The U.S. Supreme Court considered the extent of liability under Rule 10b-5 and other rules of the Securities and Exchange Commission and related statutes in Lorenzo v. Securities and Exchange Commission. The facts of the case were undisputed. Francis Lorenzo, while the director of investment banking at an SEC-registered brokerage firm, sent two e-mails to prospective investors. The content of those e-mails was cut and pasted from materials which Lorenzo’s boss supplied, and described a potential investment in a company with “confirmed assets” of $10 million. In fact, Lorenzo knew the company had recently disclosed that its total assets were worth less than $400,000.

In what many view as a departure from existing precedent set forth in the U.S. Supreme Court case of Janus Capital Group, Inc. v. First Derivative Traders, the Supreme Court found that Lorenzo violated Rule 10b-5(a) and (c), Section 10(b) of the Exchange Act and Section 17(a)(1) of the Securities Act. The case has important implications for those who assist in drafting offering documents, including officers of companies issuing securities, investment bankers, lawyers and law firms.

Lorenzo’s primary argument was that under Janus he could not be held liable under subsection (b) of Rule 10b-5 as he was not the “maker” of the statement. Janus held that held that 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.” On the facts of Janus, this meant that an investment adviser who had merely participated in the drafting of a false statement “made” by another could not be held liable in a private action under subsection (b) of Rule 10b-5.

The Supreme Court agreed with the SEC and saw it differently. The Court reviewed the relevant provisions of Rule 10b-5 and related statutes. The Court noted subsection (a) of the Rule makes it unlawful to “employ any device, scheme, or artifice to defraud.” Subsection (b) makes it unlawful to “make any untrue statement of a material fact.” And subsection (c) makes it unlawful to “engage in any act, practice, or course of business” that “operates . . . as a fraud or deceit.” [1]. Section 10(b) of the Securities Exchange Act makes it unlawful to “use or employ . . . any manipulative or deceptive device or contrivance” in contravention of SEC rules and regulations. Finally, the Court reviewed Section §17(a)(1) of the Securities Act which makes it unlawful to “employ any device, scheme, or artifice to defraud.”

The Court found dissemination of false or misleading statements with intent to defraud can fall within the scope of subsections (a) and (c) of Rule 10b-5, as well as the relevant statutory provisions. In the Court’s view, that is so even if the disseminator did not “make” the statements and consequently falls outside of subsection (b) of the Rule.

According to the Court, it was obvious that the words in these provisions are, as ordinarily used, sufficiently broad to include within their scope the dissemination of false or misleading information with the intent to defraud. By sending emails he understood to contain material untruths, Lorenzo “employ[ed]” a “device,” “scheme,” and “artifice to defraud” within the meaning of subsection (a) of the Rule, §10(b), and §17(a)(1). By the same conduct, he “engage[d] in a[n] act, practice, or course of business” that “operate[d] . . . as a fraud or deceit” under subsection (c) of the Rule. The Court said “Under the circumstances, it is difficult to see how his actions could escape the reach of those provisions.” It is also important to note that Lorenzo did not, before the Supreme Court, challenge that he acted with scienter, so the Court took for granted that he sent the emails with “intent to deceive, manipulate, or defraud” the recipients.

The Court rejected Lorenzo’s argument that, despite the natural meaning of these provisions, they should not reach his conduct. According to Lorenzo, the only way to be liable for false statements is through those provisions that refer specifically to false statements. The provisions other than Rule 10b-5(b) concern “scheme liability claims” and are violated only when conduct other than misstatements is involved. Lorenzo noted that holding to the contrary would render subsection (b) of Rule 10b-5 superfluous. The Court rejected this argument, noting that the Court and the SEC have long recognized considerable overlap among the subsections of the Rule and related provisions of the securities laws. Lorenzo’s conduct, though plainly fraudulent, might otherwise fall outside the scope of the Rule. According to the Court, accepting Lorenzo’s view that subsection (b), the making-false-statements provision, exclusively regulates conduct involving false or misleading statements would mean those who disseminate false statements with the intent to cheat investors might escape liability under the Rule altogether.

According to the dissent, under the Court’s ruling, a person who has not “made” a fraudulent misstatement within the meaning of Rule 10b-5(b) nevertheless could be held primarily liable for facilitating that same statement; the SEC or plaintiff need only relabel the person’s involvement as an “act,” “device,” “scheme,” or “artifice” that violates Rule 10b-5(a) or (c). And a person could be held liable for a fraudulent misstatement under §17(a)(1) even if the person did not obtain money or property by means of the statement, which is governed by §17(a)(2).

The dissent noted that its interpretation would not allow people who disseminate false statements with the intent to defraud to escape liability under Rule 10b-5. If a person’s only role is transmitting fraudulent misstatements at the behest of the statements’ maker, the person’s conduct would be appropriately assessed as a matter of secondary liability under existing securities law. In addition to rendering Janus a dead letter, the dissent noted the majority fails to maintain a clear line between primary and secondary liability in fraudulent misstatement cases. Maintaining this distinction is important because there is no private right of action against mere aiders and abettors.

Given the unique facts of Lorenzo we believe Janus will remain a strong and viable defense for most offering participants. Lorenzo expands potential liability for those who assist in drafting offering documents, including officers of companies issuing securities, investment bankers, lawyers and law firms. It is unclear from Lorenzo what action is necessary other than hitting the “send” button on an email to impose primary liability under Rule 10b-5(a) or (c), other than acting with scienter. While in our experience, offering participants go to great lengths to insure the truth and accuracy of offering documents, and therefore do not act with scienter, offering participants will nonetheless be attractive defendants in litigation involving offerings following the Court’s ruling in Lorenzo.

[1] Rule 10(b)-5 provides as follows:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

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

(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person in connection with the purchase or sale of any security.