Scheme Liability in Securities Class Actions: The Uncertain Impact of Lorenzo v. Securities & Exchange Commission’s Scope

In Lorenzo v. Securities & Exchange Commission, 139 S. Ct. 1094 (2019), the U.S. Supreme Court expanded the scope of the anti-fraud enforcement authority of the Securities and Exchange Commission (SEC). Rule 10b-5 of the Securities Exchange Act of 1934 makes it unlawful to issue materially misleading statements or omissions or to use manipulative and deceptive devices (i.e., scheme liability) in connection with the sale or purchase of any security. Historically, the SEC and private plaintiffs relied on Rule 10b-5(b) to prosecute claims, which prohibits issuing false or misleading information when it relates to the purchase or sale of securities. Lorenzo, however, opened the door for the SEC to more readily rely on Rules 10b-5(a) and (c) when an individual or entity assists in disseminating a false or misleading statement with intent to defraud.

With respect to private plaintiffs, Lorenzo is of particular importance because the Court has consistently rejected attempts by plaintiffs to expand Rule 10b-5 beyond the actual “makers” of misleading statements or omissions. And unlike the SEC, private plaintiffs are precluded from bringing aiding and abetting claims under Rule 10b-5. See Central Bank of Denver N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 191 (1994) (private civil liability under Rule 10b-5 does not extend to those who merely aid and abet a section 10(b) violation). Now, three years after Lorenzo was decided, this article surveys whether the Court’s decision has altered the landscape by providing private plaintiffs newly expanded authority to prosecute class action claims under Rules 10b-5(a) and (c), and how the courts have either maintained or limited Lorenzo’s scope.

The Holding

In Lorenzo, the SEC charged Francis Lorenzo, a vice president of investment banking for Charles Vista, LLC, a registered broker-dealer, with violating the anti-fraud provisions of the federal securities laws. The SEC alleged that Lorenzo sent emails to prospective investors with information materially misrepresenting the value of assets of a start-up company. Although Lorenzo sent the emails under his own name and signature block, Lorenzo’s superior supplied the content of the emails, and the emails expressly said they were being sent at the request of Lorenzo’s superior.

The Court’s decision in Lorenzo reinforced limitations applied to the scope of Rule 10b-5(b), previously announced in Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011). Janus recognized that the “maker” of the statement is the person with “ultimate authority over the statement, including its content and whether and how to communicate it,” and not just anyone else who assists in preparing or publishing a statement on behalf of others. Janus, 564 U.S. at 142–44. Accordingly, because Lorenzo merely disseminated the statements and did not control them, he was not the “maker” of a false or misleading statement and, therefore, not liable under Rule 10b-5(b).

The Court, however, rejected Lorenzo’s contention that scheme liability under Rules 10b-5(a) and (c) applied only when conduct “other than misstatements is involved.” Lorenzo, 139 S. Ct. at 1101–2. Lorenzo argued that applying Rules 10b-5(a) and (c) to alleged misstatements and omissions would render 10b-5(b) superfluous. Id. The Court countered that Lorenzo’s argument rested on the belief that Rule 10b-5’s provisions governed “mutually exclusive, spheres of conduct,” but that the courts and the SEC have “long recognized considerable overlap” among Rule 10b-5’s provisions. Id. at 1102. Thus, even though Lorenzo did not “make” the alleged misleading statements—because he did not control the statements or their contents (and instead sent the statements at his superior’s direction)—he was still liable under Rules 10b-5(a) and (c) for disseminating the statements.

Given the Court’s admission that, interpreted in this manner, Rule 10b-5’s provisions “capture a wide range of conduct” that may present difficult problems of scope or require narrowing the provisions’ reach, the question post-Lorenzo was how courts would apply the new system and whether they would narrow Lorenzo. Id. at 1101. Two important questions have arisen in this context: (1) whether courts would expand Lorenzo and find scheme liability applies to those who “make” statements and (2) whether private litigants would enjoy the benefits of Lorenzo’s expansion of scheme liability.

The Post-Lorenzo Progeny

District courts in the Second Circuit have struggled with applying Lorenzo. In Puddu v. 6D Global Technologies, Inc., for example, the Southern District of New York questioned whether Lorenzo stretches scheme liability to cases in which a defendant “makes” a statement under Rule 10b-5. 2021 WL 1198566, at *10 (S.D.N.Y. Mar. 30, 2021). The Puddu court noted that other courts are split on this issue: Some courts have found Lorenzo now permits liability under Rules 10b-5(a) and (c) for both “making” and disseminating false statements (despite this arguably creating some level of redundancy with Rule 10b-5(b)), while others have held Lorenzo merely extends scheme liability to dissemination of false statements but does not hold that misstatements alone can trigger scheme liability. Id. (comparing SEC v. Kameli, 2021 WL 2542154, at *14 (N.D. Ill. May 18, 2020), with SEC v. Rio Tinto PLC, 2021 WL 818745, at *2 (S.D.N.Y. Mar. 3, 2021)). For its part, the Puddu court concluded that a plaintiff may establish a “manipulative or deceptive” act for a scheme liability claim through alleged misrepresentations or omissions. Id. at *11. In doing so, the Southern District of New York created tension in its own district between Puddu and Rio Tinto, exemplifying the uncertain scope of Lorenzo.

