23 May 2016 - Post by:Alexander Bussey
An ‘intent to deceive’ is all you need. So held the United States Court of Appeals for the Second Circuit in the recent case of United States v. Tagliaferri, which focused on clarifying the intent required for a criminal conviction of the anti-fraud provisions in the Investment Advisers Act of 1940 (the 1940 Act). An ‘intent to deceive’ constitutes a lower standard of criminal intent than is required for other fraud offences, such as wire fraud or common law fraud. As a result, the confirmation given by the Second Circuit in this case may embolden the government to prosecute conduct that it may not have otherwise attempted to prosecute.
A brief recap of the facts
An individual, Mr Tagliaferri, managed an investment advisory firm in the U.S. Virgin Islands which managed assets of around $252 million for 115 clients. In 2014, the U.S. Government charged Mr Tagliaferri with investment adviser fraud based on three categories of conduct.
- First, he operated a scheme whereby he received kickbacks for certain investments, failing to notify clients and later mischaracterizing the payments as consulting fees.
- Secondly, in violation of firm policy, Mr Tagliaferri purchased poorly-performing securities from one client’s account with the assets of another, without disclosing the transaction to either client.
- Thirdly, Mr Tagliaferri invested $5 million in a medical archive company and misled his clients to believe the investment was actually a loan, creating fictitious sub-notes that promised repayment and depositing the fake notes into client accounts.
At trial, Mr Tagliaferri argued that he made each investment decision with a good-faith belief that the investments were in his clients’ best interests – that is, he never intended to harm his clients. Nevertheless, the jury returned a guilty verdict. Mr Tagliaferri appealed.
Question on appeal: Criminal intent
At the charging conference, the jury was instructed that a finding of fraud under the 1940 Act required proof of the defendant’s ‘specific intent to defraud’. Further, a criminal conviction required a ‘willful’ violation of the 1940 Act. The jury was instructed that “intent to defraud” meant acting ‘knowingly and with the intent to deceive’. On appeal, Mr Tagliaferri argued that the jury should have been instructed that willful ‘intent to defraud’ requires proof of both intent to deceive and intent to harm. The Second Circuit disagreed and affirmed Mr Tagliaferri’s conviction.
But intent to deceive is sufficient, says the Second Circuit
From the outset, the court acknowledged that the purpose of the 1940 Act was ‘to eliminate, or at least to expose, all conflicts of interest which might incline [an] investment adviser—consciously or unconsciously—to render advice which was not disinterested’, particularly in light of ‘the delicate fiduciary nature of an investment advisory relationship’. As such, the 1940 Act should be construed ‘not technically and restrictively, but flexibly to effectuate its remedial purposes’.
The court then turned to undertake a comparison of the Act with other securities laws. For example, it noted that both the Act and the Securities Act of 1933 (the 1933 Act) prohibit practices that ‘operate as a fraud or deceit’. In the civil context, with regard to the 1933 Act, the Supreme Court has explained that a violation of this provision requires no specific intent whatsoever, much less intent to harm (Aaron v. SEC, 446 U.S. 680 (1980)). Additionally, the 1940 Act prohibits practices that are ‘fraudulent, deceptive, or manipulative’. The court explained that in the context of other securities laws, the phrase ‘fraudulent, deceptive, or manipulative’ has been construed to cover conduct motivated not only by intent to harm, but also intent to deceive. As such, the intent element for a civil violation of the 1940 Act’s antifraud provisions would also be satisfied by intent to deceive.
The court then explained that the willfulness element for a criminal conviction simply requires that the defendant knew his conduct was unlawful. Therefore, notwithstanding this heightened standard, considering the ‘special context of a fiduciary relationship’ between an investment adviser and his client, the court found it would be inconsistent with the language and purpose of the statute to require a showing of intent to harm to establish the state of mind required for a criminal conviction under the 1940 Act.
So what’s the impact?
The Second Circuit has now reaffirmed twice in the last six months that the criminal antifraud provisions of the securities laws have a lower intent standard than that of wire fraud or common law fraud, both of which require intent to harm. In United States v. Litvak (808 F.3d 160 (2d Cir. 2015)), the Court confirmed that intent to deceive is the standard for criminal violations of the Securities Exchange Act of 1934. As a result of these decisions, the government may now be emboldened to prosecute conduct that it would not have previously acted against, given the lower standard of proof required in order to convict.
Tagliaferri also serves as a reminder that the U.S. Department of Justice is not only focused on holding individuals who work at large banks to account. It will also pursue prosecutions of individuals working at smaller firms.