SCOTUS Opens Door to Potential Expansion of Rule 10b-5 Liability for Misstatements

April 12, 2019

On March 27, 2019, Justice Breyer, writing for a six-Justice majority of the Supreme Court, issued a decision in Lorenzo v. SEC, 139 S. Ct. 1094 (2019), holding that one who knowingly distributes a material misstatement can be held liable under Rule 10b-5(a) and (c).  The decision is noteworthy for its arguable tension with Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011), in which the Court ruled that “[o]ne who [merely] prepares or publishes a [false] statement on behalf of another is not its maker,” and thus cannot be held liable in a private action under Rule 10b-5(b).  Justice Thomas, writing for himself and Justice Gorsuch, dissented, arguing that the majority’s opinion risked unduly expanding primary liability under Rule 10b-5 and rendered Rule 10b-5(b) superfluous.

By way of background, Rule 10b-5, promulgated by the Securities and Exchange Commission pursuant to Section 10(b) of the Securities Exchange Act of 1934, makes it unlawful to engage in three types of conduct in connection with the purchase or sale of any security: “(a) To employ any device, scheme, or artifice to defraud”; “(b) To make any untrue statement of a material fact . . .”; and “(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit . . . .”

In Janus, the Supreme Court considered the second prong of Rule 10b-5, and held that the “maker” of a statement for purposes of liability under that prong “is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it,” such that an investment adviser who had merely “participat[ed] in the drafting of a false statement” could not be held liable in a private action under Rule 10b-5(b).

The petitioner in Lorenzo was the director of investment banking at a registered broker-dealer who did not meet this definition of “maker,” but who had, at the direction of his boss, knowingly emailed false or misleading statements to prospective investors.  Lorenzo’s boss supplied the content of the email messages and approved them.  The SEC instituted proceedings against Lorenzo, along with his boss and the broker-dealer, and ultimately determined, among other things, that Lorenzo had violated Rule 10b-5.  On appeal, the Court of Appeals for the District of Columbia Circuit held that Lorenzo could not be held liable under subsection (b) of Rule 10b-5 because Lorenzo’s boss had asked him to send the emails, supplied the central content, and approved the messages for distribution, such that the boss was the “maker” of the misstatements under Janus.  The Court of Appeals nonetheless sustained the Commission’s finding that Lorenzo had violated subsections (a) and (c) of Rule 10b-5 by knowingly disseminating false information to prospective investors.  The Supreme Court granted certiorari in order to resolve disagreement among the Circuits about whether someone who is not a “maker” of a misstatement under Janus can nonetheless be found to have violated the other subsections of Rule 10b-5 when the only conduct involved concerns a misstatement, and answered that question in the affirmative.

The dissent warned that the majority’s opinion was “likely to have far-reaching consequences” in that it rendered Janus “a dead letter,” and “eviscerate[d]” the distinction between primary and secondary liability by holding that a person who had not “made” a fraudulent misstatement could nonetheless be primarily liable for it.  Although there is no private right of action for aiding and abetting a Rule 10b-5 violation, the dissent opined that “virtually any person who assists with the making of a fraudulent misstatement will [now] be primarily liable and thereby subject not only to SEC enforcement, but private lawsuits” because “the SEC or plaintiff need only relabel the person’s involvement as an ‘act,’ ‘device,’ ‘scheme,’ or ‘artifice’ that violates Rule 10b-5(a) or (c).”  The dissent could “discern no legal principle in the majority opinion that would preclude,” for example, a secretary asked to send a message containing misstatements from her email account, “from being pursued for primary violations of the securities laws.”

The majority, for its part, acknowledged that “one can readily imagine other actors tangentially involved in dissemination [of a misstatement] – say, a mailroom clerk – for whom liability would typically be inappropriate,” but believed that the particular facts in Lorenzo – that Lorenzo sent false statements directly to investors, invited them to follow up with questions, and did so in his capacity as vice president of an investment banking company – made this case clear cut.  The majority argued that Janus would remain relevant and continue to preclude liability where an individual neither makes nor disseminates false information, provided that “the individual is not involved in some other form of fraud.”

While it remains to be seen the extent to which an actor who is not himself the “maker” of a misstatement under Janus can nonetheless be subject to primary liability for it in a private right of action under Lorenzo, we are likely to see an uptick in private Rule 10b-5(a) and (c) actions seeking to test those boundaries.

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