Imagine that a boss prepares a materially false statement and directs her employee (who knows the statement is false) to email it to investors. Is the employee liable as a “primary violator” under the securities laws, or does her conduct constitute at most secondary liability, i.e., aiding and abetting securities fraud? The U.S. Supreme Court held oral argument on Dec. 3, 2018 in Lorenzo v. SEC to answer that question and resolve an apparent Circuit split.

Relevant Facts

Francis Lorenzo was the director of investment banking at a registered broker-dealer. Lorenzo’s client issued an amended Form 8-K devaluing its intangible assets from $10 million to zero. Two weeks later, Lorenzo emailed potential investors “several key points” about the client’s debenture offering, but omitted information about the devaluation, and instead stated that the offering came with “layers of protection,” including “over $10 mm in confirmed assets.”

Lorenzo claimed that: (1) he sent the emails at his boss’s behest; (2) his boss supplied the content, including the “several key points”; (3) he merely cut and pasted his boss’s words into the body of the emails; and (4) his boss approved the emails before he sent them. Both emails, however, urged recipients to call Lorenzo with any questions, and were signed with his name and title as “Vice President—Investment Banking.” Substantial evidence also indicated that Lorenzo knew the statements about the debenture offering’s “layers of protection” were false.

Relevant Law

The federal securities laws prohibit both fraudulent statements and fraudulent schemes. Section 17(a) of the Securities Act of 1933 makes it unlawful to (1) employ a scheme to defraud, (2) obtain money by means of an untrue statement or omission of material fact, or (3) engage in any fraudulent practice, in the offer or sale of securities. 15 U.S.C. §77q(a). SEC Rule 10b-5 (17 C.F.R. §240.10b-5), promulgated under §10(b) of the Exchange Act of 1934 (15 U.S.C. §78j), makes it unlawful to (1) employ a scheme to defraud, (2) “make” a materially false representation or materially misleading omission, or (3) engage in any fraudulent practice, in connection with the purchase or sale of securities.

In Janus Capital Group v. First Derivative Traders, 564 U.S. 135, 148 (2011), the Supreme Court held that an investment adviser that assisted in preparing a mutual fund’s prospectuses did not “make” the false statements contained therein because the adviser lacked “ultimate control” over the statements’ content and dissemination.  Rather, the “maker” of a statement under Rule 10b-5 is “the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it.” Id. at 142. By contrast, “one who prepares or publishes a [materially false] statement on behalf of another is not its maker,” but might be an aider and abettor. Id.

Janus was a private civil suit, while Lorenzo is an SEC enforcement proceeding. The distinction matters, among other reasons, because aiding and abetting (i.e., “secondary” liability) claims, while permitted in SEC actions (15 U.S.C. §78t(e)), are barred in private securities lawsuits (Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 191 (1994)). Indeed, the Janus majority stated that one purpose of its holding was to distinguish under Rule 10b-5 between primary violators and aiders and abettors: “[i]f persons or entities without control over the statement could be considered primary violators who ‘made’ the statement, then aiders and abettors would be almost nonexistent.” Janus, 564 U.S. at 143.

The Decision Below

The SEC charged Lorenzo with violating §17(a)(1) (employing a scheme to defraud)—but not, interestingly, §17(a)(2) (obtaining money or property by means of a fraudulent statement)—as well as §10(b) and Rule 10b-5. The charges were sustained upon an independent review by the full Commission.

On appeal, Lorenzo maintained—and the D.C. Circuit agreed—that under Janus, he did not “make” the false statements in his emails because he lacked “ultimate authority” over them. The D.C. Circuit, however, held—given the substantial evidence that Lorenzo knew those statements were false—that Lorenzo nonetheless violated these antifraud provisions by employing a scheme to defraud. It concluded that Lorenzo “played an active role in the fraud by folding the statements into emails he sent directly to investors.” Lorenzo v. SEC, 872 F.3d 578, 590 (D.C. Cir. 2017). Significantly, then-D.C. Circuit Judge Brett Kavanaugh (who is recused from the Supreme Court case) dissented, characterizing the majority opinion as “legal jujitsu,” and arguing—as other Circuits have held—that “scheme liability must be based on conduct that goes beyond a defendant’s role in preparing mere misstatements or omissions made by others.” Lorenzo, 872 F.3d at 600-02 (Kavanaugh, J., dissenting). See, e.g., Lentell v. Merrill Lynch & Co., 396 F.3d 161, 177 (2d Cir. 2005) (misrepresentations cannot form the “sole basis” for liability under Rule 10b-5(a) or (c)); WPP Luxembourg Gamma Three Sarl v. Spot Runner, 655 F.3d 1039, 1057 (9th Cir. 2011) (same); Public Pension Fund Group v. KV Pharmaceutical Co., 679 F.3d 972, 987 (8th Cir. 2012) (a fraudulent “scheme” must encompass “conduct beyond misrepresentations”). The Supreme Court granted certiorari to review this issue.

