DC Circuit Affirms SEC Finding That Investment Banker Who Passed Along Statements From His Boss Was Liable for Securities Fraud

Skadden, Arps, Slate, Meagher & Flom LLP

Lorenzo v. SEC, No. 15-1202 (D.C. Cir. Sept. 29, 2017)

On September 29, 2017, a two-judge majority of the D.C. Circuit upheld the Securities and Exchange Commission’s (SEC) determination that investment banker Francis Lorenzo violated Section 17(a)(1) of the Securities Act, Section 10(b) of the Securities Exchange Act and Rules 10b-5(a) and (c) by passing along to investors statements made by Lorenzo’s boss, holding that Lorenzo knew the statements were false and misleading when he sent them.

On October 14, 2009, Lorenzo, director of investment banking for a registered brokerage firm, emailed two potential investors several “key” points about Waste2Energy Holdings, Inc.’s (W2E) pending debenture offering. W2E had recently lost almost all of its value and was offering up to $15 million in convertible debentures. In his emails, Lorenzo forwarded information provided to him by his boss touting the highly attractive nature of the offering but omitted any mention of the devaluation of W2E’s intangible assets. One of the emails noted it was being sent at the request of Lorenzo’s boss, the owner of the brokerage firm, and the other email said it was being sent at the request of the owner and another broker. In both emails, Lorenzo signed his name and title at the bottom and urged the investors to call him with any questions.

On February 15, 2013, the SEC filed an action alleging Lorenzo violated Section 17(a)(1) of the Securities Act, Section 10(b) of the Securities Exchange Act and Rules 10b-5(a)-(c). An administrative law judge found the statements in the emails were false and that Lorenzo acted recklessly in passing them along to investors. The judge ordered Lorenzo to cease and desist from violating the various provisions, permanently barred him from participating in the securities industry and ordered him to pay a civil monetary penalty of $15,000.

Following an unsuccessful petition for review, Lorenzo appealed to the D.C. Circuit and argued that the statements were not false or misleading, he did not act with the requisite intent in forwarding them and he did not “make” the statements within the meaning of Rule 10b-5(b).

Judge Sri Srinivasan, writing for the majority, held that the statements were false and misleading and that Lorenzo acted extremely recklessly in sending them because, at the time he sent the emails, Lorenzo knew W2E did not have sufficient assets, was headed for financial ruin and his brokerage firm had not agreed to raise the additional monies needed to repay the debenture holders.

The court rejected the argument that merely sending the statements at the request of his boss was insufficient to establish liability. The court held that although Lorenzo’s boss supplied the content of the statements, Lorenzo effectively vouched for them by passing them along in his role as director of investment banking and by inviting the investors to call him with any questions. The court, however, agreed with Lorenzo that he was not liable under Rule 10b-5(b), holding that Lorenzo did not make the challenged statements because his boss, not Lorenzo, retained ultimate authority over the statements.

In so holding, the court considered the U.S. Supreme Court’s decision in Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011). In Janus, the Supreme Court held that an investment adviser who assisted in preparing a mutual fund’s prospectuses did not “make” the statements in the prospectuses as required under Rule 10b-5(b) because the adviser did not have “ultimate control” over the statements’ content and dissemination. Like the adviser in Janus, the court held that Lorenzo did not have “ultimate control” over the statements in the emails because Lorenzo’s boss: (1) asked him to send the emails; (2) supplied the content; and (3) approved the emails for distribution.

Relying on Janus, Lorenzo argued that because he did not “make” the statements at issue, he should not be liable under the other securities fraud provisions. The court held that the conduct at issue in Janus materially differed from Lorenzo’s conduct. In Janus, the adviser drafted false statements that an independent entity chose to disseminate in its own name, and the adviser’s role in drafting the statements was unknown to the investors who received the statements. The court held that, unlike in Janus, the investors were aware of Lorenzo’s role in the matter because he sent the emails from his account and under his name, in his capacity as director of investment banking.

This summary can be found in the November 2017 issue of Inside the Courts.