United States Securities and Exchange Commission v. Paulsen

Background

The Securities and Exchange Commission brought a civil enforcement action against John A. Paulsen, alleging that he aided and abetted securities-law violations by Deborah Kelley and Navnoor Kang. Paulsen and Kelley worked at Sterne Agee, a broker-dealer. Kang was the Director of Fixed Income and Head Portfolio Strategist for the New York State Common Retirement Fund. The Fund prohibited Kang from accepting gifts, meals, travel, or entertainment valued above $15.

The Commission’s evidence concerned a three-day ski trip to Park City, Utah, in February 2015. Kelley and Paulsen spent approximately $11,000 on the trip, including lodging, meals, ski-related expenses, and transportation for Kang and Kang’s girlfriend. Paulsen personally paid for a $125 lunch. Afterward, Kelley told Paulsen not to identify Kang or Kang’s girlfriend on his expense report. Paulsen understood that Kang was not supposed to accept entertainment from Sterne Agee employees. His expense reports inaccurately identified attendees at meals, and he later participated in a plan with Kelley to provide investigators with a false account of the trip.

Kelley and Kang later pleaded guilty to conspiracy charges involving honest-services wire fraud and securities fraud. Kelley admitted that she paid Kang’s expenses to obtain Fund business, and Kang admitted that he understood the payments were exchanged for directing Fund business to Sterne Agee.

Claims and legal standard

The Commission asserted four claims. It alleged that Paulsen aided and abetted Kelley’s violations of Sections 17(a)(1) and 17(a)(3) of the Securities Act, and her violations of Section 10(b) of the Securities Exchange Act and Rule 10b-5. It made the same two types of allegations concerning Kang.

To prove aiding-and-abetting liability, the Commission had to show a primary securities-law violation, Paulsen’s knowledge of that violation, and substantial assistance. “Scienter,” in this context, refers to the required knowledge or intent. For substantial assistance, the Commission had to provide evidence that Paulsen associated himself with the illegal venture, participated in it as something he wanted to help accomplish, and took active steps to help it succeed. Mere awareness or approval of another person’s violation was not enough.

At the summary-judgment stage, the court could rule for the moving party only if there was no genuine dispute about any important fact and the moving party was entitled to judgment as a matter of law. The court had to view reasonable factual inferences in Paulsen’s favor because he opposed the Commission’s motion.

Analysis

The Commission argued that Paulsen had a general awareness of his role in the alleged scheme because he knew the Fund’s gift rules, participated in the ski trip, concealed the entertainment on expense reports, and lied to investigators. It also argued that Paulsen’s discussion with Kelley about an energy trade showed that he knew Kang was directing Fund trades to Sterne Agee in exchange for entertainment.

Judge Gardephe concluded that the evidence did not establish Paulsen’s knowledge and intent as a matter of law. The court stated that violating the Fund’s and Sterne Agee’s gift and entertainment policies did not, by itself, establish securities fraud. The Commission needed evidence that Paulsen knew, or recklessly disregarded, that Kelley was providing entertainment to Kang in exchange for Kang directing Fund trades to Sterne Agee.

The court identified competing interpretations of Paulsen’s conduct. The Commission could argue that his inaccurate expense reports, efforts to keep the trip quiet, and statements to investigators showed that he knew about and helped conceal an illegal exchange. Paulsen, however, offered evidence that he acted to protect Kelley and Kang from discipline without knowing about a securities-law violation or an agreement to exchange entertainment for Fund business. The court also found that the energy-trade discussion and Paulsen’s communications with Kelley did not conclusively establish his knowledge of such an exchange.

Because a reasonable jury could accept Paulsen’s explanation, the court held that material factual disputes existed concerning scienter. Those disputes involved credibility, intent, and the meaning of the surrounding evidence, which the court said were matters for a jury rather than a judge on summary judgment.

Disposition

The court denied the Securities and Exchange Commission’s motion for summary judgment. It directed the Clerk of Court to terminate Docket Nos. 72 and 83 and stated that the matter would proceed to trial on July 13, 2020. The order did not determine Paulsen’s ultimate liability on the claims.