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INSIGHT: Supreme Court’s Lorenzo Ruling—Questions Remain on Interpretation

April 9, 2019, 8:01 AM

The U.S. Supreme Court handed the Securities and Exchange Commission a big win on March 27 in Lorenzo v. SEC, by expanding liability for securities fraud cases based on misstatements and omissions.

In Lorenzo, the court significantly broadened the reach of the SEC’s anti-fraud rule to cover persons who distribute statements they know to be false, whether or not they were the makers of those statements; i.e., they were involved in drafting or creating the statement.

The court’s holding will allow both the SEC and private litigants to hold defendants liable for engaging in a “scheme to defraud,” even if they only sent one or two emails, as Lorenzo did in this case.

The ruling diminishes the importance of a prior ruling—Janus Capital Group Inc., v. First Derivative Traders (564 U.S. 135)—as a limitation on liability in misstatement cases by providing opportunities to pursue fraud cases solely involving material misstatements or omissions under Rule 10b-5(a) and (c) as well.

Issue in Lorenzo

The question before the Supreme Court in Lorenzo was whether the defendant could be held liable under Rule 10b-5, which targets securities fraud and prohibits any act or omission resulting in fraud or deceit in connection with the purchase or sale of any security.

Francis Lorenzo was the director of investment banking at an SEC-registered brokerage firm who sent two emails to prospective investors. The emails described a potential investment in a company with “confirmed assets” of $10 million, although Lorenzo knew that the company actually only had assets of around $400,000.

The content of the email was provided to Lorenzo by his boss, but Lorenzo sent the emails and signed them with his own name, identifying himself as “Vice President—Investment Banking” and inviting recipients of the email to “call with any questions.”

The rule states:
“It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.”

In 2011, the court narrowed the scope of who can be held primarily liable under subsection (b) of Rule 10b-5, holding in Janus that only the “maker” of the statement, i.e., the person with ultimate authority over the statement, can be primarily liable.

Not the ‘Maker’ of Statement

Lorenzo was not the “maker” of the misstatements in the emails because his boss provided him the information. The court thus focused on what type of liability occurs when a person is not the maker of the statements, but instead disseminates false and misleading statements with the intent to defraud.

Holding that Lorenzo could be held liable under Rule 10b-5(a) or (c), the court limited Janus so that clearly fraudulent behavior would not escape liability. Even though Lorenzo was not the maker of the statements, thus making subsection (b) inapplicable, Lorenzo conceded that he was disseminating false information, and the court thus seemed intent on fitting Lorenzo’s admittedly fraudulent behavior within the scope of a Rule 10b-5 violation.

“Our conviction is strengthened by the fact that we here confront behavior that, though plainly fraudulent, might otherwise fall outside the scope of the rule,” the court plainly acknowledged.

What the Future Holds?

Future litigation will thus likely focus on factual differences from those in Lorenzo, specifically those facts that may be material enough to narrow the scope of liability under Rule 10b-5(a) and (c). Defendants may indeed argue that Lorenzo should be limited to its facts, rather than having actually broadened liability under the rule.

The court itself acknowledges that the provisions of Rule 10b-5 “capture a wide range of conduct” and that “[a]pplying them may present difficult problems of scope in borderline cases.” Although the court found nothing borderline about this case, interesting questions could soon arise as to how broadly or narrowly the courts will be willing to interpret the ruling.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

John F. Libby is a partner with Manatt, Phelps & Phillips LLP, and leads the firm’s investigations and white collar defense practice. He represents businesses, as well as their officers and directors, during criminal investigations and prosecutions, as well as complex civil litigation.

Molly Wyler is an associate with Manatt, Phelps & Phillips LLP in the investigations and white collar defense practice.