Coming Soon to an Opposition Brief Near You: U.S. Supreme Court Holds That Disseminators of False or Misleading Statements Face Liability for Securities Fraud Under Rules 10b-5(a) and (c) Even Where They Are Not Subject to Liability Under Rule 10b-5(b)

In a decision that is certain to receive a warm welcome from the securities class action plaintiffs’ bar, last week, in Lorenzo v. Securities and Exchange Commission, the U.S. Supreme Court held that a disseminator of a false or misleading statement, who cannot be liable for securities fraud under Rule 10b-5(b) because he or she was not the “maker” of that statement, nonetheless faces liability under Rules 10b-5(a) and (c) and related securities statutes.

Under Rule 10b-5(b), it is unlawful to make any untrue statement of material fact in connection with the purchase or sale of a security. Nearly eight years ago, in Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011), the Supreme Court held that only the maker of a false or misleading statement faces liability under Rule 10b-5(b) and that the maker of a statement is the person with ultimate authority over the statement including its contents and whether and how to communicate it. As a result, in that case, an investment adviser who had participated in drafting a false statement included in the prospectus of its mutual fund client avoided liability for securities fraud because the mutual fund, and not the investment adviser, was the maker of the false statement. The decision was of no small significance. In the years that followed, courts throughout the country would rely on Janus in dismissing securities-fraud claims against persons or entities who were somehow connected to a false or misleading statement, but who did not have sufficient control or authority over the statement and the means of its communication to be considered its maker. For such persons, when the only conduct alleged concerned a misstatement, securities-fraud liability was typically foreclosed, at least in the private-action context.

Now, as a result of the Supreme Court’s decision in Lorenzo, that landscape is much less clear. Lorenzo, while director of investment banking at an SEC-registered brokerage firm, sent two emails to prospective investors describing a potential investment in a company. Lorenzo knew those emails contained a misstatement about the assets of that company. The content of the emails, including the false statement, was supplied and approved by Lorenzo’s boss. In fact, the language was cut and pasted from his boss’s email. The SEC brought an enforcement action against Lorenzo and found that he had violated not only subsection (b) of Rule 10b-5, but also subsections (a) and (c), section 10(b) of the 1934 Exchange Act, and section 17(a)(1) of the 1933 Securities Act. On appeal, the District of Columbia Circuit reversed the SEC’s finding with respect to Rule 10b-5(b) because Lorenzo was not the maker of the fraudulent statement under Janus. However, the Court sustained the SEC’s finding that Lorenzo was liable for securities fraud under Rules 10b-5(a) and (c) and the 1934 Exchange Act and 1933 Securities Act provisions.

Rule 10b-5(a) makes it unlawful to “employ any device, scheme, or artifice to defraud” in connection with the purchase or sale of a security. Rule 10b-5(c) makes it unlawful to “engage in any act, practice, or course of business which operates or would operate as a fraud or deceit” in connection with the purchase or sale of a security. These subsections are often pleaded together as the basis for a single cause of action commonly referred to as “Rule 10b-5(a) and (c) scheme liability.” Sections 10(b) and 17(a)(1) of the ’34 and ’33 Acts contain similar proscriptions.

On appeal to the Supreme Court, Lorenzo argued that someone who is not a maker of a misstatement under Janus—and thus not subject to liability under Rule 10b-5(b)—cannot be found to have violated the other subsections of Rule 10b-5 or related provisions of the securities laws when the only conduct alleged concerns a misstatement. Specifically, Lorenzo argued that Rules 10b-5(a) and (c) and the other securities statutes at issue cannot be interpreted to apply to his alleged conduct because: (i) they do not refer specifically to false statements and thus would render Rule 10b-5(b) superfluous; (ii) such an interpretation would render Janus a “dead letter;” and (iii) it would erase or weaken what is otherwise a clear distinction between primary and secondary liability.

The Supreme Court rejected each argument and affirmed the decision of the Court of Appeals. In an opinion written by Justice Breyer, the Court first explained that the regulations and statutes at issue each apply to Lorenzo’s conduct according to the plain meaning and dictionary definitions of the terms they comprise. In rejecting Lorenzo’s argument that application of those statutes and regulations would render Rule 10b-5(b) superfluous, the Court explained that the provisions at issue do not govern mutually exclusive spheres of conduct. According to the Court, it and the SEC have long recognized considerable overlap among the provisions and that subsections of those provisions addressing specific conduct should not be read to restrict the reach of more general provisions. As further support for this point, the Court noted the broad, overlapping language of subsections (a) and (c) and the difficulties of identifying conduct that would fall within the ambit of only one of those subsections and not the other. The Court added that its interpretation is necessary to prevent those who disseminate false or misleading statements with an intent to cheat investors from escaping liability.

As for Lorenzo’s argument that the Court’s interpretation would nullify Janus, the Court explained that Janus concerned the liability of a drafter of a false statement, not a disseminator of one, and would remain relevant and preclude liability where an individual neither makes nor disseminates false information, provided he or she is not involved in some other form of fraud. Finally, the Court explained that its interpretation does not erase or weaken the distinction between primary and secondary liability because: (i) it is not unusual for the same conduct to be a primary violation with respect to one offense and a secondary violation with respect to another; (ii) the offense at issue is deserving of primary liability; and (iii) if a person who disseminates false statements with an intent to deceive were subject only to secondary liability, they might escape liability altogether in instances where no primary violation had been committed (perhaps because the maker of the misstatement lacked the requisite intent).

In a dissent joined by Justice Gorsuch, Justice Thomas asserted that the majority “misconstrues the securities laws and flouts our precedent in a way that is likely to have far-reaching consequences.” Relying on the canons of statutory interpretation that effect should be given to every part of a statute where possible and that specific provisions should govern general ones where parts of a statute conflict or where one would subsume the other, Justice Thomas argued that Rule 10b-5(b) should control in false statement cases and that provisions with more general language should be read to apply only to cases not within the purview of more specific provisions. Justice Thomas rejected the majority’s contention that its interpretation is necessary to prevent the disseminator of a false statement with intent to defraud from escaping liability by referencing other provisions of the securities laws under which such a person would face liability. Justice Thomas also argued that the majority’s decision does render Janus irrelevant because administrative acts undertaken in connection with fraudulent misstatements are now subject to liability. He asserted that this expansion inappropriately blurs the line between primary and aiding-and-abetting liability and subjects any person who assists in making a fraudulent misstatement not only to SEC enforcement but also to private lawsuits.

Lorenzo is a decision with sweeping and dramatic implications for false-statement securities cases, particularly private actions. The significantly wider range of misstatement-related conduct now potentially subject to primary liability substantially increases the number of targets for private securities claims. And, the exceedingly broad interpretation of the securities laws on which the decision is based may better enable all manner of private securities claims to survive motions to dismiss.

Samuel I. Portnoy, a Director in the Gibbons Commercial & Criminal Litigation Department, authored this post.