasis on this appeal.
Still, the SEC's complaint included at the end a general
aiding and abetting count including all defendants without
specifying conduct, and the SEC's opposition to the motion to
dismiss did refer to the audit letters as furthering the initial
plan. True, the SEC's argument now depends upon treating the audit
letters as the only wrongdoing by appellees. But, while this
sharpens the focus, it is not an entirely new argument.
The civil aiding and abetting offense was added to the
Exchange Act as an amendment in 1995, Private Securities Litigation
Reform Act of 1995, Pub. L. 104-67, § 104, 109 Stat. 737, following
Cent. Bank of Denver, N.A. v. First Interstate Bank of Denver,
N.A., 511 U.S. 164 (1994). In Central Bank, the Supreme Court
rejected aiding and abetting as a basis for liability for section
-9-
10(b) violations; and, in response, Congress added section 20(e),
15 U.S.C. § 78t(e), to the Exchange Act, to provide--for SEC
enforcement but not private actions--that
any person that knowingly provides substantial
assistance to another person in violation of a
provision of this chapter, . . . shall be
deemed to be in violation of such provision to
the same extent as the person to whom such
assistance is provided.
The question, then, is whether the conduct charged in
this case can comprise substantial assistance, and the first issue
is assistance of what wrong. The SEC's brief--like its original
complaint--variously refers to two different notions of the
"wrong": one is of a set of transactions in January 2005 which, to
an outsider, might seem dubious; the other is a notion that the
wrong pertinent to this appeal lay in PFTC's failure as a fiduciary
to disclose the initial loss and the remedial steps that followed.2
The initial delay and the transactions themselves
(whether or not wrongful) seemingly caused concrete financial loss,
namely, the net loss (after partial compensation) to the combined
Cardinal-Allegiance fund and the reduction in value for other
shareholders. If this were the focus, the difficulty for the SEC
2
Paragraph 1 of the complaint describes the offense as
follows: "[Defendants] engaged in a fraudulent scheme to conceal
and cover up an error that had occurred in a client's account.
Instead of disclosing the error to the client and facing the
consequences, Defendants engaged in a fraudulent course of conduct
to transfer the loss from one client to others and then to conceal
the error and the fraudulent transfer from the affected clients and
from PFTC's auditors."
-10-
would be that the transactions, including the accounting
adjustments masking them, were completed in or around January 2005,
long before the audit letters by appellees. One cannot aid and
abet a fraudulent scheme that is already complete, United States
v. Hamilton, 334 F.3d 170, 180 (2d Cir.), cert. denied, 540 U.S.
985 (2003), so the issue would be one of duration.
In Krulewitch v. United States, 336 U.S. 440 (1949), and
Grunewald v. United States, 353 U.S. 391 (1957), the Supreme Court
refused to treat conspiracies (a close counterpart to "schemes") as
continuing crimes once the initial wrong is completed, even though
continuing concealment was alleged or implicit.3 Other courts have
extended Grunewald and Krulewitch to civil conspiracies. See,
e.g., Pyramid Sec. Ltd., 924 F.2d at 1117-18; Hampton v. Hanrahan,
600 F.2d 600, 622 (7th Cir. 1979), rev'd in part on other grounds
by 446 U.S. 754 (1980).
Of course, an agreement to conceal after the fact could
be viewed as inherent in a conspiracy or any wrongful fraudulent
scheme; but then all covert joint wrongdoing would be a permanently
continuing offense, Krulewitch, 336 U.S. at 456 (Jackson, J.,
3
"[T]he Supreme Court held long ago that a conspiracy
generally ends when the design to commit substantive misconduct
ends; it does not continue beyond that point "merely because the
conspirators take steps to bury their traces, in order to avoid
detection and punishment after the central criminal purpose has
been accomplished." Grunewald v. United States . . . ." Pyramid
Sec. Ltd. v. IB Resolution, Inc., 924 F.2d 1114, 1117-18 (D.C.
Cir.), cert. denied, 502 U.S. 822 (1991).
-11-
concurring), an approach that the Supreme Court has rejected.
Similarly, "[t]hough the result of a conspiracy may be continuing,
the conspiracy does not thereby become a continuing one." Fiswick
v. United States, 329 U.S. 211, 216 (1946).
Admittedly, a borderland of uncertainty exists as to how
far the Grunewald approach extends where, for example, the
statutory offense is inherently a continuing one or an objective to
take continuing action to conceal is part of the central plan. The
problem is complicated by new case law after Grunewald, especially
in the tax area, e.g., Forman v. United States, 361 U.S. 416, 422-
24 (1960), overruled on other grounds by Burks v. United States,
437 U.S. 1 (1978), and by variations as to the offense, the facts,
and various contexts (e.g., statute of limitations, hearsay) in
which duration questions occur.
