Lorenzo and Primary Liability: An SEC Win at the High Court?

by Dorsey & Whitney LLP

The Supreme Court heard argument on the question frequently referred to in the circuit and district courts as scheme liability on Monday, December 3, 2018. Specifically, the question as framed by Petitioner Francis Lorenzo is “whether the D.C. Circuit erred in concluding a misstatement claim that does not meet the elements set forth in Janus [Janus Capital Group, Inc., v. First Derivative Traders, 564 U.S. 135 (2011)] can be repackaged and pursued as a fraudulent scheme claim under Section 10(b) of the Exchange Act . . . and Section 17(a)(1) of the Securities Act.” The D. C. Circuit and the Securities and Exchange Commission had rejected the contention.


Frank Lorenzo was a director at investment bank Charles Vista, LLC in February 2009. The firm’s largest investment banking client was start-up W2Energy Holdings, Inc. That firm’s business depended largely on the success of certain technology which failed. The firm sought to raise about $15 million through the sale of convertible debentures with the assistance of Charles Vista.

Mr. Lorenzo emailed two potential investors “several key point” about W2E’s pending debenture offering. The emails failed to mention the recent devaluation of the firm’s assets. To the contrary investors were told that there were “3 layers of protection.” One of the messages stated it had been sent at the request of Gregg Lorenzo, the owner of the firm (no relation to Petitioner). Specifically, Mr. Lorenzo, the only witness who testified before the ALJ, stated that he sent emails at the behest of his boss by cutting and pasting – he did not write them.

While the Initial Decision found that that Mr. Lorenzo did not read the text of the emails, that they were sent “without thinking,” the ALJ concluded that Mr. Lorenzo had acted willfully with the intent to deceive, manipulate, or defraud in violation of the statutes. A cease and desist order was entered along with a $15,000 penalty and a life time bar from the securities business. The Commission affirmed as did the D.C. Circuit.

The briefs of the parties centered on the question of primary liability under Janus and whether the SEC could circumvent the dictates of that case by alleging scheme liability in violation of subsections (a) and (c) of Rule 10b (see discussion here).

Petitioner’s argument

Petitioner Lorenzo began the argument by citing to Janus for the proposition that “only the maker of a misstatement can be held liable for that misstatement under Section 10(b) and Rule 10b-5.” While the lower court agreed that is the law under Janus, and that Mr. Lorenzo was not the “maker” of the statements, it found him liable. To reach that conclusion the D.C. Circuit found that Mr. Lorenzo “engaged in a deceptive act, artifice to defraud, or practice, for purposes of liability under Section 10(b) . . .” Permitting liability under this approach would allow “plaintiffs to creatively relabel their inadequate misstatement claims as claims for deceptive devices and acts,” Petitioner claimed.

Justice Sotomayor then asked Petitioner’s counsel about the text of Section 17(a). While Rule 10b-5 uses the phrase “to make” Section 17(a) says something different. The text of that section precludes obtaining “money or property by means of any – of any untrue statement of a material fact.” Since the text of that Section differs from Rule 10b-5 why “should we be treating the two identically” the Justice asked. Petitioner responded that Section 17(a)(2) had not been charged in the case, although he allowed it might have been a better choice for the SEC.

Counsel for Mr. Lorenzo went on to note that typically the courts have differentiate between deceptive conduct and deceptive statements. Since Mr. Lorenzo did not engage in any conduct beyond the misstatements he did not violate the other subsections of Rule 10b he claimed. The Justices did not, however, appear to accept this position. Justice Alito, for example, queried “Well, just take the language of (c). Why doesn’t his conduct all squarely within the language of (c)?” The response was the same from counsel: “because (c) talks about conduct. It’s a type of fraud that’s categorically different than merely misstatements or omissions.” Indeed, if sending an email written by somebody else “constitutes enough of an action to constitute primary liability, it would really leave no room for any sort of aiding and abetting liability.”

Justice Alito was not deterred: “he’s [Lorenzo] a principal under (c) . . . he did the act that is described in (c).” Justice Sotomayor stepped in, pursuing the point by first noting that Mr. Lorenzo conceded he acted with scienter and then stating that “Whether he was a maker or not, he was encouraging the customers to call him directly about buying . . .” the securities offered.

