In a clear win for the Securities and Exchange Commission (SEC), the U.S. Supreme Court held that a person who knowingly disseminates a misstatement about a security can be primarily liable under the antifraud provisions of the federal securities laws. In doing so, the Supreme Court blurred the line between “scheme liability” and liability for misstatements, as well as primary and secondary liability. This is significant because it opens the door for the SEC as well as private plaintiffs to charge misstatement cases as scheme cases, and target not only the “maker” of the misstatement, but those involved in its dissemination to the investing public.

Janus sets the stage

When the U.S. Supreme Court decided Janus Capital Group, Inc. v. First Derivative Traders in 2011, it staked out limits on the types of behavior that could lead to primary liability for making a misstatement in violation of the antifraud provisions of the securities laws. In Janus, the Court held that only the person with the ultimate authority to control the content of a fraudulent misstatement could be liable as a primary violator of SEC Rule 10b-5(b), which makes it unlawful to, with scienter, “make any untrue statement of a material fact.” But Janus opened a new debate: Where a misstatement causes a securities fraud, can someone who is not the “maker” of the statement be held primarily liable under other provisions of the securities laws prohibiting a scheme to defraud? Lorenzo answers that question with a resounding “yes.”

Background on Lorenzo

In 2009, Francis Lorenzo was the director of investment banking at a Staten Island broker dealer. Lorenzo represented a company that was developing technology to turn solid waste into renewable energy. In October 2009, the company publicly disclosed, and told Lorenzo, that it had written off $10 million in intangible assets (largely intellectual property), and that its total assets amounted to less than $400,000. Nevertheless, shortly after that revelation, Lorenzo sent emails to prospective investors in a proposed debenture offering by the company. At the request of his boss, Lorenzo copied and pasted content that his boss had written, but that Lorenzo knew was false, into the emails. The emails claimed that the company had $10 million in assets, and omitted mention of the company’s public disclosure that it, in fact, had fewer than $400,000 in assets. Lorenzo signed the emails in his name as “Vice President of Investment Banking” and invited recipients to call him with any questions.

The SEC subsequently initiated an administrative action against Lorenzo charging him with violations of § 10(b) of the 1934 Exchange Act, and Rule 10b-5 thereunder, as well as § 17(a)(1) of the 1933 Securities Act. The Commission found against Lorenzo, banned him from working in the securities industry for life, and fined him $15,000. On appeal, Lorenzo argued that, according to Janus, he could not be liable under subsection (b) of Rule 10b-5 because his boss had the ultimate authority to control the content that went into the offending emails. The D.C. Circuit agreed, and the question of whether Lorenzo violated Rule 10b-5(b) was not before the Supreme Court.

The U.S. Supreme Court’s decision in Lorenzo

The question before the Supreme Court was whether Lorenzo could be primarily liable under other antifraud provisions of the securities laws for the role he played in “disseminating” fraudulent statements to prospective investors. Specifically, did Lorenzo violate the so-called “scheme liability” subsections (a) and (c) of Rule 10b-5, which make it unlawful to, respectively, “employ any device, scheme, or artifice to defraud,” and “engage in any act, practice, or course of business which operate as a fraud or deceit upon any person” in connection with the purchase or sale of a security? Or, as Lorenzo argued, is subsection (b) of Rule 10b-5 (which explicitly makes it unlawful to “make” a false statement) the only subsection under which any person could be primarily liable for disseminating misstatements?

Lorenzo is a results-oriented decision. The Supreme Court was plainly troubled by Lorenzo’s behavior and was not about to let him off the hook. Justice Breyer, writing for the majority, noted, “[W]e see nothing borderline about this case . . . the petitioner in this case 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.” The Court disposed with several legal arguments by noting that Lorenzo’s behavior was “plainly fraudulent” and if the Court were to limit all primary exposure under the securities laws for false statements to the “maker” of the statements, his behavior might “fall outside the scope” of those laws. The Lorenzo Court’s solution was to characterize Lorenzo’s wrongful act as the “dissemination” of a false statement. Citing both dictionaries and case law attributing broad scope to the types of acts prohibited by Rules 10b-5(a) and (c), the majority held that the dissemination of a false statement was punishable as an act separate from the “making” of the statement.

In dissent, Justice Thomas, joined by Justice Gorsuch (Justice Kavanaugh, the lone dissenter at the Court of Appeals, abstained) warned that the decision would render Janus a “dead letter,” reversing the limitation for primarily liability to the “maker” of the statement, and opening the door to liability for anyone involved in disseminating the statement. In response, the majority attempted to elucidate a clear rule that would both preserve Janus and punish Lorenzo: “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).” At the same time, the Court tried to draw a box around Janus, writing that it “would remain relevant” by precluding liability for individuals who neither make nor disseminate misstatements.

The upshot

Lorenzo is a considerable victory for the SEC and the plaintiff’s bar, but only in the sense that it did not create a significant escape hatch for people, like Lorenzo himself, who knowingly play significant roles in disseminating false statements in connection with securities transactions. The Court’s focus on the term “dissemination” in its decision, however, will surely spur litigation about the meaning of the term. Lorenzo’s behavior may not have been “borderline,” but someone else’s will be.

Client Alert 2019-081

This article is presented for informational purposes only and is not intended to constitute legal advice.