KATHERINE POLK FAILLA, District Judge.
Plaintiff Securities and Exchange Commission (the "SEC") brought this civil enforcement action against Defendants Adam Mattessich and Joseph Ludovico (collectively, "Defendants"), two securities brokers formerly employed by Cantor Fitzgerald & Co. ("Cantor" or the "Firm"). The Complaint alleges that Defendants schemed to circumvent Cantor's established procedures for paying and recording commission payments to its brokers, and in so doing aided and abetted Cantor's violations of Rule 17a-3(a)(19), 17 C.F.R. § 240.17a-3(a)(19), which was promulgated under the Securities Exchange Act of 1934 (the "Exchange Act"), Pub. L. 73-291, 48 Stat. 881, and which requires registered broker-dealers to make and keep accurate records of each securities transaction attributable, for compensation purposes, to each broker. Defendants now seek to dismiss the Complaint under Federal Rule of Civil Procedure 12(b)(6). Taking the Complaint's well-pleaded allegations as true, the Court finds that the SEC has stated a claim against Defendants for aiding and abetting Cantor's books and records violations.
Cantor has been a registered broker-dealer with the SEC since December 1947. (Compl. ¶ 18). It pays commission compensation to its brokers for securities transactions that they broker on behalf of Cantor's customers. (Id. at ¶ 19). From at least
Cantor relies upon the AE system to ensure compliance with various regulatory and tax obligations, including Exchange Act Rule 17a-3(a)(19)(i), 17 C.F.R. § 240.17a-3(a)(19)(i) (the "Compensation Record Rule"), which became effective in May 2003. (Compl. ¶ 22). The Compensation Record Rule requires registered broker-dealers to make and keep a record
17 C.F.R. § 240.17a-3(a)(19)(i).
Since at least 2006, Cantor's Written Supervisory Policies (the "WSPs") have expressly prohibited off-book commission-splitting. (Compl. ¶ 23). Specifically, Section 2.1 of the WSPs, titled "Business Conduct of Cantor Fitzgerald Registered Representatives," states:
(Id.). All brokers at Cantor are required to certify their compliance with the Firm's WSPs, including Section 2.1, on an annual basis. (Id. at ¶ 24).
In or about 2002, Mattessich — then a senior execution trader at Cantor — requested, but was denied, permission from his supervisor to receive commission compensation on certain customer accounts that he serviced. (Compl. ¶¶ 2, 27). Mattessich's supervisor instructed Mattessich to transfer the accounts to more junior sales traders for coverage. (Id. at ¶ 27). Mattessich then approached Ludovico and another junior sales trader (the "Junior Sales Trader") with a scheme to circumvent the supervisor's decision and the Firm's established procedures for the paying and recording of commissions. (Id. at ¶¶ 3, 28). Mattessich proposed that certain accounts he serviced be reassigned to Ludovico's and the Junior Sales Trader's AE codes, since they were eligible to receive commission compensation under the Firm's policies. (Id.). Once Ludovico and the Junior Sales Trader received the net commission from Cantor, they would remit some portion of it to Mattessich via personal check. (Id. at ¶ 30).
Mattessich's scheme financially benefitted all participants. (Compl. ¶ 31). For instance, by taking on the additional accounts Mattessich transferred to him, Ludovico received additional compensation from Cantor. (Id.). Ludovico generally retained approximately 50% of the net commissions he received on the accounts transferred to him by Mattessich. (Id.). From January to December 2013, Ludovico gave Mattessich personal checks totaling at least $58,200 in connection with their commission-splitting arrangement. (Id. at ¶ 34).
