April 25, 2019

By Richard E. Lorant

Editor’s Note: As reported in the Fall 2018 issue of Shareholder Advocate, Cohen Milstein Partner Laura Posner and Associate Eric Berelovich submitted an amicus curiae (“friend of the court”) brief in support of the Securities and Exchange Commission in Lorenzo v. SEC.

In a victory for plain language, the Supreme Court ruled in March that an investment banker who intended to defraud clients by relaying an email with contents he knew were misleading was liable for fraud even though he didn’t technically “make” the fraudulent statement at issue.

In Lorenzo v. Securities and Exchange Commission, the Court held that the SEC correctly found Francis V. Lorenzo in violation of its Rule 10b-5(a) and (c), for his “dissemination of false or misleading statements with intent to defraud” prospective investors. The ruling upheld a decision by the D.C. Court of Appeals.

As the Supreme Court noted in its March 27 opinion, SEC Rule 10b-5’s three subsections make it unlawful: (a) “to employ any device, scheme, or artifice to defraud,” (b) “to make any untrue statement of a material fact,” or (c) “to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit … in connection with the purchase or sale of any security.”

Writing for a 6-to-2 majority, Justice Stephen Breyer held that Lorenzo, then director of investment banking at broker-dealer Charles Vista, had violated subsections (a) and (c) of Rule 10b-5 by sending prospective investors emails that vastly understated the assets of a company whose debt Charles Vista was trying to sell— “emails he understood to contain material untruths.” Rule 10b-5 was promulgated by the SEC to enforce Section 10(b) of the Securities Exchange Act (Exchange Act). The Court also held that Lorenzo was liable under Section 17(a)(1) of the Securities Act of 1933, which mirrors Rule 10b-5(a)’s language against “any device, scheme, or artifice to defraud,” this time in connection with sales and offerings.

In reaching its conclusion, the majority rejected Lorenzo’s argument that he couldn’t be held responsible under Rule 10b-5(a) and (c) because the email containing the fraudulent information was composed largely by his boss. Lorenzo, who sent the email to clients after adding his title and an offer to answer questions, did not deny knowing that the message’s content was false.

Lorenzo’s argument relied on a 2011 Supreme Court decision, Janus Capital Group, Inc. v. First Derivative Traders, which restricted primary liability under subsection Rule 10b-5(b) to “makers”—those who had “ultimate authority” over the statement’s content “and whether and how to communicate it.” The Supreme Court took the case “to resolve disagreement about whether someone who is not a ‘maker’ of a misstatement under Janus can nevertheless be found to have violated the other subsections of Rule 10b-5 and related provisions of the securities laws, when the only conduct involved concerns a misstatement,” Justice Breyer wrote.

“After examining the relevant language, precedent, and purpose,” including dictionary definitions of the words in the statute, the Court concluded that “dissemination of false or misleading statements with intent to defraud can fall within the scope of subsections (a) and (c) of Rule 10b–5 … even if the disseminator did not ‘make’ the statements and consequently falls outside subsection (b) of the Rule.”

The majority also rejected an argument made by Justice Clarence Thomas, who was joined in his dissent by Justice Neil Gorsuch, that finding Lorenzo liable would nullify the restrictions in Janus, rendering it “a dead letter” and potentially putting at risk secretaries who relayed their boss’s fraudulent emails. On the contrary, the Court said, Janus would still apply in cases “where an individual neither makes nor disseminates false information—provided, of course,

that the individual is not involved in some other form of fraud.” And while the Court recognized that Rule 10b-5’s “expansive language” could create some “problems of scope in borderline cases,” it rejected the idea that someone “tangentially involved in dissemination—say a mailroom clerk” was anything like Lorenzo, who “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.”

Allowing Lorenzo to avoid responsibility for what appeared to be “a paradigmatic example of securities fraud” would violate both Congress’s and the SEC’s intentions, Breyer wrote, not to mention common meanings of the terms used in the rules themselves. “It would seem obvious that the words in these provisions are, as ordinarily used, sufficiently broad to include within their scope the dissemination of false or misleading information with the intent to defraud,” he wrote.

Rule 10b-5 was promulgated by the SEC to enforce the Exchange Act, a sweeping law enacted after the 1929 Stock Market Crash, that is relied on by the SEC and private litigants to bring most securities fraud cases. In his conclusion, Justice Breyer wrote that in enacting the law, “Congress intended to root out all manner of fraud in the securities industry. And it gave to the Commission the tools to accomplish that job.” Under Lorenzo, those tools will continue to include any and all of the subsections of SEC Rule 10b-5.