The U.S. Supreme Court has issued a decision in the Lorenzo v. SEC case holding that an individual who disseminates false statements to investors (even if the statements were made by someone else) can be primarily liable for securities fraud under Section 10(b) of the Exchange Act and SEC Rule 10b-5. It is a 6-2 decision authored by Justice Breyer.
In Lorenzo, the court addressed an action by the Securities and Exchange Commission (SEC) against the director of investment banking at a brokerage. Lorenzo sent e-mails to investors, the contents of which were provided to him by his boss, that he knew falsely touted a potential investment. In an administrative action, the SEC found that Lorenzo had violated Section 10(b) and Rule 10b-5 and, on appeal, the D.C. Circuit affirmed that ruling.
Before the Court, Lorenzo argued that his case should be governed by subsection (b) of Rule 10b-5, which specifically addresses misstatements. The Court – in its 2011 decision in Janus – had held that an individual who does not have “ultimate authority” over a misstatement is not its “maker” and cannot be primarily liable under subsection (b). Given that Lorenzo’s boss was the maker of the misstatements (which the SEC did not contest), Lorenzo concluded that he should not have faced primary liability for his actions.
Rule 10b-5, however, contains two other subsections. By their plain language, subsections (a) and (c) cover a wide range of potential conduct, including “employing” a “device,” “scheme,” or “artifice to defraud” and “engaging in any act, practice, or course of business” that “operates . . . as a fraud or deceit.” The Court found it “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.” As to whether applying these subsections in a misstatements case would render subsection (b) “superfluous,” the Court concluded that the subsections are not mutually exclusive and any other conclusion “would mean those who disseminate false statements with the intent to cheat investors might escape liability under the Rule altogether.”
In a vigorous dissent, Justice Thomas (joined by Justice Gorsuch)), argued that the majority decision “eviscerates” the Janus distinction between primary and secondary liability. Justice Thomas noted that this will have a wide impact on the enforcement of the securities laws, because “virtually any person who assists with the making of a fraudulent misstatement will be primarily liable and thereby subject not only to SEC enforcement, but private lawsuits.” Moreover, this potential liability could extend widely to anyone who participates in the dissemination of misstatements, including administrative employees (secretaries, mail clerks, etc.).
Held: Judgment affirmed.
Quote of note: “Coupled with the Rule’s expansive language, which readily embraces the conduct before us, this considerable overlap suggests we should not hesitate to hold that Lorenzo’s conduct ran afoul of subsections (a) and (c), as well as the related statutory provisions. Our conviction is strengthened by the fact that we here confront behavior that, though plainly fraudulent, might otherwise fall outside the scope of the Rule. 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. But using 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.”
Note: The absence of aider and abettor liability in private actions alleging violations of Section 10(b) and Rule 10b-5 means that who can be subject to primary liability is a crucial question. Just as Janus resulted in significant litigation over who is a “maker” of corporate statements, Lorenzo is likely to lead to significant litigation over who is a “distributor” of corporate statements. Stay tuned.
Disclaimer: The author of The 10b-5 Daily assisted with the submission of an amicus brief by a group of law professors in support of the petitioner.