The upcoming battle over the intersection of scheme liability and Janus “maker” liability has been joined now that SEC respondent Francis Lorenzo has filed his reply to the government’s merits brief. The case is set for oral argument on December 3 and there is at least the possibility that the outcome could result in a tie vote given that Justice Kavanaugh has recused himself because he participated in the case as a judge on the D.C. Circuit and dissented from the panel majority opinion that upheld most of the Commission’s opinion finding Lorenzo liable for securities violations (Lorenzo v. SEC, November 1, 2018).
The road to oral argument. The SEC, in an administrative proceeding, charged Lorenzo, director of investment banking at registered broker-dealer Charles Vista, LLC, with violating Securities Act Section 17(a)(1), Exchange Act Section 10(b), and Exchange Act Rules 10b-5(a), (b), and (c) for sending emails that contained false or misleading statements to investors at the behest of Lorenzo’s boss. (Charles Vista and its owner, Gregg Lorenzo—no relation to petitioner Francis—previously settled with the SEC). The emails asserted that Charles Vista’s only client, Waste2Energy Holdings, Inc., had $10 million in assets, had purchase orders or letters of intent for $43 million in orders, and that the company could raise funds to repay convertible debentures (the offering was to be for $15 million). The emails were labeled as being sent per the request of Lorenzo’s boss, urged clients to call Lorenzo with any questions, and were signed by Lorenzo with an indication of his title. Meanwhile, Waste2Energy’s prospects soured and its intangibles related to its gasification technology were worthless.
Lorenzo’s case was assigned to an SEC administrative law judge who found Lorenzo liable for the charged conduct. The Commission then upheld the ALJ and imposed on Lorenzo a permanent industry bar and a civil monetary penalty of $15,000. Lorenzo filed a petition for review in the D.C. Circuit and the panel majority held that substantial evidence supported the Commission’s conclusions that Lorenzo’s emails contained false or misleading statements and that Lorenzo acted with scienter. A key factor was Lorenzo’s position that he believed the statements in the emails were truthful. But the majority rejected the Commission’s conclusion that Lorenzo was the “maker” of the emailed statements (the person with “ultimate authority” per the Supreme Court’s Janus opinion was Lorenzo’s boss). Moreover, because the Commission’s sanctions were partly the result of its consideration of Lorenzo’s Rule 10b-5(b) violation, which specifically mentions “statement” and evokes Janus, the sanctions had to be remanded to the Commission for further consideration because Lorenzo could not be liable under that provision.
Then-Judge Kavanaugh dissented from the panel opinion. Judge Kavanaugh first suggested that the panel ignored the ALJ’s finding that Lorenzo never read or otherwise considered the statements contained in the emails he sent. Moreover, while agreeing that Lorenzo was not a “maker” of the statements at issue, Judge Kavanaugh said he would have gone further and found no liability for Lorenzo because scheme liability requires more than false or misleading statements. According to Judge Kavanaugh, the panel decision could upset the distinction between primary and secondary liability.
As a result, the question that will be before the Supreme Court this December is whether a person who knowingly disseminates false or misleading statements in connection with a securities transaction, but who did not “make” those statements, can nevertheless be held liable for violations of Securities Act Section 17(a)(1), Exchange Act Section 10(b), and Exchange Act Rules 10b-5(a) and (c). Although Lorenzo and the government differ somewhat in how they phrase this question, they both raise essentially the same question.
A “backdoor” to primary liability? Much of the case will turn on the questions implied by Justice Kavanaugh’s dissent from the Lorenzo panel opinion. As a general proposition, the Supreme Court’s Central Bank opinion foreclosed aiding and abetting liability in private securities suits because of the possibility that the plaintiff might not have relied on the aider and abettor’s statements. Likewise, in Stoneridge, the justices declined to extend private securities liability to the acts of persons upon whom investors did not rely. The Janus “maker” holding also will play an important role in the outcome of Lorenzo.
Chief among the government’s arguments for affirmance it its contention that while Janus applies to Rule 10b-5(b), it does not apply to other statutory or regulatory provisions that do not explicitly reference the term “statement.” For comparison purposes, here is the text of the applicable provisions in the Lorenzo case (emphasis added):
- Securities Act Section 17(a)(1)—"(a) It shall be unlawful for any person in the offer or sale of any securities … by the use of any means or instruments of transportation or communication in interstate commerce or by use of the mails, directly or indirectly—(1) To employ any device, scheme, or artifice to defraud..."
- Exchange Act Section 10(b)—“ 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: *** (b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities-based swap agreement, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.”
- Exchange Act Rule 10b-5—“ 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.”
The government and Lorenzo also differ regarding the significance of Lorenzo’s own actions. According to the government, Central Bank and Stoneridge are inapt because the SEC charged Lorenzo for his own conduct, which made him primarily liable; Lorenzo argued before the D.C. Circuit that he believed the truthfulness of the statements in the emails he sent. The government noted that Central Bank specifically left open the possibility of primary liability if the elements of such liability were properly alleged. The government also observed that the SEC, in an enforcement action, is not required to prove reliance.
Lorenzo countered that he was being held liable for securities violations based on the “ministerial” act of forwarding emails. From Lorenzo’s viewpoint, the D.C. Circuit established a much lower threshold for primary liability and, thus, made it more difficult to distinguish primary and secondary liability as required by, for example, Central Bank, Janus, and Stoneridge. Moreover, Lorenzo argued that the government’s view could breathe life into the implied cause of action for aiding and abetting.
On this last point, the government’s merits brief emphasized the potential consequences of Lorenzo’s theory: (1) the government could not bring primary liability cases unless the respondent made the misstatement; and (2) in cases where all elements of primary liability could not be proved against the maker of a false statement, the government might be unable to bring an aiding and abetting case against a person who had fraudulently disseminated the false statements. The government, urging the justices to reject Lorenzo's policy arguments, ended its brief thus: "A clear statement by this Court reiterating that the antifraud provisions at issue here should be interpreted according to their plain text would promote rather than undermine certainty and predictability."
The case is No. 17-1077.