Supreme Court: Intentionally Disseminating a False Statement One Did Not “Make” May Still Violate SEC Rule 10b-5

Pillsbury Winthrop Shaw Pittman LLP

Pillsbury Winthrop Shaw Pittman LLP

In a significant ruling, the U.S. Supreme Court has expanded the potential liability of those involved in disseminating material misrepresentations to potential investors—exposing them to primary liability under SEC Rule 10b-5.

  • Takeaways

  • No Blanket “I’m Only the Messenger” Defense to Rule 10b-5: A person in a responsible position who disseminates a materially false statement, knowing it to be false, cannot escape primary scheme liability under Rules 10b-5(a) and 10b-5(c) simply by proving that he was not the “maker” of the false statement under Rule 10b-5(b).
  • Subparts of Rule 10b-5 not mutually exclusive: Harkening back to the more expansive view of Rule 10b-5 that it took from the 1940s through the 1970s, the Court in Lorenzo says that each succeeding prohibition of 10b-5 was meant to cover additional kinds of illegalities, not to narrow the reach of the past parts.
  • Private parties and the SEC may now pursue primary liability claims under Rules 10b-5(a) and (c) against a broader range of individuals even where they are not the “maker” of the misstatement at issue.

SEC Rule 10b-5(b) makes it unlawful “[t]o make any untrue statement of a material fact . . . in connection with the purchase or sale of any security.” The Court in Janus Capital Group Inc. v. First Derivative Traders, 564 U.S. 135, 142 (2011) limited “maker” liability under 10b-5(b) to “the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it.” In Lorenzo v. Securities & Exchange Commission, No. 17-1077, 2019 WL 1369839 (S. Ct. Mar. 27, 2019), the Court considers whether one who is not a “maker” of a false statement under 10b-5(b) can nonetheless be primarily liable under 10b-5(a) or 10b-5(c) for disseminating the false statement, knowing it to be false.

The Lorenzo Case:

Petitioner Francis Lorenzo was the director of investment banking for a broker-dealer on Staten Island. Lorenzo had one client: Waste2Energy, which said it was developing technology to convert “solid waste” into “clean renewable energy.” In an SEC filing, Waste2Energy said it had total assets of $14 million, of which $10 million was intellectual property. Waste2Energy hired Lorenzo’s firm to sell $15 million of debentures.

Unfortunately for Waste2Energy, its technology did not work, rendering its intellectual property worthless. In a later SEC filing, Waste2Energy publicly disclosed that it had written off all of its intellectual property and had total assets of less than $400,000.

Undeterred by this bad news, Lorenzo’s boss told him to send emails to two prospective investors, touting the debentures as having “‘3 layers of protection,’ including $10 million in ‘confirmed assets.’” Though he knew that was untrue, Lorenzo sent the emails, signing them with his own name, identifying himself as “Vice President - Investment Banking,” and inviting the investors to “call with any questions.”

The SEC instituted administrative proceedings against Lorenzo, finding that he had violated Rule 10b-5 as well as § 17(a)(i) of the Securities Act of 1933 and § 10(b) of the Securities Exchange Act of 1934. It barred him from working in the securities industry for life.

On appeal, the D.C. Circuit affirmed the finding that Lorenzo had the “scienter” (mental state embracing interest to defraud) required by Rule 10b-5 but said he was not a “maker” under Janus because Lorenzo’s boss, and not Lorenzo, had had the “ultimate authority” over the fraudulent emails. However, the D.C. Circuit affirmed the SEC’s finding that Lorenzo had violated Rules 10b-5(a) and 10b-5(c). Rule 10b-5(a) makes it unlawful “[t]o employ any device, scheme, or artifice to defraud,” while Rule 10b-5(c) makes it unlawful “[t]o 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.”

The Supreme Court granted review to decide 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 . . . when the only conduct involved concerns a misstatement.”

The Court, 6-2, answered that question “yes.” Justice Breyer wrote the opinion of the Court. Justice Thomas (joined by Justice Gorsuch) dissented; Justice Kavanaugh did not participate (but likely would have dissented, as he had dissented in the D.C. Circuit).

To the Court majority, the answer as to VP Lorenzo was easy: while the question might have been difficult had Lorenzo been someone “tangentially involved in dissemination [of the false statement]—say, a mailroom clerk,” here Lorenzo “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.” To the Court, these facts created “scheme” liability under 10b-5(a) and 10b-5(c), even though Lorenzo was not a “maker” under 10b-5(b), under its Janus ruling. After consulting dictionaries, the Court found the language of 10b-5(a) and 10b-5(c) broad enough to encompass this kind of behavior, and citing a number of its own precedents, said the various subparts of 10b-5 were meant to be broad and overlapping, not narrow and mutually exclusive. The Court also rejected the dissent’s arguments that this construction rendered Janus a “dead letter” or muddied the distinction between primary liability and secondary (aiding and abetting) liability—this is significant because secondary liability is enforceable only by the SEC and not by private parties.

The dissent argued that while Lorenzo might have “assisted in [his boss’s] scheme . . . he did not himself plan, scheme, design, or strategize” and therefore should not be held primarily liable. In other words, scheme liability “cannot be construed to encompass primary liability solely for false statements.” To do otherwise, argued the dissent, renders 10b-5(b) superfluous. Ultimately, to the dissent Lorenzo is in “precisely the same position as a secretary asked to send an identical message from her e-mail account,” and hence neither should be primarily liable.

In rejecting a narrow interpretation of Rule 10b-5, the Court’s decision makes it hard to predict where disseminator liability will end, but it is easy to predict that private plaintiffs will be tempted to test the limits.

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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