Justice Kagan followed-up, stating that under Central Bank “if your actions fit within the language of the particular provision of the statute that you’re charged on, then you’re a primary violator of that provision. Right?” While Counsel for Petitioner tried to retreat to the argument that the conduct involved here does not fall within the language of the statute, Justice Kagan continued to push the point. Later Justice Breyer essentially affirmed the notion, stating that “And so, fine, then he’s not the maker. But it seems pretty bad. I mean, he’d been working with this company for quite a long time and these investors. And so what is it that makes this aiding and abetting? Maybe he didn’t make the statement, but he was sure a big deal participant.”

Respondent’s argument

Counsel for the Government opened with a focus on the facts: “Petitioner’s decision to send emails that grossly misrepresented the financial prospects of his client and to give illusory promises designed to deceive investors into backing a business that he knew was failing constitute a quintessential securities fraud. His conduct falls within the plain text and the common-sense meaning of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and subsections (a) and (c) of Rule 10b-5.”

Chief Justice Roberts noted that the opening argument offered by Respondent “sounds like the argument your – your client made in Janus that was rejected by this Court.” Counsel immediately noted that 10b-5(b) was the predicate for that case, a subsection not at issue here. Justice Ginsburg picked up the point, asserting that Petitioner’s claim the argument being made “is just an end run around Janus.” The Government rejected this contention, noting first that Janus will continue to have vitality. The critical point, however, is one referenced by Justice Kagan who “said, Central Bank was very clear that the test for primary liability is simply that the defendant has to satisfy all the elements. And – Central Bank says expressly that even if somebody is a secondary actor in some colloquial sense, like a lawyer or an accountant, that person can still be primarily liable under the securities laws if that person satisfies all of the statutory requirements, as Petitioner did here and as I don’t take him to seriously contest.” Justice Gorsuch attempted to interject with a multi-step question that appeared designed to undercut the Government’s position. The point, however, seemed to be lost when other Justices interjected.

The Government shifted the argument back to the conduct noting: “And this email was extraordinarily deceptive, as was commented earlier. There were – there were three gross mischaracterizations of the company under the representation that they would provide different layers of protection.” Returning to Janus Respondent reiterated the established point that the Court there was only concerned with (b) and the meaning of that subsection. This is what Respondent called the “real flaw in Petitioner’s argument, which is, again, that subsection (b) somehow restricts the meaning of (a) and (c) in Rule 10b-5 and also somehow restricts the meaning of subsection (a) of a completely different statute, the Securities Act of 1933.” That is simply incorrect.

Later in the argument Justice Breyer seemed to sum-up stating: “But I just wondered why this isn’t fairly simple, because now that we did in Janus is we took a category of things which we thought the maker had made the false representation, and we thought, no, he wasn’t the maker, but, still, he might be the big boss of a group of people who, in fact, took actions or made statements to cause the false representation to arise in the mind of the listener. I thought perhaps you would agree.” Respondent did agree.


Lorenzo presents a straight forward issue regarding the language of Section 10(b) and the rule under it and Janus which focused on one word in one subsection of Rule 10b-5(b). The question, often raised by the SEC, was if a case predicated on false statements could escape what appeared to be the Janus trap — that only the maker could be a primary violator. Here since Mr. Lorenzo is not the “maker” under everyone’s reading of the record, there appeared to be clear error.

A critical point threaded through Lorenzo, however, is that he acted with scienter. Precisely how that point became established under the facts as found by the ALJ here is at times difficult to understand. The admission makes Mr. Lorenzo appeared to be intentionally acting to deceive the clients rather than simply bumbling about at the behest of his boss by cutting and pasting emails together as told. Stated differently, Mr. Lorenzo moved from being a secondary actor to a primary one if Janus did not preclude primary liability for those who are not makers.

The Central Bank holding, repeated referenced throughout the arguments, appears to negate the notion that Janus somehow precludes primary liability in this case. To the contrary, as Central Bank directs, if the conduct is prohibited by the text of the statute the actions can only constitute a primary violation. That is the reason Central Bank found that Section 10(b) does not encompass aiding and abetting liability despite decades of prior circuit and district court decisions. Here that same simple notion may well mean that the SEC will prevail in the Supreme Court after a string of difficult losses.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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