Unsurprisingly, neither Ludovico nor Mattessich disclosed the commission-splitting to Cantor, nor did they keep records of the commission compensation paid to Mattessich. (Compl. ¶ 40). As a result, Cantor did not make and keep records of the compensation Mattessich received through the scheme, and Cantor did not have information about such compensation available to provide regulators when requested. (Id.). In February 2018, Mattessich and Ludovico were permitted to resign voluntarily from Cantor as a result of this conduct. (Id. at ¶ 39). On June 29, 2018, contemporaneous with the filing of this action, the SEC settled administrative cease-and-desist proceedings against Cantor regarding books and records violations. (Id. at ¶ 18).
The SEC filed the Complaint in this action on June 29, 2018. (Dkt. #1). On July 31, 2018, Defendant Ludovico requested leave to file a motion to dismiss. (Dkt. #26). On August 30, 2018, the Court held a pre-motion conference and set a briefing schedule for Defendants' motions to dismiss. (Dkt. #32). On September 21, 2018, Defendant Mattessich notified the Court that he would join in any motion to dismiss filed by Defendant Ludovico. (Dkt. #34).
When considering a motion to dismiss under Federal Rule of Civil Procedure
The Complaint charges Mattessich and Ludovico each with a single count of aiding and abetting Cantor's violations of Section 17(a) of the Exchange Act, 15 U.S.C. § 78q, and Rule 17a-3(a)(19), 17 C.F.R. § 240.17a-3(a)(19), promulgated thereunder. The SEC seeks both injunctive relief, enjoining Defendants from future violations of Section 17(a) of the Exchange Act, as well as civil penalties pursuant to Section 21(d)(3) of the Exchange Act, 15 U.S.C. § 78u(d)(3).
Section 20(e) of the Exchange Act establishes liability for those who aid and abet others in securities violations. 15 U.S.C. § 78t(e). It provides that:
Id.
To state a claim for aiding and abetting, the SEC must allege three things: "[i] the existence of a securities law violation by the primary (as opposed to the aiding and abetting) party; [ii] knowledge of this violation on the part of the aider and abettor; and [iii] substantial assistance by the aider and abettor in the achievement of the primary violation." SEC v. Apuzzo, 689 F.3d 204, 211 (2d Cir. 2012) (internal quotation marks omitted) (citing SEC v. DiBella, 587 F.3d 553, 566 (2d Cir. 2009)). Defendants' motion to dismiss argues that the SEC has failed adequately to allege all three elements of an aiding and abetting claim. The Court disagrees with Defendants as to all three elements.
Section 17(a) of the Exchange Act provides that "[e]very . . . [registered] broker or dealer . . . shall make and keep for prescribed periods such records . . . as the Commission, by rule, prescribes as necessary or appropriate[.]" 15 U.S.C. § 78q(a)(1). Pursuant to Section 17(a), the SEC enacted the Compensation Record Rule, which became effective on May 2, 2003. As noted, the Rule requires broker-dealers to make and keep current
17 C.F.R. § 240.17a-3(a)(19)(i).
By its terms, the Compensation Record Rule requires broker-dealers, such as Cantor, to record the amount of monetary compensation attributable to each associated person (i.e., broker) for each purchase and sale of a security. Compensation is "attributable" to an employee if it is earned or accrued in favor of such employee. See Books and Records Requirements for Brokers and Dealers Under the Securities Exchange Act of 1934 (hereinafter, "Books and Records Requirements"), 76 S.E.C. Docket 343, Release No. 34-44992, 2001 WL 1327088, at sec. III(E) (Oct. 26, 2001) ("Under this requirement, firms must make records of all commissions, concessions, overrides, and other compensation to the extent they are earned or accrued for transactions." (emphases added)). The Complaint here alleges that Mattessich earned (and received) commission compensation on customer accounts for which Cantor's books and records reflected that the commission was attributable to Ludovico. Thus, the SEC argues, and the Court agrees, Cantor violated the Compensation Record Rule.
