Lorenzo v. SEC: A shift towards broadening the scope of the securities fraud doctrine under Rule 10b-5.

“Don’t shoot the messenger.” This phrase was at the heart of the defense in Lorenzo v. SEC, one of the most recent Supreme court cases to consider whether an individual can be held liable under Rule 10b-5 for knowingly disseminating fraudulent statements in connection with the purchase or sale of securities. 

Lorenzo, the director of investment banking at an SEC-registered brokerage firm, sent two emails to investors that described a potential investment in a company with “confirmed assets” of $10 million. Despite his email, Lorenzo knew that the company had recently disclosed that it had less than $400,000 in total assets. Lorenzo’s supervisor drafted and approved the content of the emails and instructed Lorenzo to send them. The Court in Lorenzospecifically considered whether emailing misstatements can be considered conduct sufficient to satisfy the requirements for a scheme to defraud liability under Rule 10b-5(a) and (c). Ultimately, the Supreme Court held Lorenzo liable for participating in an unlawful scheme to defraud by distributing, not making, the false statements written by his supervisor. Lorenzo v. SEC, (Mar. 27, 2019); (Ronald Mann, SCOTUSblog). The Court determined that the more general subsections Rule 10b-5(a) and (c) extended liability for fraud to those that also distribute false statements. Id.

Prior to Lorenzo, the Supreme Court acted on a deliberate policy to restrict the use of Rule 10b-5 in the context of private actions. (RTTB).Janus Capital v First Derivative Traderslimited liability to only primary violators, those who had “ultimate control” over the misstatement, while Morrison arguably limited the ability of private litigants to sue foreign companies for securities fraud. (Steven Solomon, Harvard Law School Forum on Corporate Governance and Financial Regulation). Traditional Rule 10b-5 claims required a showing that the defendant “(1) made a material misrepresentation or a material omission as to which he had a duty to speak or used a fraudulent device; (2) with scienter; (3) in connection with the purchase or sale of securities.” (SEC v. Landberg). The LorenzoCourt called attention to other subsections in Rule 10b-5 that provide a basis for a claim by prohibiting “any device, scheme, or artifice to defraud” or participation in any “act, practice, or course of business” which constitutes fraud or deceit. Rule 10b-5(a) & (c). 

Under the Janusstandard, only the supervisor would be held liable for “making” such untrue statements of material fact. However, in Lorenzo, the Court appeared to broaden liability beyond the Janus“ultimate control” standard. In doing so, the majority looked to Rule 10b-5(a) and (c). These provisions make it illegal to “employ any device, scheme, or artifice to defraud,” or “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. Rule 10b-5. The Court found Lorenzo liable for “engaging in a fraudulent scheme” since he could not be liable for “making” a false statement.

This decision was not reached without its critics. Justice Kavanaugh, writing the dissent in the D.C. Circuit’s decision, warned of the dangers of expanding Rule 10b-5’s liability to messengers. Lorenzo, 872 F.3d. at 598 (Kavanaugh, J., dissenting). He argues that the SEC’s actions – which included suspending Lorenzo from the securities industry for life and imposing a $15,000 fine – were unjust because they essentially punished Lorenzo for merely forwarding an email after being directed to do so by his boss. Id. Additionally, Judge Kavanaugh reasoned that “scheme liability” should be based on “conduct that goes beyond a defendant’s role in preparing misstatements or omissions made by others.” (Matthew C. Turk and Karen E. Woody, Kelley School of Business). Agreeing with Judge Kavanaugh, one amici curiae filed in Lorenzoargued that if the Court extended liability as it did, then it would be abolishing the important distinctions between primary and secondary liability established in Janusand Stoneridge. (Lorenzo v. SEC, at 7; see also supraKelley School of Business.)

After Lorenzo, is Janusstill good law? Most argue that Janusremains good law and that Lorenzoarticulates a safe-harbor rule: an individual that neither makesnor disseminatesfalse information will not be primarily liable under Rule 10b-5. (Ronald Mann, SCOTUSblog). This safe harbor is much narrower than before March 2019, and murky waters linger. Instead of looking to the clearer question of whether a defendant madea false statement, courts will now have to develop a test for determining whether a defendant’s distribution of a false statement triggers liability. 

This expansion of Rule 10b-5 signals a change in trends. After years of limiting the scope of federal antifraud provisions, the LorenzoCourt has pushed back the boundaries. It remains to be seen how much effect this decision will have on SEC enforcement and private litigation in the future. Will there be a spike in litigation against parties originally thought to be safeguarded by the prohibition of “aiding and abetting” liability under Rule 10b-5? This important question has yet to be answered.