Lorenzo v. SEC: Rule 10(b)(5) of the Securities Exchange Act

Lorenzo v. SEC

In March of 2019, the U.S. Supreme Court decided Lorenzo v. SEC, deciding that someone who is not a “maker” of a false statement can nonetheless be held liable under Rule 10(b) of the Exchange Act for knowingly disseminating a misstatement made by another person. The decision is a significant departure from prior case law, which held that only the maker of the misstatement could be held liable.

The Lorenzo decision will have a profound impact on cases brought under Rule 10(b) and will significantly expand liability for people who participate in a scheme to commit fraud to include those who knowingly or recklessly transmit false or misstatements that were made by someone else.

The decision significantly erodes previous limitations on liability that were established in Janus v. First Derivative Traders and Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A.

Background of Lorenzo v. SEC: Rule 10(b)(5)

The defendant, Francis Lorenzo, was the director of investment banking at a brokerage firm. He was charged with violating Rule 10(b)(5) by sending false and misleading emails to prospective investors that included statements that were made by and attributed to his superior. Lorenzo knew that the statements were false and misleading, but he relied on the Supreme Court’s prior decisions that limited liability to makers of misstatements to protect him from liability.

In upholding Lorenzo’s liability for sending the false statements, the Court noted that, while prior precedent would indeed protect Lorenzo from liability under Rule 10(b)(5)(b), that precedent did not protect him from liability under Rule 10(b)(5) sections (a) and (c), which prohibit “artifices” and “schemes” to defraud.

Rule 10(b)(5) contains three subsections that prohibit fraudulent conduct in connection with the sale of securities. Under the rule, it is unlawful to:

  1. employ any device, scheme, or artifice to defraud;
  2. to make any untrue statement of a material fact or to omit to state a material fact necessary to make the statements made...not misleading; or
  3. to engage in any act, practice, or course of business which or would operate as a fraud or deceit upon any person.

The Court acknowledged that liability for actors tangentially involved in disseminating false or misleading statements would typically be inappropriate under Rule 10(b)(5). However, Lorenzo, who was acting in his capacity as a vice president of an investment banking company, was a “paradigmatic example” of someone who should be held liable for securities fraud.

The Court’s decision significantly expands the reach of Rule 10(b)(5) to include people who commit fraud “using false representations to induce the purchase of securities” and emphasizes that even “bit participants” could be held liable under the rule.

Lorenzo Expands Liability Under Rule 10(b)

In the two years since Lorenzo, lower courts have embraced the decision that interprets Rule 10(b)(5) as a series of broad, overlapping antifraud provisions. The decision has even been expanded to impose liability upon people who fail to correct a misstatement by their employer. See, Malouf v. SEC, No. 16-9546, 2019 WL 3788225 (10th Cir. Aug 13, 2019).

Post-Lorenzo, allegations of misconduct under Rule 10(b)(5) will be viewed cumulatively, as the decision rejects distinctions between false statements and deceptive acts and paves the way for broad liability for fraudulent misstatements.

Lorenzo v. SEC also calls into question the continued viability of Janus and whether liability for a misstatement still extends only to the “maker.” While the majority in Lorenzo insists that Janus still precludes liability where a defendant neither makes nor disseminates false information, questions remain as to the extent of liability for someone who helps draft misstatements that were issued by a different entity that controlled the content of the statements.

Lorenzo Blurs the Distinction Between Primary and Secondary Liability

Lorenzo also raises questions about primary and secondary liability under Rule 10(b). While the Exchange Act authorizes claims against people who “knowingly or recklessly provid[e] substantial assistance for another person” in violation of Rule 10(b), the Court’s decision in Central Bank held that private actions under Rule 10(b) cannot be premised on secondary liability. As a result, it is unclear whether there will remain a distinction between someone who disseminates false and misleading statements made by someone else, and someone who provides substantial assistance to someone who makes a false and misleading statement.

Future cases will need to determine the extent to which Lorenzo v. SEC expands liability under Rule 10(b) and the amount of control over a false and misleading statement that is necessary to confer liability.

Hope Lefeber: Defense Against Allegations of Securities Fraud

The Lorenzo decision will make it easier for the SEC to seek to impose liability on someone who disseminates misstatements to prospective investors. As a result, brokers must take additional care when sending information to potential investors, and could easily find themselves facing scrutiny from the SEC.

If you believe you are under investigation, it is critical that you have an experienced federal financial and securities fraud attorney on your side.

New York City white-collar criminal defense attorney Hope Lefeber has been defending people accused of federal financial crimes for more than 30 years. She began her career as an attorney with the U.S. Securities & Exchange Commission where she learned first-hand how the government investigates and prosecutes cases of alleged fraud. Today, she uses that experience to defend people who have been accused of federal white-collar crimes including financial and securities fraud.

Ms. Lefeber has earned a reputation as a fierce advocate for her clients who meticulously prepares every case she handles. She is hands-on in her defense and thoroughly reviews and investigates every piece of information the government will try to introduce.

If you or someone you care about is under investigation or facing federal charges for financial and securities fraud, Hope Lefeber should be your first call. Contact Hope Lefeber today to schedule a confidential consultation to discuss how she can help.

Categories: Securities