303 F. Supp. 3d 746
S.D. Ind.2018Background
- ITT Educational operated two private student‑loan programs (PEAKS trust and CUSO credit‑union program) for which ITT provided guarantees; high default rates in 2011–2013 increased ITT’s contingent obligations.
- SEC sued ITT, CEO Kevin Modany, and CFO Daniel Fitzpatrick in 2015 alleging deceptive practices: covertly making “payments on behalf of borrowers” (POBOB) to avoid trigger payments to PEAKS, understating CUSO liabilities by presenting a different payment method in disclosures, and misleading auditors and investors.
- SEC settled with ITT; claims against Modany and Fitzpatrick proceed to trial.
- Both sides filed partial summary‑judgment motions addressing discrete elements (interstate commerce, "in connection with"/"in the offer or sale," advice‑of‑counsel, scheme liability, control person liability, Rule 13b2‑2 deceit of auditors, and SOX §304).
- The court resolved some legal elements for trial (granted in part/denied in part): it found interstate‑commerce satisfied for certain filings/conference calls; held defendants are control persons for statements they signed; rejected primary liability under §17(a)(2) as to personal receipt of money; and left most scheme, omission, auditor‑deceit, aiding/abetting, and SOX scienter questions for the jury.
Issues
| Issue | Plaintiff's Argument (SEC) | Defendant's Argument (Modany & Fitzpatrick) | Held |
|---|---|---|---|
| Whether acts used interstate commerce / were "in connection with" purchases or sales (§10(b)) | Misstatements/omissions in public filings and earnings calls are designed to reach investors and thus satisfy interstate commerce and "in connection with" elements. | Defendants disputed the link to securities transactions and contested the SEC's reliance on allegations rather than record evidence. | Interstate‑commerce element conceded for specified filings/calls — GRANTED. "In connection with" element denied as to summary judgment because SEC relied on allegations, not record proof — DENIED. |
| Advice‑of‑counsel as an affirmative defense / evidence of scienter | SEC: defendants did not seek legal advice on the relevant disclosure issues, so they cannot rely on that defense. | Defendants: they do not assert advice‑of‑counsel as an affirmative defense but will use counsel advice as evidence negating scienter; record shows in‑house and outside counsel involvement. | Court denied SEC's motion to bar evidence because defendants disclaimed an affirmative defense; but defendants are precluded from asserting it as an affirmative defense at trial. |
| Scheme liability under Rule 10b‑5(a)/(c) — must there be deceptive acts beyond misstatements? | SEC: its evidence (lying to auditors/noteholders, hiding servicer‑removal option, POBOB) shows deceptive acts beyond misstatements. | Defendants: scheme liability cannot rest on mere misstatements and omissions; SEC must show inherently deceptive conduct separate from statements. | Court follows the majority view: scheme liability requires deceptive acts beyond misstatements. On the record, SEC presented disputed evidence of such acts (misleading auditors, hiding counsel opinion, etc.), so defendants' summary judgment motion on scheme liability denied. |
| Control‑person liability (§20(a)) | Because Modany (CEO/chair) and Fitzpatrick (CFO) participated in disclosure process and signed/certified filings, they had control and are liable as control persons. | Defendants: board/committees exercised corporate control; signing filings does not alone establish actual exercise of control over operations or specific misconduct. | Court: signing/certifying public filings supports control‑person liability for those specific filings — GRANTED IN PART. For other acts not tied to signed filings, genuine factual disputes remain — DENIED IN PART. |
| Deceit of auditors (Rule 13b2‑2) — did defendants make false/misleading statements or omissions to auditors? | SEC: management concealed POBOB, withheld a CUSO October 2013 cash‑flow estimate, and failed to disclose parity‑model divergence to auditors. | Defendants: auditors received DB model, monthly servicing reports and were aware of parity decline; October CUSO model was unreliable and not used; no false statements were made. | Court found genuine factual disputes as to (1) whether divergence between DB model and parity was disclosed and (2) whether the October 2013 CUSO estimate existed and was withheld despite being reliable. Summary judgment denied on these auditor‑deceit theories. |
| §17(a) "in the offer or sale" and §17(a)(2) "obtain money or property" | SEC: misstatements/omissions in periodic reports and S‑8s link to offers/sales and ITT (through inflated equity) obtained benefit. | Defendants: SEC relies on allegations not evidence; Forms S‑8 do not show actual offers/sales absent evidence of option exercises; defendants did not personally obtain money/property. | Court: Forms S‑8 sufficed to defeat summary judgment on "in the offer or sale" (DENIED). But SEC failed to show Modany/Fitzpatrick personally obtained money/property under §17(a)(2) — summary judgment for defendants on §17(a)(2) personal‑receipt theory — GRANTED. |
| SOX §304 disgorgement — must issuer misconduct be intentional/knowing? | SEC: §304 aims to recoup incentive‑based compensation after restatements due to misconduct; does not require proof of personal intent. | Defendants: "misconduct" requires intentional wrongdoing. | Court: §304 requires material noncompliance by issuer as result of knowing wrongdoing (not mere negligence). SEC motion for legal ruling denied; genuine legal/ factual issues remain for trial. |
Key Cases Cited
- Anderson v. Liberty Lobby, 477 U.S. 242 (summary judgment standard for assessing materiality and genuine issues)
- Zandford v. S.E.C., 535 U.S. 813 (Rule 10b‑5 "in connection with" doctrine)
- Durham v. United States, 766 F.3d 672 (7th Cir.) ("in connection with" requires misrepresentation to coincide with or touch a securities transaction)
- Donohoe v. Consolidated Operating & Production Corp., 30 F.3d 907 (7th Cir.) (elements for control‑person liability)
- In re Alstom S.A. Sec. Litig., 406 F. Supp. 2d 433 (S.D.N.Y.) (scheme liability may require deceptive acts beyond misstatements)
- Life Partners Holdings, Inc. v. SEC, 854 F.3d 765 (5th Cir.) (discussing SOX §304 disgorgement and issuer misconduct)
- S.E.C. v. Ferrone, 163 F. Supp. 3d 549 (N.D. Ill.) (SEC bears burden to prove scienter in §10(b)/Rule 10b‑5 claims)