The Commission prevailed in the Supreme Court for the first time in years. In doing so the agency achieved one of its long sought goals which should aid its enforcement program. The victory should also assist plaintiffs in securities class actions. Lorenzo v. Securities and Exchange Commission, No. 17-1077 (March 27, 2019)
The facts in the action were largely undisputed. Francis Lorenzo was the director of investment banking at Charles Vista, LLC, a regional broker. Waste2Energy Holdings, Inc. was its only investment banking client. In the summer of 2009, the company retained the investment banking firm to sell $15 million of debentures. Subsequently, in early October 2009 Mr. Lorenzo was told that the firm’s intellectual property was worthless and had to be written off. That would leave its total assets as of March 31, 2009 at $370,552. A June 2009 public filing by the company stated that it had assets of $14 million.
Mr. Lorenzo sent two e-mails to prospective investors on October 14, 2009. The e-mails were authored by Mr. Lorenzo’s boss who directed that they be sent. The e-mails touted the layers of protection investors would have including $10 million in confirmed assets. The e-mails did not disclose that Waste2Energy only had assets worth less than $400,000. Mr. Lorenzo signed the emails, noting that would be investors should call with questions.
The Commission instituted proceedings which named Mr. Lorenzo as a Respondent along with his boss who settled. Mr. Lorenzo was found to have violated Securities Act Section 17(a)(1) and Exchange Act Section 10(b). A cease and desist order was entered and a $15,000 penalty imposed. He was also barred from the securities business. The Court of Appeals affirmed in a 2-1 decision, concluding that Mr. Lorenzo violated Subsections (a) and (c) of Rule 10b-5 and each of the charged Sections. Certiorari was granted to determine if someone who was not a “maker” of a false statement as in Janus Capital Group, Inc., v. First Derivative Traders, 564 U.S. 135 (2011) could be held liable under subsections (a) and (c) of Rule 10b-5.
Justice Breyer, joined by five other Justices, delivered the opinion of the Court, concluding 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, as well as the relevant statutory provisions. In our view, that is so even if the disseminator did not ‘make’ the statements and consequently falls outside subsection (b) of the Rule.” This conclusion “would seem obvious,” Justice Breyer wrote, from consideration of the language. That language speaks about a “device,” “scheme,” and “artifice to defraud” as well as “fraud or deceit.” Since Mr. Lorenzo did not challenge the determination of scienter by the lower court, it is “difficult to see how his actions could escape the reach of those provisions.”
While the Court’s reading of the statutory langage essentially concluded its analysis, two supporting points were proffered. First, the dictionary definitions of the words used in the statute confirms that Mr. Lorenzo’s conduct falls squarely within the statutory language given the wide range of conduct engulfed by the words. Second, the Court was confronted with “behavior that, though plainly fraudulent, might otherwise fall outside the scope of the Rule. Lorenzo’s view that subsection (b), the making-false statements provision, exclusively regulates conduct involving false or misleading statements would mean those who disseminate false statements with the intent to cheat investors might escape liability under the Rule altogether” despite having committed securities fraud (emphasis original). That is not the point of the securities laws.
Mr. Lorenzo’s claim that the other provisions of the statute address scheme liability, not misstatements as here ignores the text of the statute. The premise of this theory is that each statutory provision should be read as applying to separate spheres of conduct. That, however, is contrary to the manner in which the statutes have always been read – that is, as having “considerable overlap among the subsections.”
Finally, Mr. Lorenzo’s claim, as well as that of the dissent authored by Justice Thomas and joined by Justice Gorusch, that reading that statute in this manner undercuts Janus is incorrect. In that case the Court only addressed the question of liability for the maker of the statement. It said nothing about those who disseminate such statements. There is no reason Janus will not remain viable. Indeed, as the Court held in Central Bank of Denver, N. A. v. First Interstate Bank of Denver, N.A., 511 U.S 164 (1994), there must be a clear line between primary and secondary liability. In the securities markets even a “bit” player can be a primary violator if all the elements of the statute are met.
The Court’s conclusion creates the expansive version of primary liability the SEC has sought for years. Perhaps ironically, the scheme liability theory the agency created in an effort to reach its goal was largely ignored by the Court. Rather, the opinion crafted by Justice Breyer is little more than a reiteration of Central Bank. There the Court rejected the conclusion of every court which had considered the question, by holding that Section 10(b) did not encompass aiding and abetting liability. The statute does reach any conduct which falls within the ambit of its expansive language – even that of a “bit” player, according to the Court.
The Court’s effort to bolster its rationale by claiming that an admitted fraudster might escape liability if the statutes were read as Mr. Lorenzo suggested is puzzling in the context of an SEC enforcement action. After Central Bank Congress passed legislation giving the Commission authority to bring actions based on aiding and abetting. Accordingly, Mr. Lorenzo could have been found liable for aiding and abetting a fraud if the Commission chose to charge the case in that manner. The fact that the agency chose not to use all of the authority it was given by Congress says nothing about how the statute should be interpreted.
Finally, the Court’s determination may also be a victory for the class action bar. While private litigants cannot bring fraud claims based on an aiding and abetting theory, they can now pursue even “bit” players in a securities fraud by wedging the conduct into the expansive contours of the statutes. Lorenzo is the ode to expanding securities fraud liability.