D.C. Circuit Tells SEC That a Negligent Omission Can’t Be Willful

What happened here? The case involved an adviser’s failure to disclose compensation it received through a revenue sharing agreement and the conflicts of interest associated with the compensation. The Commission argued that principals of The Robare Group (TRG) “acted willfully because ‘they both reviewed each of the Forms ADV before filing’ them with the Commission . . . , ‘were responsible’ for the forms’ content” and “‘acted intentionally, as opposed to involuntarily’ because they ‘intentionally chose the language contained in the Forms ADV and intentionally filed those Forms.’” Robare, No. 16-1453 at 17. However, the Commission conceded that the principals had acted negligently and did not subjectively intend to omit material information. The court held that, although TRG and its principals negligently failed to disclose the agreement and conflicts of interest in the firm’s Forms ADV, the SEC must show more than just negligence to support a finding of willfulness under Section 207.

Because the Commission did not find that TRG’s principals acted recklessly or intentionally, the court also held the Commission could not sustain a finding of willfulness under Section 207. The court stated that the Commission’s willfulness analysis “misinterpret[ed] Section 207, which does not proscribe willfully completing or filing a Form ADV that turns out to contain a material omission but instead makes it unlawful ‘willfully to omit . . . any material fact’ from a Form ADV.” Id. (emphasis in original). The court added that the “statutory text signals that the Commission had to find, based on substantial evidence, that at least one of [the firm’s] principals subjectively intended to omit material information from [the firm’s] Forms ADV.” Id. Citing non-securities authority, the court found that “intent” and “negligence” are mutually exclusive grounds for liability. Id.

Of Wonsover and willfulness. For many years, the SEC regularly included in settled enforcement actions a “willful” finding, citing Wonsover v. SEC, 205 F.3d 408, 414 (D.C. Cir. 2000). The willfulness finding permits the Commission to impose administrative sanctions in administrative proceedings under certain provisions of the federal securities laws and also triggers certain collateral consequences, including, statutory disqualification under the Exchange Act, although it otherwise is not considered to necessarily find or imply scienter. Thus, until the Robare decision, the Wonsover standard was generally considered to be a low bar: “[W]illfully . . . means intentionally committing the act which constitutes the violation” and does not require that “the actor . . . also be aware that he is violating one of the Rules or Acts.” Id. (citation omitted). Indeed, it is rare for the SEC to find a violation without also finding the conduct willful even in cases involving strict liability or negligence. For example, in the recent settlements in the SEC’s mutual fund Share Class Selection Disclosure Initiative, the consent orders included the traditional language that the Sections 206(2) and 207 violations were willful, as in Robare, even without any allegation of knowledge or intent. This nonetheless triggered statutory disqualifications under the Exchange Act and other collateral consequences for initiative participants. In contrast, many other statutes, including the criminal provisions of the federal securities laws, require a showing of an intent to commit a willful act that violated the law.

Interestingly, the Robare court assumed that Wonsover was the appropriate standard for willfulness but simply rejected the Commission’s application of that standard of willfulness under Section 207. Wonsover involved willfulness under Section 15(b)(4) of the Exchange Act.  In that case, the Commission found that Wonsover had violated Section 5 of the Securities Act of 1933, which does not require scienter, but also found that Wonsover knew his inquiry into the sources of unregistered securities at issue was inadequate under the circumstances. As a practical matter, the Robare court appears to have articulated a standard of willfulness more akin to scienter than the Commission’s traditional interpretation of Wonsover. If simple negligence is not sufficient—or more dramatically, cannot be simultaneously charged with Section 207 as the opinion seems to suggest—this decision will narrow the range of cases that qualify for a Section 207 charge. And read together, these cases suggest that courts may require a finding of some intent beyond simply committing a negligence-based violation in order to be found willful even under other provisions of the federal securities laws.

What of negligence? The opinion has some important guidance regarding negligence cases charged by the Commission as well. In Robare, the court agreed with the Commission that TRG acted negligently by “persistently fail[ing] to disclose known conflicts of interest arising from the payment arrangement,” even though TRG’s “principals acknowledged the payment arrangement [] created potential conflicts of interest and that they knew of their obligation to disclose this information to clients.” Robare, No. 16-1453 at 12–13. Based on the specific facts here, the court held that the Commission did not need expert testimony that the defendants violated an industry standard of care and held that conformance with an industry standard of care would not necessarily defeat a finding of negligence. The court concluded that the defendants’ clear, repeated violations of their fiduciary duty were unreasonable, and therefore demonstrated negligence.

Takeaways: The Commission staff is evaluating what this opinion means for the Enforcement program. With the D.C. Circuit finding that negligent conduct cannot be deemed “willful” for purposes of Section 207, there are many questions about how the Commission will charge Advisers Act cases and what effect this decision may have on the application of willfulness in other areas of the federal securities laws such as Exchange Act Section 15(b)(4)(D), Advisers Act Section 203(e)(5), and Section 9(b) of the Investment Company Act of 1940. The SEC may also need to consider whether the D.C. Circuit finding impacts the ability of the SEC in certain circumstances to impose on SEC registrants administrative sanctions in administrative proceedings that are premised on provisions of the federal securities laws that require a willful violation (e.g., pursuant to Section 15(b) of the Exchange Act or Section 203(e) or (f) of the Advisers Act). As a result, in the near term it will be important to carefully evaluate whether a willfulness charge is appropriate in each matter—whether ongoing or future settlement negotiations, pending settlements or litigation— particularly where negligence-based charges form the core of a matter.