I. Overview and Summary

On March 27, 2019, the US Supreme Court's decision in Lorenzo v. Securities and Exchange Commission[1] resolved the issue of whether a securities fraud claim may proceed under a "scheme liability" theory if the alleged misconduct involves the dissemination of a materially false statement, with scienter, that the defendant did not "make" for purposes of Rule 10b-5 liability. The 6-2 decision[2] held defendant Francis Lorenzo liable under Rule 10b-5(a) and (c), which prohibit fraudulent schemes and fraudulent practices, because Lorenzo sent emails knowing they contained materially false statements. The court held that Lorenzo was liable under these provisions even though the statements had been written by his supervisor and, therefore, Lorenzo could not be liable for "making" the statements under Rule 10b-5(b) based on the court's prior decision in Janus Capital Group, Inc. v. First Derivative Traders.

II. Background

The federal securities laws prohibit both: (1) making fraudulent statements; and (2) employing fraudulent schemes and practices in connection with the sale of securities.[3] In its 2011 Janus Capital Group, Inc. v. First Derivative Traders decision, the Supreme Court held that only a person who has "ultimate authority" over a misstatement may be held liable under Rule 10b-5(b), which prohibits the making of fraudulent statements.[4]

"Scheme liability" under Rule 10b-5(a) and (c) prohibits deceptive conduct, as opposed to deceptive statements. A circuit split developed as to whether fraudulent statements made by a person without "ultimate authority" pursuant to Janus could serve as the basis for scheme liability under Rule 10b-5(a) and (c).

a. The 2011 Janus Decision

In Janus, plaintiffs in an investor class action alleged that Janus Capital Group, Inc. (JCG), a publicly traded company, and Janus Capital Management, LLC (JCM), its wholly owned investment adviser subsidiary, were responsible for misleading statements in Janus Investment Fund prospectuses for various funds regarding the company's policies against "market timing,"[5] in violation of Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) and Rule 10b-5 thereunder.

The Supreme Court held that JCM could not be held liable for the misleading statements. The court ruled that, for purposes of Rule 10b-5 liability, the "maker of a statement is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it . . . . One who prepares or publishes a statement on behalf of another is not its maker."[6] The court found that JCM, although "significantly involved" in preparing the prospectuses, could not be held liable for the misleading statements because it was subject to the "ultimate control" of Janus Investment Fund.[7]

b. The Aftermath of Janus

Following the Supreme Court's decision in Janus, circuit courts wrestled with the implications of that decision on "scheme liability" under Section 17(a)(1) of the Securities Act of 1933 (Securities Act) and Rules 10b-5(a) and (c), which prohibit employing fraudulent schemes and practices in connection with the offer, purchase, or sale of securities. Specifically, courts had to determine whether a claim may proceed under a scheme liability theory if the alleged misconduct consists of fraudulent statements that the defendant did not "make" under Janus.

Circuit courts split on the question. The US Courts of Appeals for the Second, Eighth, and Ninth Circuits held that fraudulent misstatements alone cannot form the basis for "scheme liability" under Rule 10b-5(a) and (c).[8] In Public Pension Fund v. KV Pharmaceutical, the Eighth Circuit joined the Second and Ninth Circuits in holding that "a scheme liability claim must be based on conduct beyond misrepresentations or omissions actionable under [SEC] Rule 10b-5(b)."[9]

Conversely, the Eleventh and DC Circuits each held that misstatements alone may be sufficient to establish liability under Rule 10b-5(a) and (c). In SEC v. Big Apple Consulting USA, the Eleventh Circuit held that misstatements may be sufficient to establish liability under a scheme liability theory, noting that "Janus only discussed what it means to 'make' a statement for purposes of Rule 10b-5(b) and did not concern [scheme liability under] section 17(a)(1) or Rule 10b-5(a) or (c)."[10] The DC Circuit's decision in Lorenzo v. SEC extended the circuit split, leading the Supreme Court to take the case under review in June 2018.

c. Lorenzo v. SEC[11]

