Last week, SCOTUS decided Lorenzo v. SEC, a case involving a claim that an investment banker was liable for securities fraud when, at the direction of his boss, he cut, pasted and disseminated to potential investors information that his boss had provided, even though the banker knew the information was false. In a 2011 case, Janus Capital Group, Inc. v. First Derivative Traders, SCOTUS had held that, an “investment adviser who had merely ‘participat[ed] in the drafting of a false statement’ ‘made’ by another could not be held liable in a private action under subsection (b) of Rule10b–5.” (Rule 10b–5(b) prohibits the “mak[ing]” of “any untrue statement of a material fact.”) In Lorenzo, the question before the Court was whether a person who did not “make” statements (that is, who did not have “ultimate authority” over the statements), but who knowingly disseminated false statements to potential investors with intent to defraud, could be found to have violated subsections (a) and (c) of Rule 10b–5. The answer, in an opinion written by Justice Breyer, was yes. Will this case embolden plaintiff’s counsel to push the envelope and assert claims against people who are only peripherally involved in the dissemination of allegedly false information? Time will tell what the ultimate impact of this case may be.
Lorenzo was the director of investment banking at a registered broker-dealer with one investment banking client. The client hired the firm to sell $15M of debentures, and Lorenzo was directed by his boss to send to prospective investors two emails with content describing the offering provided and approved by his boss. The materials that Lorenzo cut and pasted into his emails stated that the company had $10 million in “confirmed assets,” but failed to add that the company had previously publicly stated that its assets were actually worth less than $400,00, a fact of which Lorenzo was well aware. The e-mails stated that they were sent “[a]t the request of ” the owner of the firm, but Lorenzo signed the e-mails with his name, as “Vice President—Investment Banking,” and said that he was available to respond to questions.
The SEC charged Lorenzo with violations of Rule 10b-5, and barred him from serving in the securities industry. Lorenzo appealed. The appellate court found that, “in light of Janus, he could not be held liable under subsection (b) of Rule 10b–5” because Lorenzo was not the “maker” of the misstatement. However, the court upheld the SEC’s sanction, reasoning that, “by knowingly disseminating false information to prospective investors, Lorenzo had violated other parts of Rule 10b–5, subsections (a) and (c), as well as §10(b) and §17(a)(1).”
Under subsection (b) of Rule 10b-5, it is unlawful to “make any untrue statement of a material fact.” Subsection (a) addresses scheme liability by making it unlawful to “employ any device, scheme, or artifice to defraud,” while subsection (c) prohibits engaging in “any act, practice, or course of business” that “operates . . . as a fraud or deceit.”
The Supreme Court held that
“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 our view, that is so even if the disseminator did not ‘make’ the statements and consequently falls outside subsection (b) of the Rule. It would seem 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.”
Given that Lorenzo did not challenge the scienter finding in the case before SCOTUS, “[u]nder the circumstances, it is difficult to see how his actions could escape the reach of those provisions.” While a mailroom clerk might be outside the scope of these subsections if the clerk disseminated the materials, in this case, Lorenzo “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.”
Lorenzo argued that subsection (b) is the only one of the three subsections that applies to false statements; to say otherwise would mean that subsection (b) is essentially superfluous. However, according to the Court, these three provisions are not independent and have long been viewed as overlapping. The Court’s “conviction is strengthened by the fact that we here confront behavior that, though plainly fraudulent, might otherwise fall outside the scope of the Rule…. [U]sing false representations to induce the purchase of securities would seem a paradigmatic example of securities fraud. We do not know why Congress or the Commission would have wanted to disarm enforcement in this way.”
Lorenzo also contended that “applying subsections (a) or (c) of Rule 10b–5 to conduct like his would render our decision in Janus …“a dead letter…. But we do not see how that is so.” Janus applied to “makers” of misstatements, but “said nothing about the Rule’s application to the dissemination of false or misleading information.” Lorenzo also claimed that the Court’s decision would eviscerate the distinction between “aiding and abetting” (secondary) liability (which, under Central Bank, is not subject to a private right of action), and primary liability, but the Court responded that the “line we adopt today is just as administrable: Those who disseminate false statements with intent to defraud are primarily liable under Rules 10b–5(a) and (c), §10(b), and §17(a)(1), even if they are secondarily liable under Rule10b–5(b).” Lorenzo also maintained that “classifying dissemination as a primary violation would inappropriately subject peripheral players in fraud (including him, naturally) to substantial liability.” However, the Court “suspect[ed] the investors who received Lorenzo’s e-mails would not view the deception so favorably.”
Justice Thomas dissented, joined by Justice Gorsuch. Thomas argued that the Court was erasing the distinction between primary and secondary liability in this context “by holding that a person who has not ‘made’ a fraudulent misstatement can nevertheless be primarily liable for it.” In addition, he argued, the Court’s interpretation of the more general provisions in subsections (a) and (c) “completely subsumes Rule 10b–5(b) and §17(a)(2) of the 1933 Act in cases involving fraudulent misstatements, even though these provisions specifically govern false statements. The majority’s interpretation of these provisions cannot be reconciled with their text or our precedents.”
With regard to subsection (a), Thomas argued that the “act of knowingly disseminating a false statement at the behest of its maker, without more, does not amount to ‘employ[ing] any device, scheme, or artifice to defraud’ within the meaning of those provisions.” Lorenzo’s conduct did not involve any “planning, scheming, designing, or strategizing”; it was more administrative in nature. Subsection (c) “seems broader at first blush. But the scope of this conduct-based provision—and, for that matter, Rule 10b–5(a) and §17(a)(1)—must be understood in light of its codification alongside a prohibition specifically addressing primary liability for false statements….The conduct-based provisions of Rules 10b–5(a) and (c) and §17(a)(1) must be interpreted in view of the specificity of these false-statement provisions [of (subsection(b)], and therefore cannot be construed to encompass primary liability solely for false statements.” In addition, Thomas agreed that the Court’s reading makes subsection (b) superfluous. Thomas “would hold that the provisions specifically addressing false statements ‘must be operative’ as to false-statement cases, and that the more general provisions should be read to apply ‘only [to] such cases within [their] general language as are not within the’ purview of the specific provisions on false statements.”