Sec. & Exch. Comm'n v. Rashid
| Decision Date | 23 September 2020 |
| Docket Number | 17-cv-8223 (PKC) |
| Parties | SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. MOHAMMED ALI RASHID, Defendant. |
| Court | U.S. District Court — Southern District of New York |
FINDINGS OF FACT AND CONCLUSIONS OF LAW
Defendant Mohammed Ali Rashid is a former senior partner at the private-equity firm Apollo Management, L.P. ("Apollo" or the "Company"). Plaintiff Securities and Exchange Commission ("SEC") asserts that Rashid fraudulently claimed that personal expenses were business expenses and these expenses were thereafter paid by private-equity funds advised by Apollo and Rashid. At trial, the SEC proved that Rashid was reimbursed for personal expenses that included a New Year's trip to Brazil, a friend's bachelor party and wedding, a flight to the Super Bowl and numerous dinners with friends and family at high-end Manhattan restaurants. The SEC urges that Rashid's submission of false expense reports violates sections 206(1) and (2) of the Investment Advisers Act of 1940 (the "Advisers Act"), 15 U.S.C. §§ 80b-6(1), (2), or, alternatively, that he aided and abetted violations of the Advisers Act pursuant to sections 209(d) and (f), 15 U.S.C. §§ 80b-9(d), (f).
The Court presided at a nine-day bench trial at which 33 witnesses testified. The Court now finds that the SEC proved by the preponderance of the evidence that Rashid engaged in a practice of knowingly and falsely submitting personal expenses as business expenses and was recklessly indifferent to whether these false business expenses were charged to the funds he advised. The Court finds that: (1) Rashid knowingly, repeatedly and falsely claimed that personal expenses were business expenses; (2) Rashid, as a senior partner of Apollo, acted with reckless indifference in failing to ensure that none of these false business expenses were charged to the funds he advised; and (3) the false business expenses, in fact, were charged to the funds, thereby operating as a fraud upon them. These findings lead to the conclusion that Rashid violated section 206(2) of the Advisers Act. The Court will enter a permanent injunction against Rashid's future violations of section 206, and assess a first-tier civil penalty of $7,500 for each of his thirty-two separate violations that the SEC proved at trial.
"A fundamental purpose" in Congress's passage of the Advisers Act "was to substitute a philosophy of full disclosure for the philosophy of caveat emptor and thus to achieve a high standard of business ethics in the securities industry." SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 186 (1963). "Section 206(1) and 206(2) of the [Investment Advisers] Act set 'federal fiduciary standards to govern the conduct of investment advisers' and impose 'enforceable fiduciary obligations' on those advisers." SEC v. Penn, 225 F. Supp. 3d 225, 236 (S.D.N.Y. 2016) (Caproni, J.) (quoting Transamerica Mortg. Advisors, Inc. (TAMA) v. Lewis, 444 U.S. 11, 17 (1979)). "Given the 'delicate fiduciary nature of . . . [the] investment advisory relationship,' Section 206 places 'an affirmative duty' on advisers to act with the 'utmost good faith, and [with] full and fair disclosure of all material facts, as well as an affirmative obligation to employ reasonable care to avoid misleading.'" SEC v. Gruss, 245 F.Supp. 3d 527, 591 (S.D.N.Y. 2017) (Sweet, J.) (quoting Capital Gains Research Bureau, Inc., 375 U.S. at 194).
Section 206(1) makes it unlawful for an investment adviser to knowingly and intentionally defraud a client, whereas section 206(2) makes it unlawful to engage in conduct that "operates as a fraud" on a client. Section 206(1) states that: "It shall be unlawful for any investment adviser by use of the mails or any means or instrumentality of interstate commerce, directly or indirectly - (1) to employ any device, scheme, or artifice to defraud any client or prospective client . . . ." 15 U.S.C. §§ 80b-6(1). Section 206(2) makes it unlawful "to engage in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client . . . ." Id. § 80b-6(2).
