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On March 27, 2019, the Supreme Court held that an individual who disseminates false or misleading statements with an intent to defraud can be found to have violated the “fraudulent scheme” provisions of Rule 10b-5(a) and (c) even if such an individual did not “make” the statements and is therefore outside the scope of subsection (b) of Rule 10b-5. Lorenzo v. SEC, 139 S. Ct. 1094 (2019) (Breyer, J.). A 6-2 Justice majority affirmed the D.C. Circuit’s conclusion that petitioner-defendant is liable for knowingly conveying his boss’s false statements to potential investors. Justice Kavanaugh was recused from the case, as he dissented from the D.C. Circuit’s ruling.

Background

SEC Rule 10b-5 proscribes three types of securities fraud: subsection (a) makes it unlawful “[t]o employ any device, scheme or artifice to defraud”; subsection (b) prohibits making a false statement or omitting information that would be misleading to an investor; and subsection (c) prohibits engaging in fraudulent or deceitful conduct.

In 2013, the SEC initiated an administrative enforcement action against a representative of a registered broker-dealer, alleging that he intended to defraud potential investors when he sent two emails to potential investors, “at the request” of his boss, making misrepresentations and omitting material information. An SEC administrative law judge found that defendant’s conduct amounted to offenses under all three provisions of Rule 10b-5. The SEC affirmed this ruling in 2015, issuing a lifetime bar prohibiting defendant from working in the securities industry; and imposing a $15,000 monetary penalty.

Defendant appealed to the D.C. Circuit, and in 2017 the court reversed the SEC, finding that although defendant had the requisite intent to defraud, defendant was not the “maker” of the statements under the test set forth in Janus Capital Group v. First Derivative Traders, 564 U.S. 135 (2011).[1]

Defendants Can Face Primary Liability Under Rules 10b-5(a) and (c) for Disseminating False or Misleading Information

In an opinion delivered by Justice Breyer, the Court concluded that the language of subsections (a) and (c) of Rule 10b-5 is “sufficiently broad to include within their scope the dissemination of false or misleading information with the intent to defraud.” The Court emphasized that defendant knew the emails he sent to potential investors contained materially false information, he sent them in his capacity as vice president of an investment banking company, and he invited follow-up questions. While acknowledging that borderline cases could involve difficult questions concerning the scope of these provisions, which should be read narrowly to avoid liability for tangential actors (for example, a mailroom clerk), the Court determined that there was “nothing borderline” about defendant’s actions in this case.

The Court further addressed three primary arguments advanced by defendant and articulated in a dissenting opinion penned by Justice Thomas and joined by Justice Gorsuch. First, both defendant and the dissent posited that subsections (a) and (c) of Rule 10b-5 address only “scheme liability claims,” not liability for false statements, and that to hold otherwise would render subsection (b) “superfluous.” Citing dictionary definitions and historical precedent, the dissent reasoned that subsection (a) cannot impose liability for a mere misstatement that does not involve “some form of planning, designing, devising, or strategizing.” The dissent further opined that while subsection (c) appears to proscribe broader conduct, it must not be construed to encompass primary liability solely for misstatements because that conduct is specifically covered by the language in subsection (b) of Rule 10b-5.

The majority, however, held that the subsections of Rule 10b-5 are not mutually exclusive; to the contrary, the Court and the SEC have always understood that these subsections, as well as related provisions of the securities laws, overlap and may prohibit the same conduct in certain circumstances.

Second, defendant and the dissent both raised a concern that the Court’s decision in Janus would be a “dead letter” if the Court were to apply subsections (a) and (c) to fraudulent misstatements. The majority dismissed this concern, noting that Janus did not address the application of Rule 10b-5 to dissemination of false or misleading information, and further noted that Janus would still have force and preclude liability where an individual neither makes nor disseminates with fraudulent intent the false or misleading information—“provided, of course, that the individual is not involved in some other form of fraud.”

Finally, the majority addressed the dissent’s concern that imposing liability in this case would improperly result in an individual who disseminates but does not “make” a misstatement being held both primarily liable under subsections (a) and (c), as well as secondarily liable under subsection (b) of Rule 10b-5. The Court noted, “[I]t is hardly unusual for the same conduct to be a primary violation with respect to one offense and aiding and abetting with respect to another.” Further, the Court explained that a construction of Rule 10b-5 that would impose only secondary liability on an individual who fraudulently disseminates false statements would risk allowing such an individual to “escape liability” altogether (for example, where the “maker” of the statement is found not to have held the requisite intent, and there is therefore no primary violation for the disseminator to have aided and abetted). The Court stated: “That is not what Congress intended. Rather, Congress intended to root out all manner of fraud in the securities industry. And it gave to the [SEC] the tools to accomplish that job.”