Second Circuit Holds that Investment Advisers Can Commit Fraud without Any Intent to Harm Clients
On May 4, 2016, in United States v. Tagliaferri (2016 WL 2342677), a Second Circuit panel affirmed the conviction of an investment advisor for violating Section 206 of the Investment Advisers Act of 1940, holding that Section 206 requires proof only that an adviser intended to deceive a client, and not necessarily that the adviser intended to harm the client. Much like the Second Circuit’s December 2015 decision in United States v. Litvak (808 F.3d 160), this decision focused on the nature of defendant Tagliaferri’s deception and not its outcome. In so holding, the panel clarified that prosecutors have a relatively low bar for obtaining convictions under Section 206.
Prosecutors from the Southern District of New York charged James Tagliaferri, the founder of a boutique investment advisory firm, with, among other things, fraud under Section 206 for allegedly investing his clients’ funds in exchange for undisclosed kickbacks. Tagliaferri argued that he could not be guilty under Section 206 because he never intended to harm his clients. Tagliaferri asked the trial court to instruct the jury that intent to harm was a necessary element of a Section 206 violation, but the Court declined to give this instruction, and Tagliaferri was convicted. Tagliaferri appealed the conviction to the Second Circuit, which affirmed.
In upholding the trial court’s jury instruction, the Second Circuit panel first noted that Section 206 “imposes criminal penalties on anyone who ‘willfully violates’ its provisions or any SEC rule or regulation promulgated thereunder.” The Second Circuit then found that, under Supreme Court precedent, “willful” meant “an act done with a bad purpose” and, under Second Circuit precedent, a showing of willfulness required only that the prosecution “establish a realization on the defendant’s part that he was doing a wrongful act.”
The panel then analyzed this definition of “willfulness” in the context of the acts prohibited under Section 206, which include “engag[ing] in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client,” and “engag[ing] in any act, practice, or course of business, which is fraudulent, deceptive, or manipulative.” The panel held that neither act “requires specific intent to harm” because “the former is effect‐focused, not intent‐focused, and the latter requires, at minimum, intent to deceive.” Since Section 206 was designed to “to capture conduct that was fraud [and] to capture conduct that ‘operates as a fraud,’” prosecutors were only required to prove that Tagliaferri intended to deceive his clients to convict him of violating Section 206.
Notably, in support of this holding, the panel relied in part on United States v. Litvak, a decision by a different Second Circuit panel in December 2015. In overturning a bond trader’s securities fraud conviction because the trader was not allowed to introduce certain expert testimony, the Litvak panel held that Section 10(b) of the Securities Exchange Act of 1934 did not require any proof of intent to harm. The Tagliaferri panel held that, since Litvak held that Section 10(b) does not require intent to harm, and since Section 10(b) has a stricter intent requirement than Section 206, it would be inconsistent to conclude that Section 206 required prosecutors to prove a specific intent to harm.
While investment advisers undoubtedly knew even before Tagliaferri that any deception of their clients would be improper, the decision is an important reminder that the sanctions for any deception can be criminal. It is no defense to contend that an act of deception was not intended to harm a client.