by Greg Morvillo and Christine Hanley

Rudyard Kipling famously quipped “Oh, East is East and West is West and never the twain shall meet.”  Although crafted in 1889, this sentiment is newly applicable to a D.C. Circuit Court of Appeals opinion in The Robare Group v. S.E.C, 922 F.3d 468, 479-80 (D.C. Cir. 2019).  The D.C. Circuit essentially held that Willfulness is Willfulness and Negligence is Negligence, and never the twain shall meet, only less poetically.  This potentially landmark decision held that willfulness and negligence are mutually exclusive standards of liability – one requiring intent to commit wrongdoing and the other requiring a lack of intent to commit wrongdoing – and the SEC cannot impose civil liability under both standards for the same conduct. 

Robare arose out of a 2014 administrative cease and desist proceeding against The Robare Group (“TRG”), an investment advisory firm, and its principals and co-owners, Mark L. Robare and Jack L. Jones.  The complaint alleged that respondents received a fee from Fidelity Investments (“Fidelity”), which provided clearing services for TRG’s advisory clients, whenever TRG’s clients invested in certain funds offered on Fidelity’s online platform.  The SEC further alleged that TRG failed to disclose this fee and that TRG had a conflict of interest arising from the revenue-sharing arrangement between TRG and Fidelity. 

The SEC alleged that TRG’s failure to disclose the fee arrangement in, among other things, its Forms ADV violated Sections 206(1), 206(2) and 207 of the Investment Advisers Act of 1940.  The Advisers Act imposes “federal fiduciary duty standards”[1] on investment advisors, requiring them to disclose “all material facts and all possible conflicts of interest.”[2]  Section 206(1) penalizes the failure to disclose potential conflicts of interest to clients or potential clients with scienter, which is defined as the “intent to deceive, manipulate, or defraud,”[3] while Section 206(2) penalizes the same conduct done negligently.  Additionally, Section 207 penalizes the willful misrepresentation or omission of a material fact in Form ADV.

On review before the SEC, the Commission determined that for purposes of Section 206, TRG and its principals’ failure to disclose the revenue sharing arrangement in its Forms ADV and other materials was negligent.  However, under Section 207, the Commission imposed liability calling the exact same conduct “willful.”  The Commission reasoned that Robare and Jones had “both reviewed each of the Forms ADV before filing” them and “were responsible for [their] content.”  The Commission concluded that “willfulness” for purposes of Section 207 required only that Robare and Jones “acted intentionally, as opposed to involuntarily” when reviewing and filing the Forms ADV.

TRG, Robare, and Jones appealed the Commission’s decision to the D.C. Circuit Court of Appeals.  The appellate court upheld the Commission’s negligence finding under Section 206 but reversed its finding of willfulness, holding that the Commission had misinterpreted the willfulness standard under Section 207.  In doing so, the appellate court assumed (but did not decide) that “willfulness” has the same meaning under Section 207 that it has under Section 15(b)(4) of the Securities Exchange Act of 1934.  For purposes of that section, the D.C. Circuit previously held in Wonsover v. SEC, 2015 F.3d 408, 414 (D.C. Cir. 2000) that “willfully” means “intentionally committing the act which constitutes the violation.” 

The appellate court concluded that, as applied to Section 207, “willfulness” per Wonsover required not just that Robare and Jones intentionally reviewed and filed the Forms ADV, but that they did so intending to omit material information.  The appellate court contrasted willfulness to negligence, where the actor has no intent to commit a violation but nevertheless acts in a manner that is unreasonable.  It concluded by holding that because the Commission found that Robare and Jones’ conduct was negligent but not intentional or reckless, it could not in the same breath find the identical conduct to be willful. 

Robare’s impact on SEC civil enforcement actions – which the SEC uses to suspend or bar registered entities and broker-dealers from working in the industry and to seek disgorgement and civil penalties – is not settled.  It will depend on courts’ willingness to apply the D.C. Circuit’s interpretation of “willfulness” outside the context of the Advisers Act to civil liability provisions in other federal securities statutes.  Courts have typically interpreted “willfulness” in the context of civil liability under the federal securities statutes to require knowledge of one’s actions without necessarily possessing a “bad purpose” or an intent to break the law.[4]  If courts determine that Robare’s holding applies broadly, it could significantly limit the SEC’s ability to litigate and settle civil enforcement actions against defendants on tandem theories of willfulness and negligence for the same conduct.   

Logic dictates that the SEC will attempt to limit Robare’s application as much as possible, but that may prove difficult considering that the D.C. Circuit stated it was merely borrowing the interpretation of willfulness already used in the context of Section 15(b)(4) of the Exchange Act.  Thus, Robare’s holding that willfulness and negligence are distinct theories of liability already has a foothold in at least two federal securities statutes.  Kipling would approve.   

Footnotes

[1] Transamerica Mortg. Advisors, Inc. v. Lewis, 444 U.S. 11, 17 (1979).

[2] Laird v. Integrated Res., Inc., 897 F.2d 826, 835 (5th Cir. 1990); see also S.E.C. v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 186 (1963); Vernazza v. SEC, 327 F.3d 851, 860 (9th Cir. 2003).

[3] S.E.C. v. Steadman, 967 F.2d 636, 641 (D.C. Cir. 1992).

[4] See, e.g., United States v. Schwartz, 464 F.2d 499, 510 (2d Cir. 1972) (“it seems reasonably well settled that ‘willfully’ in the SEC statutes does not have any ‘bad purpose’ connotation”) (citation omitted); Hughes v. Sec. & Exch. Comm’n, 174 F.2d 969, 977 (D.C. Cir. 1949) (“‘It is only in very few criminal cases that ‘willful’ means ‘done with a bad purpose.’ Generally, it means ‘no more than that the person charged with the duty knows what he is doing. It does not mean that, in addition, he must suppose that he is breaking the law.”); Gearhart & Otis, Inc. v. Sec. & Exch. Comm’n, 348 F.2d 798, 803 (D.C. Cir. 1965) (“a willful violation of Section 7 of the Securities Act amounts to a willful violation of Exchange Act 15(b)(4)”).

Greg Morvillo is a partner and Christine Hanley is an associate at Orrick Herrington & Sutcliffe LLP.

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