The Argument in the Supreme Court

At oral argument in the Supreme Court, Lorenzo urged that primary liability under a “fraudulent scheme” theory requires something more than merely transmitting someone else’s statements. Otherwise, the primary/secondary liability distinction delineated by the “maker” requirement in Janus will be eviscerated because persons who simply pass along fraudulent statements authored by third parties nonetheless will face “primary” liability under a fraudulent scheme theory. Lorenzo also argued that fraudulent “conduct” is a type of fraud that is “categorically different” from misstatements or omissions.

Several of the Justices, however, questioned why Lorenzo’s conduct—sending emails about his own client that he apparently knew to be false, in his capacity as director of investment banking, and encouraging investors to contact him—did not suffice to establish scheme liability. Justice SamuelAlito also questioned Lorenzo’s distinction between fraudulent “conduct” and fraudulent “statements,” noting that “I don’t quite know how you’re going to engage in a fraud without saying some words.” Oral Argument Transcript, Lorenzo v. SEC, No. 17-1077 (Tr.) (Dec. 3, 2018) at 11:4-25, 12:1-5.

By contrast, Justice Neil Gorsuch appeared to agree with Lorenzo, stating that “you have to have an act that deceives someone else. And the only thing that deceived anybody allegedly here were these emails,” which—under Janus—Lorenzo himself did not “make.” Id. at 34:10-17. Chief Justice John Roberts, meanwhile, pushed the SEC to explain why its position would not render Janus a “dead letter,” as Lorenzo had argued. Id. at 42:9-14.

Potential Implications

If the Supreme Court affirms Lorenzo, the “fraudulent scheme” theory may provide a back-door channel for primary liability that is currently barred under Janus. That is, defendants whose conduct is limited to knowingly publishing false statements authored by third parties—and who therefore might be immune from Rule 10b-5 liability in private civil suits because they did not “make” any materially false statements—could now face potential liability to investors under a “scheme” theory.

In the enforcement context, the Supreme Court’s decision may make less of a difference. As Lorenzo himself noted, even if primary liability were unavailable under §17(a)(1) or §10 and Rule 10b-5, a party in similar circumstances could still be charged as an “aider and abettor,” which requires only (1) the existence of a primary violation; (2) knowledge of the primary violation (In SEC aiding and abetting actions, a showing of “recklessness” satisfies the knowledge element. See 15 U.S.C §78t(e); SEC v. Wey, 246 F. Supp. 3d 894, 928 (S.D.N.Y. 2017)); and (3) substantial assistance by the aider and abettor. SEC v. Apuzzo, 689 F.3d 204, 206 (2d Cir. 2012). Some jurisdictions further require proof that the aider and abettor’s conduct “proximately” caused the primary violation.

However, counsel for the government cautioned at oral argument that aiding and abetting liability is not always available to the SEC because in an SEC action, “[y]ou have to find the primary violator.” Tr. at 46:6-11. He then provided a hypothetical situation where a corporate executive makes a misleading statement in a financial report, but lacks the scienter required for primary liability because she reasonably relied upon reports of lower-level employees. In that instance, he argued, the Commission would not be able to charge the executive as a primary violator, and therefore also could not pursue the lower-level employees as aiders and abettors. Id. at 46:12-24.

Thus, as the government noted, if the Supreme Court finds in Lorenzo’s favor, there may be instances (although perhaps rare) where, paradoxically, no one can be held liable by the SEC (at least under Rule 10b-5) for making a false statement to investors, despite the fact that at least one person in the chain of transmission knew the statement was false. On the other hand, if the court finds for the government, individuals who—as Lorenzo is alleged to have done—knowingly pass along materially false information at a superior’s direction might face liability as primary violators rather than mere aiders and abettors, allowing private litigants to recover from a wider cast of defendants.

Amanda Senske is an associate at Walden Macht & Haran, where she focuses on white-collar representation, including advising individuals and companies in criminal and regulatory actions. Daniel A. Cohen is senior counsel at the firm and concentrates on commercial litigation.