Indeed, other district courts in the Second Circuit have grappled with this same conflict. On the same day Puddu was decided, a federal court in the District of Connecticut rejected an expansive application of Lorenzo. In In re Teva Securities Litigation, the court noted that while the plaintiffs and certain courts in the Second Circuit believed Lorenzo eliminated the rule that scheme liability depends on conduct other than misstatements, other courts, including the Rio Tinto court, disagreed. In re Teva Securities, 2021 WL 1197805, at *5 (D. Conn. Mar. 30, 2021). Teva found that Lorenzo was distinguishable and did not go so far as to state that a defendant “could be held primarily liable under all three subsections of Rule 10b-5 for a series of misstatements and omissions that are, admittedly, partly actionable under Rule 10b-5(b).” Id. at *6. The Second Circuit has yet to square the holdings of Puddu, Rio Tinto, and Teva.

Other courts have adopted the expansive view of Lorenzo. After some struggle on the issue, a district court in the Northern District of Illinois held that “making” misstatements may form liability under Rules 10b-5(a) and (c). The court initially declined to provide a formal ruling on the issue in SEC v. Ustian, 2019 WL 7486835, at *40 (N.D. Ill. Dec. 13, 2019), though it noted the conflicting views of Lorenzo. However, the court then issued two rulings that held misstatements alone may form liability under Rules 10b-5(a) and (c). See Kameli, 2020 WL 2542154, at *14; SEC v. Winemaster, 529 F. Supp. 3d 880, 918 (N.D. Ill. 2021).

It is no surprise that private plaintiffs pursuing claims under the federal securities laws are relying on Lorenzo. While the district courts did not analyze whether Lorenzo applied equally to Rule 10b-5 claims brought by private plaintiffs, the class action plaintiffs in both Puddu and Teva relied on Lorenzo in attempting to establish scheme liability. Likewise, district courts in the Ninth Circuit have addressed Lorenzo in class actions. See, e.g., In re Vaxart, Inc. Sec. Litig., 2021 WL 6061518, at *9 (N.D. Cal. Dec. 22, 2021) (finding that although Lorenzo held that dissemination of misrepresentations may result in scheme liability, scheme liability did not apply in the instant case because there was no plausible allegation defendant disseminated or assisted in disseminating misrepresentations). As such, it appears that private litigants, not just the SEC, may have a new tool when pursuing Rule 10b-5 claims.

Thus far, few appellate courts have substantively addressed Lorenzo. The Tenth Circuit, however, held that Rules 10b-5(a) and (c) apply to failure to correct misstatements. In Malouf v. SEC, the petitioner, Dennis Malouf, contended he could not be liable for failing to correct misstatements “because the failure to correct is inseparable from the misstatements themselves,” and that the SEC had inappropriately conflated the “making” false statement category of 10b-5 and section 17(a) with the scheme liability provisions of the same statutes. 933 F.3d 1248, 1259 (10th Cir. 2019). Citing Lorenzo, the Tenth Circuit rejected this claim. Id. at 1260. Indeed, the court took its finding a step farther and found that, given the similarities between section 17(a)(3) of the Securities Act of 1933 and Rule 10b-5(c), the court should interpret the provisions coextensively and both are controlled by Lorenzo.

The Second Circuit has not substantively weighed in on Lorenzo’s scope. In a footnote in Plumber & Steamfitters Local 773 Pension Fund v. Danske Bank A/S, the court briefly referenced Puddu but did not reach the petitioner’s claim that “Lorenzo requires us to reexamine our precedents insofar as they require scheme claims to be premised on deceptive acts that are distinct from misstatements and omissions that underlie an accompanying Rule 10b-5(b) claim” because the Rule 10b-5 claim suffered from other errors. 11 F.4th 90 n.6 (2d Cir. 2021). Thus, it remains to be seen how the Second Circuit will square the conflicting rulings.

The Impact of Lorenzo on Securities Class Actions

Three years after the Court’s decision in Lorenzo, the dust has not settled. Courts continue to grapple with how expansively to apply Lorenzo. While some circuit courts have suggested that courts should adopt a more expansive view of Lorenzo when claims are brought pursuant to Rules 10b-5(a) and (c), the Second Circuit has yet to weigh in. Because the Second Circuit is one of the most influential circuits for securities law, its position on Lorenzo will be critical in determining the future scope of Rules 10b-5(a) and (c) in private class actions.

Until there is further clarity, however, companies and individuals must be particularly wary when “disseminating” statements, even if they are ultimately not in control of the statement or omission. Litigants will continue to rely on Lorenzo and pursue broad scheme liability claims based on conduct related to the dissemination of misstatements.