Lorenzo v. SEC, 872 F.3d 578 (D.C. Cir. 2017), cert. granted 138 S. Ct. 2650 (2018)
The U.S. Supreme Court granted a petition for a writ of certiorari urging it to decide whether the scheme liability provisions of Securities Exchange Act Rule 10b-5(a) and (c) may be used to impose liability in connection with false or misleading statements by a person who is not a “maker” of those statements within the meaning of Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011), and who is thus not liable under the false-and-misleading statements provision of Rule 10b-5(b).
On October 14, 2009, at the behest of his boss, petitioner Francis Lorenzo — who was director of investment banking at a registered brokerage firm — emailed two potential investors several “key” points about Waste2Energy Holdings, Inc.’s (W2E) pending debenture offering. In his emails, Lorenzo forwarded information provided to him by his boss touting the highly attractive nature of the offering but omitting any mention of the devaluation of W2E’s intangible assets.
On September 29, 2017, a 2-1 majority of the D.C. Circuit upheld the SEC’s determination that Lorenzo had violated Section 17(a)(1) of the Securities Act, Section 10(b) of the Securities Exchange Act and Securities Exchange Act Rules 10b-5(a) and (c) by copying, pasting and sending statements prepared by Lorenzo’s boss to investors. The D.C. Circuit held that substantial evidence supported the SEC’s determination that Lorenzo acted extremely recklessly in sending his boss’ statements to investors because he knew they were false at the time, used them to deceive investors and was therefore liable for engaging in a fraudulent scheme.
The D.C. Circuit held, however, that Lorenzo was not liable under Rule 10b-5(b) for “making” the statements because he did not have “ultimate control” over their content and dissemination, as required to impose liability under the Supreme Court’s decision in Janus. In explaining its rationale for imposing liability for false statements under the fraudulent scheme provisions of Rules 10b-5(a) and (c) while declining to impose liability for those same statements under Rule 10b-5(b), the court noted that claims involving false statements are not exclusively within the purview of Rule 10b-5(b); Rules 10b-5(a) and (c) may encompass conduct involving the dissemination of false statements even if that conduct is beyond the reach of Rule 10b-5(b). Judge Brett Kavanaugh dissented, expressing his view that scheme liability must be based on conduct that goes beyond a defendant’s role in preparing misstatements or omissions made by others.
With its decision, the D.C. Circuit joined the Eleventh Circuit in holding that a person who is not the “maker” of a false statement could still be liable for fraudulent scheme claims. See SEC v. Big Apple Consulting USA, Inc., 783 F.3d 786, 795-96 (11th Cir. 2015).
In his petition to the Supreme Court, Lorenzo contended that the false statements that form the basis of the misstatement claim cannot be the sole basis for the fraudulent scheme claim. Lorenzo asserted that a majority of circuits that have ruled on this issue, including the Second, Eighth and Ninth circuits, have held that misstatements alone cannot form the basis of a fraudulent scheme claim under Rule 10b-5(a) or (c) and that additional deceptive conduct is required to impose liability. See Lentell v. Merrill Lynch & Co., 396 F.3d 161, 177 (2d Cir. 2005), WPP Lux. Gamma Three Sarl v. Spot Runner, Inc., 655 F.3d 1039, 1057-58 (9th Cir. 2011) and Pub. Pension Fund Grp. v. KV Pharm. Co., 679 F.3d 972, 986-87 (8th Cir. 2012). Lorenzo further asserted that the D.C. Circuit’s holding allows the SEC to relabel inadequate fraudulent statement claims as fraudulent scheme claims to sidestep the standards set forth in Janus, thereby rendering it meaningless. Lorenzo also contended that the D.C. Circuit’s decision erases the distinction between primary and secondary violators of the securities laws, thereby exposing large numbers of defendants who are secondary actors to aiding-and-abetting claims that would otherwise be barred in private litigation.
In its opposition to Lorenzo’s petition, the SEC argued that the imposition of liability under Rule 10b-5(b) for “making a false statement” did not preclude the imposition of liability under Rules 10b-5(a) and (c) for “disseminating a false statement.” The SEC similarly rejected Lorenzo’s concern regarding meritless private actions, noting the additional reliance requirement that must be established by private plaintiffs and the heightened pleading standards imposed by the Private Securities Litigation Reform Act (PSLRA).
The ultimate outcome in Lorenzo may very well depend on whether Judge Kavanaugh is confirmed to the Court, and if so, whether he participates in the decision.