Defendants argue that the Complaint does not allege a primary violation of the Compensation Record Rule because the Rule requires that a registered broker-dealer keep records of only the compensation that it pays to its brokers, and does not reach private agreements between brokers to split commissions. (See Def. Br. 7). They contend that because Cantor's records accurately reflected the compensation that Cantor itself paid to Ludovico and Mattessich, Cantor did not violate the Compensation Record Rule. (See id. at 8).
Defendants' argument is too clever by half: It reads a limitation into the Rule, regarding who pays the compensation, that is untethered from the plain language of the Rule.
Defendants' attempt to characterize their remuneration scheme as a private agreement between brokers to share post-tax compensation (see Def. Br. 7, 12, 15; Def. Reply 2), does not take it outside the scope of the Rule. The Complaint alleges that Ludovico shared his post-tax compensation with Mattessich because part of that compensation constituted commission that was owed, or attributable, to Mattessich for accounts that Mattessich had transferred to Ludovico.
Further, Defendants' interpretation is inconsistent with the stated purpose of the Compensation Record Rule, which is to "allow securities regulators to quickly identify compensation trends and focus examinations." Books and Records Requirements, 2001 WL 1327088, at sec. III(E). The purpose of the Rule is thwarted to the extent that brokers can enter private agreements to share commission compensation that are not reflected on the broker-dealer's books and records.
Defendants next point to the Compensation Record Rule's rule-making history to argue that if the SEC had wanted to prohibit commission-splitting, then the five SEC rule-making releases issued over seven years would have said so. (See Def. Br. 10-11). But the SEC concedes that commission-splitting is not per se prohibited (see Transcript of Aug. 30, 2018 Pre-Motion Conference (Dkt. #37) at 26:12-27:16), and that is not the violation with which the SEC has charged Defendants. On-the-books commission-splitting is permitted by both Cantor's internal systems and the Compensation Record Rule. Thus, it is of no moment that the rulemaking history does not address commission-splitting. Had Cantor's books and records reflected Mattessich's and Ludovico's commission-splitting scheme, then Cantor would not have violated the Compensation Record Rule.
Defendants' final contention on the primary violation element, that the Rule is vague because it did not put the industry on notice that it would apply to post-tax commission-sharing between brokers, is belied by the Rule's plain language, which, as noted above, does not contain any exclusions. Defendants claim that if the Compensation Record Rule "spelled out to broker-dealers" that commission-splitting must be recorded, then broker-dealers could have, inter alia, "issued compliance alerts, [and] amended internal policies."
Turning to the second element of the aiding and abetting violation, the Court finds that the Complaint adequately alleges that Defendants had knowledge of Cantor's violations of the Compensation Record Rule. Specifically, the Complaint alleges that both Defendants were aware of Cantor's AE code system, which the Firm used to apportion and record commission payments (see Compl. ¶¶ 20, 29-30), and that Defendants secretly agreed to split commissions that were paid to Ludovico by Cantor, circumventing the AE code system (see id. at ¶¶ 30-32). Because Defendants knew that the AE code system reflected the commissions as paid to Ludovico, when in fact a portion of the commissions were transferred to Mattessich, Defendants knew that Cantor's compensation records were inaccurate. Such allegations suffice to show that Defendants had knowledge of Cantor's violations of the Compensation Record Rule. Cf. Apuzzo, 689 F.3d at 211 ("Apuzzo knew that the results from the transactions would be inaccurately reflected in URI's financial statements if the true structure of the transactions was not known to URI's auditor; and Apuzzo knew that URI's auditor was being misled." (emphases added) (quoting SEC v. Apuzzo, 758 F.Supp.2d 136, 148 (D. Conn. 2010))).
Defendants argue that because commission-sharing is in and of itself a legal and accepted practice, doing so did not give Defendants "knowledge" of primary violations of the securities laws by Cantor. (See Def. Br. 16-17). But the Complaint alleges facts indicating that Defendants knew their conduct to be wrongful. Specifically, the Complaint alleges that since 2006, Cantor's WSPs have expressly prohibited off-book commission-splitting. (See Compl. ¶ 23). The Complaint contains further allegations indicating that Defendants had notice that such conduct would cause Cantor to violate regulatory requirements. (See id. at ¶¶ 24-25). Both Defendants signed certifications attesting to their understanding that the purpose of the Firm's policies and procedures, including its policy against sharing commissions, was to ensure compliance with applicable regulatory requirements. (Id.).
