On March 27, 2019, the Supreme Court issued a 6-2 decision in Lorenzo v. Securities and Exchange Commission, delivered by Justice Breyer, holding that dissemination of false or misleading statements with intent to defraud falls within the scope of “scheme liability” under Rules 10b-5(a) and (c), as well as § 10(b) of the Exchange Act and § 17(a)(1) of the Securities Act, even if the disseminator did not “make” the statements. The holding stands in contrast to the Court’s 2011 holding in Janus Capital Group, Inc. v. First Derivative Traders, 564 US 135 (2011). In Janus, the Court held that an individual who did not “make” the false or misleading statement could not be held liable under Rule 10b-5(b).

The Lorenzo holding expands the reach of primary securities fraud liability to persons who knowingly distribute false or misleading statements, whether or not they drafted the statements. Though the holding may have been based largely on its unusual facts (and the Court’s expressed desire not to let Lorenzo escape liability for “plainly fraudulent conduct”), it creates the possibility of increased enforcement action (and private litigation) asserting primary scheme liability based on minimal conduct (such as, in Lorenzo’s case, two emails).

Factual Background

Lorenzo was the director of investment banking at a registered broker-dealer with a single investment banking client, Waste2Energy Holdings, Inc. Shortly after Waste2Energy publicly disclosed that it had total assets less than $400,000, Lorenzo sent two emails to prospective investors describing Waste2Energy’s debenture offering and stating that Waste2Energy had $10 million in “confirmed assets.” Lorenzo testified that he sent the emails at the direction of his boss, who supplied the content and approved the messages. Lorenzo signed each email with his name and title and invited the recipients to contact him with questions.

The SEC instituted proceedings against Lorenzo, his boss, and the broker-dealer. The Commission found that Lorenzo had violated Rule 10b-5, § 10(b), and § 17(a)(1) by sending false and misleading statements to investors with intent to defraud. Lorenzo appealed on two grounds. First, he argued that he lacked the requisite intent to defraud. The DC Circuit rejected this argument, and Lorenzo, surprisingly, did not challenge the scienter finding on appeal. Second, Lorenzo argued that, based upon Janus, he could not be held liable under Rule 10b-5. The Court of Appeals panel agreed in part, holding that Lorenzo could not be liable under subsection (b) because Lorenzo’s boss had “ultimate authority” over the content and dissemination of the messages. Thus, the boss, not Lorenzo, was the “maker” under Janus. The panel, however, held that Lorenzo was liable under subsections (a) and (b) (as well as § 10(b) and § 17(a)(1)) for knowingly disseminating false information to prospective investors.

Rule 10b-5 and Janus

Rule 10b-5 makes it unlawful to:

(a) To employ any device, scheme, or artifice to defraud,

(b) To make any untrue statement of a material fact . . . , or

(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit . . .

in connection with the purchase or sale of any security.

17 CFR §240.10b–5.

In Janus, the Court examined subsection (b) and held that only “makers” could be liable under that provision. A “maker” is a person or entity that has “ultimate authority over the statement, including its content and whether and how to communicate it.” The Court analogized the situation to that of a speechwriter: “[W]hen a speechwriter drafts a speech, the content is entirely within the control of the person who delivers it. And it is the speaker who takes credit—or blame—for what is said.” Thus, the Court held that an investment advisor who had merely “participat[ed] in the drafting of a statement” which was then “made” by another could not be held liable under subsection (b).

The Supreme Court’s Holding

The Supreme Court, adopting the DC Circuit’s determination that Lorenzo was not a “maker” under Janus, granted certiorari to resolve whether someone who is not a “maker” could be found to violate the other subsections of Rule 10b-5 when the only alleged misconduct involves a misstatement. The Court affirmed the DC Circuit’s opinion, and held that disseminating false or misleading statements with intent to defraud can fall within the scope of subsections (a) and (c) even if the disseminator did not “make” the statements and thus could not be liable under subsection (b).

The Court first pointed to the plain wording of the different subsections and noted that subsections (a) and (c) were broad enough to cover Lorenzo’s dissemination of the misleading emails with the requisite “intent to deceive, manipulate, or defraud.” The Court rejected Lorenzo’s argument that subsections (a) and (c) concern “scheme liability” while only subsection (b) should apply when misstatements are involved. The dissent likewise argued that “knowingly disseminating a false statement at the behest of its maker” did not qualify as fraudulent scheme implicating scheme liability under subsections (a) and (c)—“That Lorenzo knew the messages contained falsities does not change the essentially administrative nature of his conduct here; he might have assisted in a scheme, but he did not himself plan, scheme, design, or strategize.” The majority, however, noted that there are many areas of overlap in conduct prohibited by the securities laws, including the clear overlap between subsections (a) and (c) of Rule 10b-5. The Court’s conclusion that Lorenzo’s conduct violated subsections (a) and (c) was “strengthened by the fact that we here confront behavior that, though plainly fraudulent, might otherwise fall outside the scope of the Rule.”

The Court next addressed Lorenzo’s (and the dissent’s) arguments that applying subsections (a) or (c) would (1) nullify the Janus decision and (2) weaken the distinction between primary and secondary (aiding and abetting) liability. As to the first of these arguments, the Court noted that Janus did not involve the disseminator of the alleged misstatement: “We can assume that Janus would remain relevant (and preclude liability) where an individual neither makes nor disseminates false information—provided, of course, that the individual is not involved in some other form of fraud.” As to Lorenzo’s second argument, the Court held that it is not unusual for conduct to be both a primary violation of one offense and a secondary violation of another. The Court further stated that if knowing dissemination of a misstatement made by another was only a secondary violation, such fraud could escape liability altogether if the “maker” did not violate subsection (b) by, for example, lacking the requisite intent. The Court held that such an outcome was not the intent of Congress in enacting the securities laws or the SEC in implementing rules to enforce those laws.

Potential Impact

While the Lorenzo decision involved an SEC enforcement matter, its holding is equally applicable to civil litigation among private parties. As the Court held, the Janus decision remains viable law. However, the parameters of that decision have been seriously eroded and it remains to be seen whether the SEC and plaintiff’s bar will feel empowered to bring more “scheme liability” cases.