Francis Lorenzo was the director of investment banking at Charles Vista, LLC, a registered broker-dealer owned by Gregg Lorenzo. Charles Vista's largest and only investment banking client, Waste2Energy Holdings, Inc. (W2E), was a start-up company that claimed to have developed a "gasification" technology that could generate electricity by converting solid waste to gas. This technology never materialized.[12]

In September 2009, W2E retained Charles Vista, LLC to offer up to $15 million in convertible debentures[13] in order to stay afloat. On October 1, 2009, Lorenzo reviewed an amended Form 8-K and a Form 10-Q filed that day by W2E. The amended Form 8-K reported that the company's gasification technology should have been valued at zero, rendering the company's total assets as of March 31, 2009 to be worth $370,552. The Form 10-Q valued the company's assets at $660,408 as of June 30, 2009. On October 2, 2009, Lorenzo emailed the two filings to other Charles Vista brokers.[14] On October 14, 2009, Lorenzo emailed two potential investors with information regarding W2E's upcoming debenture offering. The email stated that that there were "layers of protection" on the investment, including that the company "has over $10 million in confirmed assets," but did not disclose that the assets were worth far less, despite the October 1, 2009 filings.[15] Lorenzo signed the emails and ended them by asking the recipients to call him with any questions.[16]

Lorenzo testified before a Securities and Exchange Commission (SEC) administrative law judge that his boss, Gregg Lorenzo, had written the emails' content and directed that they be sent.[17] The judge, however, found that Lorenzo knew of the assets’ decreased value when he sent the emails,[18] and held that Lorenzo had "willfully violated the antifraud provisions of the Securities and Exchange Acts [Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5] by his material misrepresentations and omissions concerning W2E in the emails."[19] The SEC affirmed the administrative law judge’s decision on April 29, 2015,[20] and Lorenzo appealed to the DC Circuit.

d. The Circuit Decision

On appeal, Lorenzo first challenged the SEC’s finding that the relevant statements were materially false or misleading and were made with the requisite mental state. The DC Circuit held that the SEC's findings as to falsity and Lorenzo's scienter "are supported by substantial evidence with regard to each of the three pertinent statements in Lorenzo’s emails."[21] The DC Circuit also held that Lorenzo could not be held liable for violating Rule 10b-5(b), because he did not "make" the statements under the "ultimate authority" standard set by Janus, since he sent the emails on behalf of his boss, Gregg Lorenzo.[22]

However, the DC Circuit found that Rule 10b-5(a) and (c) "do not speak in terms of an individual's 'making' a false statement,"[23] and therefore, Lorenzo could be found liable under these provisions, known as the "scheme to defraud" provisions of Rule 10b-5.[24] The court held that, although Lorenzo did not "make" the statements under Janus because he lacked ultimate authority over them, his role in the fraud, which involved dissemination of statements he knew were materially false, constituted a "deceptive 'device,' 'act,' or 'artifice to defraud' for purposes of liability under Section 10(b), Rule 10b-5(a) and (c), and Section 17(a)(1)."[25] The court distinguished Janus, noting that Lorenzo "transmitted misinformation directly to investors, and his involvement was transparent to them" whereas, in Janus, the misstatements were disseminated "only through the intervening act of 'another person.'"[26]

Finally, the DC Circuit rejected Lorenzo's contention that finding him primarily liable under Rule 10b-5(a) and (c) would undermine prior Supreme Court holdings by allowing private plaintiffs to pursue securities claims against secondary actors. The DC Circuit found that, unlike in Janus, Lorenzo was a principal violator in the scheme to defraud based on his direct contact with investors and role in sending the emails; thus, he could be subject to liability under Rule 10b-5(a) and (c) as a primary actor. The DC Circuit stated that there was still "ample room" for a distinction between primary and secondary liability.[27]