At least on appeal, the SEC sidesteps the problem of
scheme duration. The ongoing wrong that it says was aided and
abetted by appellees was not the transactions themselves nor the
scheme that embodied them but arose out of an ongoing fiduciary
duty by PFTC to disclose the original loss and the subsequent
partial transfer of loss to the clients adversely affected. The
SEC argued below that all of the defendants including appellees had
such a fiduciary duty, but it no longer maintains that position on
appeal.
-12-
Instead, the SEC argues that, given PFTC's continuing
duty as a fiduciary to make this disclosure, which is at least
arguable, Restatement (Third) of Agency § 8.11 (2006), the
appellees' audit letters "assisted" PFTC in continuing to breach
its duty because--the SEC claims (appellees say this is
speculative)--accurate answers to the audit letters would have
revealed PFTC's conduct to auditors and eventually to the combined
plan and Putnam funds. An underlying necessary premise is that the
non-disclosure was not only a breach of fiduciary duty but also a
violation of section 10(b), so invoking SEC jurisdiction.
A breach of fiduciary duty can sometimes be central to a
section 10(b) violation; an example would be a purchase or sale
that is deemed fraudulent or manipulative because it is based on
undisclosed inside information in breach of a fiduciary duty.
E.g., United States v. O'Hagan, 521 U.S. 642 (1997). Possibly the
securities transactions in this case, if they were violations, are
so partly because of fiduciary duty to manage them in the clients'
interest.
But, by contrast to the usual bilateral purchase or sale
involving a material misstatement or omission, the non-disclosures
did not cause either the transactions or the concrete losses
resulting from them. See Loss & Seligman, Securities Regulation
3710-12 (3d rev. ed. 2003). Even if the non-disclosures were
regarded as a continuing breach of fiduciary duty, it is perhaps
-13-
arguable but not crystal clear in this case that the non-
disclosures themselves constitute a securities law violation.
Admittedly, the boundary lines are not sharply etched:
in SEC v. Zandford, 535 U.S. 813 (2002), the Supreme Court mingled
concepts of fiduciary duty and non-disclosure in extending section
10(b) to a broker who embezzled client proceeds derived from the
sale of securities. Id. at 820-23. But even there the Court did
not suggest that the wrongdoing could be treated as a continuing
securities violation after the embezzlement and could be used to
make liable for it those who learned of the wrong but did not
disclose it.
The SEC's attempt to do so here would extend the supposed
wrong indefinitely and until its disclosure--not just as a common
law breach of duty but as a federal securities violation. Then,
through the aiding and abetting device, the SEC's approach would
create new liability under section 10(b), long after the original
transactions, for individuals like appellees otherwise assumed to
be not liable for those transactions. And it would do so based
solely on general denials of knowledge of wrongdoing.
Whether or not the January 2001 transactions were
violations of section 10(b) has not been briefed to us; but they
occurred in the same time frame as the original purchases for
Cardinal and the as-of adjustments and they affected the value of
holdings both of Cardinal-Allegiance and others. The mere denials
-14-
of knowledge by appellees a year or more later may be wrongful, but
the wrongs were not in our view the aiding and abetting of ongoing
securities fraud merely by dint of some other fiduciary to disclose
its errors or wrongs.
False statements that impede discovery of a crime or
fraud that has already been completed may well be punished in some
circumstances--for example, as perjury or obstruction of justice.
But those who lied do not thereby become responsible for the crime
or fraud itself unless it is then ongoing and assisted by the lie.
Cf. 18 U.S.C. § 1621 (2006); 2 LaFave, Substantive Criminal Law §
13.6 (2d ed. 2003). The distinction can greatly affect the
consequences for the offender; obstruction is one thing; liability
for the original wrong, another.
Ironically, the SEC's complaint might have sustained an
aiding and abetting claim based directly on appellees' alleged
agreement at the January 5, 2001, meeting. Where a wrongful act is
proposed, there is some precedent for treating as aiding and
abetting a bystander's contemporaneous assurance that no
repercussions will follow, and this might even be inferred from
silence where consciously intended to further a planned or an
ongoing violation.4
4
See State v. Conde, 787 A.2d 571, 579-82 (Conn. App. 2001),
cert. denied, 793 A.2d 251 (2002); see also State v. Doody, 434
A.2d 523, 529-30 (Me. 1981); LaFave, supra, § 13.2(a), at 340.
Compare Armstrong v. McAlpin, 699 F.2d 79, 92 (2d Cir. 1983)
(finding that "[a]wareness and approval, standing alone, do not
-15-
But the SEC has not relied upon such a theory in this
court; and the appellees have therefore had no reason to answer it.
And, of course, it depends on viewing the original transactions
themselves as violations of section 10(b) which is the argument
that the SEC seemed to make in its complaint but has not developed
on this appeal. So we mention this alternative only to make clear,
for future cases, that we have not considered and rejected it.
Affirmed.
constitute substantial assistance" to securities fraud where the
approval did not cause the underlying conduct).
-16-