SEC Rule 10b-5(a) and (c) (the “scheme liability provisions”) broadly prohibit “any device, scheme, or artifice to defraud” and any “act, practice, or course of business” that operates as a fraud in a securities transaction. Rule 10b-5(b) more specifically prohibits “mak[ing] any untrue statement of a material fact.” In Lorenzo v. SEC, the Supreme Court held that the scheme liability provisions impose liability on those who fraudulently disseminate false statements, even if the disseminators would not be liable under subsection (b). In doing so, it overturned precedents in the Second, Eighth, and Ninth Circuits. Following Lorenzo, circuits will need to define the scope of Rule 10b-5(a) & (c). The Supreme Court described those provisions as capturing “a wide range of conduct,” but also warned that future cases could “lead to narrowing their reach.”
The Lorenzo Decision
Lorenzo, an investment banker, sent two emails that he knew contained false statements, in an effort to solicit investment in a debenture offering. The emails had been drafted by and sent at the request of Lorenzo’s boss. Before the Supreme Court, Lorenzo did not challenge that he had acted with intent to deceive. The SEC also accepted that Lorenzo did not “make” false statements under Rule 10b-5(b) because Lorenzo’s boss had “ultimate authority” over the emails’ contents under Janus Capital Group v. First Derivative Traders. Thus, the sole question was whether distributing false statements with deceptive intent falls within the scope of the scheme liability provisions.
The Supreme Court held that it does. The Court analyzed the scope of the scheme liability provisions by reference to the dictionary definitions of their terms, interpreting them so broadly that they would arguably capture all fraudulent conduct, including misstatements. The Court then rejected Lorenzo’s contention that each subsection of Rule 10b-5 covers “different, mutually exclusive, spheres of conduct,” instead noting that its prior decisions had “long recognized considerable overlap among the subsections of the Rule.” The Court also disagreed with Lorenzo’s argument that its holding would eviscerate Janus, noting that Janus would still apply where “an individual neither makes nor disseminates false information,” so long as that individual did not engage in other fraudulent conduct.
Thus, following Lorenzo, the scheme liability provisions cover a “wide range of conduct,” including conduct involving misstatements a defendant did not make. The decision, however, cautions against an overly expansive reading. The Court expressed repeated concern about excluding “plainly fraudulent” conduct from the scope of Rule 10b-5. It thus left open “difficult problems of scope in borderline cases,” noting that such cases could “lead to narrowing” of the scheme liability provisions.
Lorenzo significantly expands liability for conduct involving false or misleading statements, and it will revise several circuits’ approaches to the scheme liability provisions. Lorenzo plainly rejected the reasoning of circuits that had “emphasized the importance of maintaining a distinction among the various Rule 10b-5 claims.” Less clear is whether circuits may continue to insist that “a scheme liability claim must be based on conduct beyond misrepresentations or omissions actionable under Rule 10b-5(b).” Permitting plaintiffs to recast any misstatement or omission as a “scheme” or “artifice to defraud” would erode limitations on Rule 10b-5(b) and shift claims by both the SEC and private litigants toward the scheme liability provisions. But the Supreme Court rejected Lorenzo’s argument that he had not engaged in conduct beyond misrepresentations. If even minor acts like the distribution of false statements satisfy the need for additional conduct, then Circuits will face difficult line-drawing problems.
Following Lorenzo, circuits will need to decide when conduct involving misstatements falls within the broad language of the scheme liability provisions. One interesting question is whether, notwithstanding the Court’s statements about Janus’s continued vitality, the scheme liability provisions would change Janus’s result. In Janus, a corporation created an investment fund as a separate entity. Although the corporation was “significantly involved” in preparing misleading prospectuses, only the investment fund filed those prospectuses. The Supreme Court thus held that the investment fund alone faced liability for making misleading statements under Rule 10b-5(b). Following Lorenzo, plaintiffs might pursue the corporation under the scheme liability provisions, arguing that it engaged in a scheme or artifice to defraud by creating a separate entity, drafting misleading disclosures, and then leaving the investors to deal with the entity alone. If accepted, such arguments would make Lorenzo one of the most significant securities cases of the past decade.
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