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U.S. Supreme Court Holds that “Disseminating” But Not “Making” False Statements Can Still Constitute Securities Fraud

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In Lorenzo v. SEC, the Supreme Court decided that those who do not “make” but who “disseminate” false or misleading statements to potential investors with the intent to defraud can still be found to have violated Rule 10b-5 and Section 10(b) of the Securities Exchange Act of 1934. Securities and Exchange Commission Rule 10b-5 makes it unlawful to:

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

(b) “make any untrue statement of a material fact,” or

(c) “engage in any act, practice, or course of business” that “operates . . . as a fraud or deceit” in connection with the purchase or sale of securities.

In Janus Capital Group, Inc. v. First Derivative Traders, 564 U. S. 135, 142 (2011), the Supreme Court held that to be liable under Rule 10b-5(b), the person or entity must be a “maker” of the false statement, which required that person or entity to have “ultimate authority over the statement, including its content and whether and how to communicate it.” Thus, an investment adviser who did not “control” but 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). Id. at 145.

In Lorenzo, the director of investment banking of a broker-dealer, Francis Lorenzo, sent two emails to prospective investors about a debenture offering that falsely described the investment as having “3 layers of protection,” including $10 million in “confirmed assets.” Maj. Op. at 3. Lorenzo did not dispute that he knew that this statement was false because he knew the company’s assets were worth less than $400,000. Id. at 2-3. Likewise, he did not contest the finding that he had acted with scienter. Id. at 4. Nonetheless, he argued that he could not be primarily liable for a Rule 10b-5 violation under Janus because his boss drafted and instructed him to send the emails, and thus he was not the “maker” of a false statement. Id. at 3-4.

Writing for the majority, Justice Breyer disagreed. “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.” Id. at 6.

In response to the dissent’s argument that the majority opinion renders Janus a “dead letter,” the Court held that Janus “would remain relevant (and preclude liability) where an individual neither makes nor disseminates false information−provided, of course, that the individual is not involved in some other form of fraud.” Id. at 10. Although Lorenzo argued that “classifying dissemination as a primary violation would inappropriately subject peripheral players in fraud (including him, naturally) to substantial liability . . . , even a bit participant in the securities markets ‘may be liable as a primary violator under [Rule] 10b-5’ so long as ‘all of the requirements for primary liability . . . are met.’” Id. at 11-12.

Justice Thomas, joined by Justice Gorsuch, dissented, arguing that Lorenzo “might have assisted in a scheme, but he did not himself plan, scheme, design, or strategize.” Dis. Op. at 5. “[T]he majority fails to maintain a clear line between primary and secondary liability in fraudulent misstatement cases. Maintaining this distinction is important because, as the majority notes, there is no private right of action against mere aiders and abettors.” Id. at 9 (citing Central Bank of Denver, N. A. v. First Interstate Bank of Denver, N. A., 511 U.S. 164, 191 (1994)). The “majority does precisely what we declined to do in Janus: impose broad liability for fraudulent misstatements in a way that makes the category of aiders and abettors . . . ‘almost nonexistent.’” Id. at 9. “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 . . . .” Id. at 8.

The majority responded that it “is hardly unusual for the same conduct to be a primary violation with respect to one offense and aiding and abetting [secondary liability] with respect to another.” Maj. Op. at 11. Justice Kavanaugh did not participate in the decision, but had dissented from the D.C. Circuit’s 2-1 affirmance of the SEC’s imposition of liability and sanctions.

Lorenzo was a closely watched case because observers wondered if “scheme liability” would be circumscribed like Rule 10b-5(b) liability was in Janus. It also raises the important question of the extent to which a person who participates or assists in the dissemination of a fraudulent statement will be primarily liable and therefore subject to not only SEC enforcement, but private lawsuits. The answer to that question for now is unclear. The Court noted that “while one can readily imagine other actors tangentially involved in dissemination−say, a mailroom clerk-for whom liability would typically be inappropriate,” “we see nothing borderline about this case,” where “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.” Id. at. 7.

The Court’s opinion can be found here: https://www.supremecourt.gov/opinions/18pdf/17-1077_21o3.pdf.

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