Defendants also argue that they did not have knowledge of the specific SEC Rule that they caused Cantor to violate. In this regard, Defendants point out that "the Complaint does not allege that Ludovico was ever made aware of the [Compensation Record Rule's] passage[.]" (Def. Br. 17). However, to state a claim for aiding and abetting, the SEC need not allege that Defendants knew the specific books-and-records rule that they helped violate. The Compensation Record Rule itself contains no scienter requirement, see SEC v. Drexel Burnham Lambert Inc., 837 F.Supp. 587, 610 (S.D.N.Y. 1993), and the aiding and abetting provision of the Exchange Act requires only that the aider and abettor "knowingly or recklessly provide[] substantial assistance to another person" who commits a violation, 15 U.S.C. § 78t(e). Cf. SEC v. Falstaff Brewing Corp., 629 F.2d 62, 77 (D.C. Cir. 1980) ("Except in very rare instances, no area of the law not even the criminal law demands
To satisfy the substantial assistance component of an aiding and abetting violation, the SEC must show that a defendant "in some sort associated himself with the venture, that [he] participated in it as in something that he wished to bring about, and that he sought by his action to make it succeed." Apuzzo, 689 F.3d at 212 (internal quotations and alterations omitted). The SEC is not required to plead that the aider and abettor proximately caused the primary securities law violation. Id. at 213.
The Complaint alleges that Mattessich and Ludovico agreed to engage in a compensation-splitting scheme and that they participated in the scheme when Ludovico paid and Mattessich accepted, on a monthly basis, a portion of the commissions Ludovico received on certain accounts. The allegations of Defendants' active steps to implement and carry out the scheme include Ludovico's writing of commission checks to Mattessich and Mattessich's acceptance of such checks totaling over $58,200. (See Compl. ¶¶ 32, 34). Those steps, in combination with their failure to report such commission-splitting scheme to Cantor, are sufficient to support an allegation of substantial assistance. See, e.g., Drexel Burnham Lambert, 837 F. Supp. at 610 (holding that defendants aided and abetted broker-dealer's violation of books and records rule under Section 17(a) of the Exchange Act and Rules 17a-3 and 17a-4 promulgated thereunder where they failed to record beneficial interests in securities purchased through the broker-dealer); In re Howard A. Rubin, SEC Release No. 27828, 1990 WL 1102975, at *2 (Mar. 20, 1990) (Settled Administrative Order) (finding that individual aided and abetted Rule 17a-3 where he "did not record, and caused not to have been recorded, on a blotter or other record, any information" concerning a transaction by a broker-dealer).
Defendants' corollary argument — that the SEC was also required to allege recklessness here because recklessness is a statutory element for an aiding-and-abetting claim under Section 20(e) of the Exchange Act (see Def. Br. 24) — is incorrect. Section 20(e) of the Exchange Act states that one can be held liable for aiding and abetting if that person "knowingly or recklessly provides substantial assistance." 15 U.S.C. § 78t(e) (emphasis added). Thus, the SEC can allege either knowledge or recklessness; it need not allege both. Given that the SEC has adequately pleaded that Defendants knowingly provided substantial assistance, the SEC's failure to plead separately that Defendants were reckless does not warrant dismissal of its Complaint.
For the reasons stated in this Opinion, Defendants' motion to dismiss is DENIED. The Clerk of Court is directed to terminate the motion at docket entry 35. On or before September 23, 2019, the parties shall submit a proposed Case Management Plan, as well as the joint status letter contemplated by the Plan.
SO ORDERED.