III. Supreme Court Decision

On March 27, 2019, the Supreme Court affirmed the DC Circuit's decision, holding that dissemination of false or misleading statements with intent to defraud can fall within the scope of Rules 10b-5(a) and (c) even if the disseminator did not "make" the statements and therefore falls outside Rule 10b-5(b).[28] Notably, Lorenzo did not challenge the DC Circuit's holding that he disseminated the statements with scienter.[29] The court found that, by sending emails he understood to contain material untruths, Lorenzo "employ[ed]" a "device," "scheme," and “artifice to defraud” within the meaning of Rule 10b-5(a), Section 10(b) of the Exchange Act, and Section 17(a)(1) of the Securities Act, and he "engage[d] in a[n] act, practice, or course of business" that "operate[d] . . . as a fraud or deceit" under Rule 10b-5(c).[30]

The court acknowledged that Rule 10b-5(a) and (c) capture a wide range of conduct; therefore, applying them "may present problems of scope in borderline cases." The court nevertheless noted that the present case was not itself borderline, because Lorenzo, with scienter, "sent false statements directly to investors, invited them to follow up with questions, and did so in his capacity as vice president of an investment banking company"—conduct that fit squarely within the provisions of Rule 10b-5(a) and (c).[31]

The majority rejected Lorenzo's argument that "the only way to be liable for false statements is through those provisions that refer specifically to false statements" and the "premise … that each of th[e] provisions [of Rule 10b-5] should be read as governing different, mutually exclusive, spheres of conduct."[32] The court found there is considerable overlap between the antifraud provisions of Rule 10b-5, and this overlap is necessary to encompass fraudulent conduct, such as Lorenzo's, that may otherwise fall outside of the provisions. The court stressed the "expansive" language of Rule 10b-5, as well as its purpose of encouraging full disclosure and a "high standard of business ethics in the securities industry."[33] It reconciled its decision with the Janus decision, finding that Janus is not a "dead letter," as argued in Justice Thomas's dissent,[34] because it still applies where a person "neither makes nor disseminates false information—provided, of course, that the individual is not involved in some other form of fraud."[35]

The court also rejected Lorenzo's contention that allowing primary liability in the present case would render superfluous the SEC's authority to bring aiding and abetting cases under Rule 10b-5.[36] In the court's view, the Lorenzo decision does not "create[] a serious anomaly or otherwise weaken[] the distinction between primary and secondary liability," noting that it is typical "for the same conduct to be a primary violation with respect to one offense and aiding and abetting with respect to another."[37]

IV. Implications

The Lorenzo decision is a win for the SEC who may now, with certainty, bring primary liability cases under Rule 10b-5(a) and (c) against those who did not "make" statements under Janus but who nevertheless disseminated materially false and misleading statements with scienter. As the court noted in Lorenzo, the overlap between the antifraud provisions, coupled with the expansive language of Rule 10b-5, allows courts to hold individuals liable for fraudulent conduct that does not fall within Rule 10b-5(b).[38] In the dissent's view, the majority's "sweeping" decision renders Rule 10b-5(b) superfluous.[39] However, the majority pointed out that "this Court and the Commission have long recognized considerable overlap among the subsections of the Rule and related provisions of the securities laws."[40]

The most potentially significant implications of the Lorenzo decision are likely to arise in private litigation. Although Lorenzo occurred in the context of a SEC action, private plaintiffs are likely to seek to apply the reasoning of the decision to expand the scope of individuals who may be held liable in private actions under Rule 10b-5. Private plaintiffs are not allowed to sue individuals for aiding and abetting under Rule 10b-5.[41] Private plaintiffs may now seek to pursue individuals they could not previously reach by alleging, under Lorenzo, that the individuals are primarily liable under Rule 10b-5(a) and (c) for knowingly disseminating fraudulent statements the individuals did not "make." Of course, for these claims to be successful, plaintiffs must still plead a strong inference of scienter under the federal securities laws as well as "reliance," which the court in Lorenzo noted cannot be based on "undisclosed deceptions upon which the plaintiffs could not have relied."[42] Both of these requirements will present hurdles in any efforts by private plaintiffs to expand the reach of Lorenzo.