On December 5, 2018, the U.S. Supreme Court heard oral argument in a case that could provide badly-needed guidance regarding the securities law liability of those who disseminate false statements they have not personally prepared or authorized.
By far the most important anti-fraud provisions in the federal securities laws are Section 10(b) of the Securities Exchange Act and Rule 10b-5. These provisions make it unlawful to make a materially false or misleading statement in connection with the purchase or sale of a security. They also prohibit the use of a deceptive scheme in connection with a securities transaction.
In the case argued on December 5, an investment banker (Francis Lorenzo) sent emails to prospective investors regarding a debt offering by a start-up energy technology company. The emails were sent over Lorenzo’s name, identified him as “Vice President - Investment Banking,” and invited potential investors to contact him. As determined by the SEC and sustained by the circuit court, the emails contained statements that were false or misleading and Lorenzo acted with an intent to deceive the investors. However, the substantive content of the false statements had been written by Lorenzo’s boss, who requested that the statements be sent to investors.
Following a hearing, the SEC determined that Lorenzo violated both the “false statement” and “deceptive scheme” prohibitions in Rule 10b-5. The U.S. Court of Appeals for the District of Columbia Circuit found that Lorenzo was not subject to “false statement” liability because he was not the “maker” of the statements, but agreed that he was nevertheless liable for engaging in a deceptive scheme: “Lorenzo played an active role in perpetrating the fraud by folding the statements into emails he sent directly to investors in his capacity as director of investment banking . . . .” Lorenzo v. Securities and Exchange Commission, 872 F.3d 578, 580 (2017).
In the Supreme Court, Lorenzo’s attorneys argued that disseminating a false statement prepared by someone else cannot by itself constitute engaging in a deceptive scheme. They also argued that Lorenzo is not subject to primary liability because the DC Circuit found that he was not the “maker” of the statement under the restrictive interpretation of that term in Janus Capital Group Inc. v. First Derivative Traders, 54 U.S. 135 (2011). In response, the SEC argued that disseminating a statement is indeed a type of conduct and, based on the facts in Lorenzo’s case, the dissemination was itself a primary violation of the prohibition against engaging in a deceptive scheme.
Because newly-seated Justice Brett Kavanaugh was a DC Circuit judge when that court addressed the Lorenzo matter, Kavanaugh is not participating in this case at the Supreme Court level. This means that the Supreme Court might be evenly divided, four to four, on key issues and thus be unable to reach a decision. If that occurs, the DC Circuit’s ruling (finding Lorenzo liable for engaging in a deceptive scheme) would stand.
But if the Supreme Court reaches a decision, the ruling is likely to provide new insight into the scope of liability for dissemination of false statements prepared by others. If the majority sides with Lorenzo, many individuals who disseminate such statements would beyond the reach of “scheme” liability and would not be primary violators within the scope of “false statement” liability. That outcome could be devastating for private plaintiffs asserting Rule 10b-5 claims against corporate officers or other individual defendants based on false statements in company press releases and SEC filings.
Potential SEC whistleblowers should be aware, however, that regardless of the outcome in the Lorenzo case, the SEC will retain an important enforcement tool unavailable to private plaintiffs, i.e., “aiding and abetting” liability. Under Section 20(e) of the Securities Exchange Act, the SEC (but not private plaintiffs) can pursue Rule 10b-5 claims against any person or entity that “knowingly or recklessly provides substantial assistance to another person” in connection with a securities law violation. Such an “aider and abettor” is “deemed to be in violation . . . to the same extent as the person to whom such assistance is provided.”
Consequently, if a whistleblower provides information indicating that false or misleading information has been disseminated to investors, the SEC can not only pursue the entity on whose behalf the statement was made and the individual primarily responsible for the statement, but can also assert claims against all those who provided substantial assistance to the primary violators. If the SEC recovers more than $1 million in such an action, a whistleblower who provided original information that led the successful SEC action would be entitled to a significant monetary award.
Whistleblower Aid, Inc.
The foregoing is provided by Whistleblower Aid, Inc. (WBA) for general information purposes and is not intended to be, and should not be, taken as legal advice. See https://whistlebloweraid.org/contact/#whistleblower-contact for guidance on how to contact WBA.
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