Because of the distinction between intentional fraud and conduct that "operates as a fraud," liability under sections 206(1) and (2) have different state-of-mind requirements. A defendant may be liable under section 206(2) based on proof of negligence. See, e.g., SEC v. DiBella, 587 F.3d 553, 569 (2d Cir. 2009) ( ). To be liable under section 206(1), a defendant must have acted with scienter. Dembski v. United States Sec. & Exch. Comm'n, 726 Fed. App'x 841, 844 (2d Cir. 2018) ("Scienter is required for a Section 206(1) violation but need not be found for a violation of Sections 206(2) or (4).") (summary order) (citing In the Matter of David Henry Disraeli & Lifeplan Assocs., Inc., SEC Release No. 8880 (Dec. 21, 2007)); accord SEC v. Moran, 922 F. Supp. 867, 896-97 (S.D.N.Y. 1996); SEC v. Treadway, 430 F. Supp. 2d 293, 338 (S.D.N.Y. 2006) () (Marrero, J.). This is because the language of section 206(1) "is identical in all relevantrespects" to section 17(a)(1) of the Securities Act of 1933, 15 U.S.C. § 17q(a), which has a well-established scienter requirement." Moran, 922 F. Supp. at 896 (citing Aaron v. SEC, 446 U.S. 680, 697 (1980)). By contrast, when Congress prohibited activity that "operates as a fraud or deceit," as in section 206(2), it did not require proof of intent to injure or defraud. See, e.g., Moran, 922 F. Supp at 897.
Thus, in order to prove the section 206(1) claim, the SEC must demonstrate by a preponderance of the evidence that in submitting his expense reports, Rashid employed a fraudulent scheme against his clients and did so with scienter. To prove the section 206(2) claim, the SEC need only demonstrate that Rashid's submissions operated as a fraud or deceit upon his clients, and that his state of mind was at least one of negligence.
The Court finds that the SEC failed to prove by a preponderance of the evidence that Rashid acted with the scienter required of section 206(1) in employing a device, scheme or artifice to defraud a fund. To be clear, the record amply demonstrates that Rashid intentionally submitted false expense reports for the purpose of obtaining reimbursement for his personal expenses. But the SEC failed to prove that Rashid had actual knowledge that the funds paid his expenses, or that his recklessness was of a nature that satisfies the scienter required under the federal securities laws. Rashid's false expense submissions listed research codes associated with various portfolio companies. Apollo itself then directed the funds who owned those companies to pay the entirety of Rashid's reimbursements. While Rashid lied on his expense reports and was recklessly indifferent about the source of his reimbursements, significant responsibility lies with Apollo.
The SEC urges that, in the alternative, Rashid is liable under the Advisers Act because he aided and abetted the fraudulent actions of his employer, Apollo. 15 U.S.C. § 80b-9(f). To prove that Rashid is liable for aiding and abetting a violation of section 206(1) or (2), the SEC must prove by a preponderance of the evidence "(1) the existence of a securities law violation by the primary (as opposed to the aiding and abetting) party; (2) knowledge of this violation on the part of the aider and abettor; and (3) substantial assistance by the aider and abettor in the achievement of the primary violation." DiBella, 587 F.3d at 566 (quotation marks omitted). "[T]o satisfy the 'substantial assistance' component of aiding and abetting, the SEC must show that the 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." SEC v. Apuzzo, 689 F.3d 204, 206 (2d Cir. 2012) (quotation marks and alterations omitted). The same lack of knowledge and intent that dooms the direct violation of section 206(1) also dooms the aider and abettor claim.
However, as noted, the Court finds that Rashid knowingly, falsely and repeatedly claimed that his personal expenses were business expenses and these false business expenses were, in fact, paid by the private-equity funds that he advised. He was recklessly indifferent to the identity of the entity who paid for these fake business expenses. Repeatedly, he caused or acquiesced in the entry of internal project codes corresponding to a portfolio company in which a fund held a large equity position and, thus, it was reasonably foreseeable to him that these phony business expenses would be charged to a fund. His knowing and deliberate actions had the effect of operating as a fraud on the funds. But even if his actions had been merely negligent, i.e., he failed to use reasonable care to ensure that his knowingly false business expenses were not charged to the funds, it nevertheless would support a finding that he violated section 206(2).
1. Rashid received a bachelor's degree from Georgetown University and an MBA from Stanford University. (Rashid Dec. ¶ 1.)1 He was employed at Apollo from 2004 until February 2014, during which time he was promoted to the job titles of partner and senior partner. (Fact Stip. ¶¶ 1, 3.)2
2. During his time at Apollo, Rashid was viewed as a "very hard worker" who put in long hours. (Tr. 14, 479.) His job primarily consisted of evaluating companies for possible investment, with his expertise principally focused on the metals and mining industries. (Rashid Dec. ¶ 2; Tr. 173.) His work required extensive travel. (Rashid Dec. ¶ 2.) Apollo ultimately entered into a separation agreement with Rashid, effective February 28,...
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