Berman Tabacco


April 15, 2019

On March 27, 2019, in a 6-2 ruling authored by Justice Breyer, the Supreme Court resolved a circuit split and closed a notable loophole in federal securities laws whereby a person who knowingly disseminates a false statement with the intent to deceive investors could escape liability if they did not personally author the statement.

The case, Lorenzo v. Securities and Exchange Commission, involved two types of liability that arise from Rule 10b-5 of the Securities Exchange Act of 1934. First, anyone who knowingly makes a false statement is liable under Rule 10b-5(b). As the Supreme Court held in 2011, only a person with “ultimate authority” over the content and dissemination of a statement is considered the “maker” of it. Second, anyone who engages in what is commonly referred to as “scheme liability” is liable under Rule 10b-5(a) and (c). Those subsections generally prohibit “employing any device, scheme, or artifice to defraud” and “engag[ing] in any act, practice, or course of business which operates…as a fraud or deceit.”

Most private securities class actions involve false statements under Rule 10b-5(b) because many circuit courts, including the Second, Eighth and Ninth Circuits have held that misstatements alone cannot support scheme liability under subsections (a) and (c) of the Rule.

The Lorenzo matter originated from a Securities and Exchange Commission (“SEC”) proceeding and explored the scope of misstatement liability under the subsections of Rule 10b-5. In 2009, Francis Lorenzo was the director of investment banking at a brokerage firm when he sent two emails to prospective investors. The content of those emails was written by Mr. Lorenzo’s boss and described potential investment in a company with “confirmed assets” of $10 million. Mr. Lorenzo knew at the time he sent the emails that the company had recently disclosed that its total assets were worth less than $400,000, but he went ahead and sent the emails anyway.

In 2015, the SEC found that Mr. Lorenzo had violated various securities laws, including Rule 10b-5, by sending false and misleading emails to investors with an intent to defraud. The fact that Mr. Lorenzo did not write the content of the emails before sending them did not change the SEC’s conclusion.

Mr. Lorenzo appealed the decision to the D.C. Circuit Court of Appeals challenging his liability under Rule 10b-5(b) because he was not the “maker” of the false statement. The D.C. Circuit agreed that Mr. Lorenzo was not liable under subsection (b) because he did not “make” the false statements as described by the Supreme Court’s 2011 decision Janus Capital Group Inc., et al. v. First Derivative Traders. In Mr. Lorenzo’s case, his boss was the “maker” of the statement because he drafted the content of the emails. Nonetheless, the D.C. Circuit held, Mr. Lorenzo could be liable for scheme liability because he knowingly sent emails to investors containing false and misleading information. When this ruling was issued, Justice Kavanaugh was a judge on the D.C. Circuit. He was the dissenting voice on the matter, calling the majority opinion “legal jujitsu.” With this opinion, the D.C. Circuit joined the Eleventh Circuit in finding that misstatements alone can support scheme liability.

Hoping for a different outcome, Mr. Lorenzo appealed to the Supreme Court. But the Supreme Court affirmed, finding that by “sending emails he understood to contain material untruths” Mr. Lorenzo violated subsections (a) and (c) of Rule 10b-5. Justice Breyer further stated that to hold otherwise would mean that those who disseminate false statements with the intent to cheat investors might escape liability, which is not what Congress intended. The Court cautioned that, while subsections (a) and (c) capture a wide range of conduct, there could be borderline cases or situations where liability would be inappropriate, for instance if the person was someone like a mailroom clerk who was only tangentially involved in distributing the false statements. In the case of Mr. Lorenzo, however, Justice Breyer stated that “we see nothing borderline about this case” as he sent false and misleading information to prospective investors with the intent to defraud. Five other justices joined Breyer in the majority opinion, with Justices Thomas and Gorsuch dissenting. Justice Kavanaugh did not participate because of his involvement in the matter at the D.C. Circuit.

The Lorenzo opinion embraces the broad fraud prevention goals of Rule 10b-5, making clear that a person who knowingly disseminates a false statement with the intent to deceive investors can be held liable for scheme liability, even if they did not personally author the false statement. And the holding is not limited to SEC proceedings because the same legal theories will apply to 10b-5 claims in investors’ securities class actions.

Future fraudsters are now on notice – even if they do not “make” a false statement they may still be liable for scheme liability if they disseminate it.