In its 2011 decision in the Janus Group case, the U.S. Supreme Court held that one who does not “make” a false statement cannot be held liable under section (b) of Rule 10b-5. In an enforcement action brought against him by the SEC, the defendant, Francis Lorenzo, argued that under the Janus case, he could not be held liable under the securities laws for forwarding a misleading email his boss had written because he did not “make” the false statement. The case ultimately made its way to the U.S. Supreme Court. On March 27, 2019, the Court found that even if Lorenzo could not be held liable under section (b) of the Rule because he did not “make” the statement, he could still be held liable under the scheme liability provisions in sections (a) and (c) of the Rule for disseminating the document. The Court’s March 27, 2019 opinion in Lorenzo v. Securities and Exchange Commission can be found here.
In 2009, Francis Lorenzo worked as the director of investment banking at Charles Vista, LLC, a broker-dealer. Charles Vista served as the placement agent for a private debenture offering for one of the firm’s clients, Waste2Energy Holdings (“W2E”), a publicly-traded energy company. On October 1, 2009, W2E issued a revised SEC filing indicating that its asset value was dramatically lower than the company had previously reported as result of a revaluation of the company’s intangible assets. The record shows that Lorenzo received a copy of W2E’s revised SEC filing.
On October 14, 2009, two weeks after W2E had issued its revised filing, Lorenzo sent separate emails to two prospective investors for the debenture offering. Both emails expressly stated that they were being sent at the request of others at Charles Vista. Both emails recited favorable financial attributes of W2E. Neither email mentioned W2E’s revised SEC filing or the company’s revaluation of its intangible assets. In both messages, Lorenzo stated that the recipients could call him with any questions. He signed both messages with his name and title as “Vice President – Investment Banking.”
In February 2013, the SEC commenced enforcement proceedings against Lorenzo and others in connection with the W2E offering. The other defendants settled with the SEC; the action against Lorenzo proceeded to trial before an administrative law judge. After trial, the ALJ issued findings of fact stating that Lorenzo’s boss had drafted the content of the emails and had asked Lorenzo to send the emails. The ALJ also concluded that Lorenzo had not read the emails or even considered the emails’ content before sending them. Nevertheless, the ALJ concluded that Lorenzo should be liable under the securities laws for having acted with anintent to deceive, manipulate, or defraud. The Commission upheld the ALJ’s decision.
Lorenzo appealed the Commission’s ruling to the D.C. Circuit Court of Appeals. On September 29, 2017, the D.C. Circuit (with then-Judge Brett Kavanaugh dissenting) issued its opinion ruling (1) that Lorenzo could not be held liable for a fraudulent misrepresentation under Rule 10b-5(b) because he did not “make” the statements at issue, but (2) nonetheless upholding, in a 2-1 vote, the Commission’s finding of liability under Rule 10b-5(a) and (c) against Lorenzo because the statements in Lorenzo’s emails were false or misleading and he possessed the requisite intent.
Lorenzo filed a petition for writ of certiorari with the U.S. Supreme Court. The petition described the question presented as “whether a misstatement claim that does not meet the elements set forth in Janus can be repackaged and pursued as a fraudulent scheme claim.” In support of his petition, he cited a split among the circuits on the question of whether “a misstatement standing alone can be the basis of a fraudulent scheme claim.” The Court granted the writ on June 18, 2018.
The Relevant Regulatory Provision
Rule 10b-5 makes it unlawful:
(a) to employ any device, scheme, or artifice to defraud,
(b) to make any untrue statement of material fact …, or
(c) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit…
The March 27 Opinion
In a March 27, 2019 majority opinion written by Justice Stephen Breyer (with Justice Thomas, joined by Justice Gorsuch, dissenting, and with Justice Kavanaugh not participating in the case), the Court affirmed the D.C. Circuit and held that disseminating false or misleading statements with the intent to defraud can give rise to liability under sections (a) and (c) of Rule 10b-5, and related statutory provisions, even if the dissementator did not “make” the statements and therefore cannot be held liable under section (b) of the Rule.
In reaching this conclusion, the Court said that even if Lorenzo did not “make” the statements, by sending the emails to customers containing information he knew to be false, he employed a “device,” a “scheme,” and an “artifice to defraud” within the meaning of section (a) of the Rule, and he engaged in an act or practice that “operated as a fraud or deceit” within the meaning of section (a). The Court said “under the circumstances, it is difficult to see how Lorenzo’s actions could escape the reaches of these provisions.”
The Court also rejected Lorenzo’s argument that the only way for liability to attach to false statements was through the false statement provisions in section (b) of the Rule. Lorenzo had argued that any other interpretation would render section (b)’s false statement provisions “superfluous.” The court rejected the argument that each subsection governs a separate type of conduct, saying that there is considerable “overlap” between the Rule’s subsections and related statutory provisions. The Court added that its “conviction” was “considerably strengthened by the fact that the plainly fraudulent behavior confronted here might otherwise fall outside the Rule’s scope.” The use of false representations to induce securities purchases, the Court said, “would seem a paradigmatic example of securities fraud.”
The court noted that the Rule’s provisions “capture a wide range of conduct.” Applying them in “borderline cases” may “present difficult problems of scope.” For example, the court said, “one can readily imagine other actors tangentially involved in dissemination – say, a mailroom clerk – for whom liability would typically be inappropriate.” However, the court said, “we see nothing borderline about this case,” where the relevant conduct “consists of disseminating false or misleading information to prospective investors with the intent to defraud.”
Finally, the majority rejected the dissent’s contention that the majority’s interpretation would render Janus a “dead letter.” Janus, the Court said, would remain relevant (and would preclude liability) where an individual “neither makes nor disseminates” false information.
This decision is favorable for the government and even potentially for private securities litigation plaintiffs. The opinion recognizes a broad reading of Rule 10b-5, with the Rule’s various provisions overlapping with each other in support of the Rule’s overall fraud prevention goal. In its March 27, 2019 client alert about the ruling, the Skadden law firm said “We anticipate that private plaintiffs will attempt to seize upon this decision to expand potential liability under Section 10(b).”
However, it could also be argued that the Court’s decision is just a reflection of the case it was presented. As Ronald Mann noted in his March 27, 2019 analysis of the decision on the SCOTUSblog, Lorenzo’s conduct “evidently struck a majority of the justices as reprehensibly fraudulent conduct of the kind that should be at the center of securities enforcement efforts.” Most of the Justices, Mann said, “appeared to see this as a case of core enforcement rather than a stretch,” and a “straightforward” decision from the Court imposing liability on Lorenzo “seemed inevitable.”
The relationship the court drew between “making” and “dissemination” a false statement is interesting, particularly in the current age when so much information is shared electronically, often as an attachment or a link. The court’s conclusion that someone can be liable for disseminating a false statement even without having “made” it could potentially have some interesting implications in the current electronic age when so much information is “forwarded” in electronic communications.
At the same time, the court’s suggestion that there could be “borderline” cases where the dissemination is too tangential for liability to attach could present some interesting areas for future dispute. There undoubtedly will be future cases in which enforcement targets argue that their involvement was too “borderline” or “tangential” for them to be held liable. In that regard, it is important to note that the Court viewed Lorenzo’s knowledge of the email’s falsity as a “given.” A different case, in which an email or a document is forwarded without knowledge of falsity, likely would not support liability even given the dissemination. It clearly mattered to the court that Lorenzo sent the email knowing it was false.