Opinion analysis: Justices uphold securities liability for distributing false statements

This mornings decision in Lorenzo v. Securities and Exchange Commission brings no surprises, as the court’s holding follows the views apparent at the oral argument (discussed in my earlier post). Specifically, Justice Stephen Breyers opinion for six justices holds that defendant Francis Lorenzo is liable for participating in an unlawful scheme to defraud by distributing false statements written by his supervisor, even though the supervisors role protected Lorenzo from any liability for making the statements himself.

Although the case affects several related provisions of the securities laws, its principal application is Rule 10b-5 of the Securities and Exchange Commission. That rule has three subsections, and this case involves the distinction between the second subsection and the first and third subsections. On the one hand, subsection (b) specifically proscribes mak[ing] any untrue statement of a material fact; on the other, subsections (a) and (c) more generally proscribe employ[ing] any device, scheme, or artifice to defraud and engag[ing] in any act, practice, or course of business which operates as a fraud or deceit. With regard to subsection (b), we know from the Supreme Courts 2011 decision in Janus Capital v First Derivative Traders that only the maker of the statement is liable for its falsity. Here, where Lorenzo is not responsible as the maker of false statements drafted by his supervisor, the question arises whether he still can be held responsible for fraud under the more general provisions of subsections (a) and (c) because he sent those statements in personal emails to his individual customers.

A majority of the justices (including all four of the dissenters from the 5-4 decision in Janus) hold that Lorenzo is liable. As you would have expected from the argument, Breyers central point is a plain-language move: It would seem obvious that the words in [the more general provisions], are, as ordinarily used, sufficiently broad to include within their scope the dissemination of false or misleading information with the intent to defraud. Indeed, for the majority, it is difficult to see how sending emails [Lorenzo] understood to contain material untruths could escape the reach of those provisions. Breyer strengthens this conclusion by reciting dictionary definitions suggesting that the provisions should capture a wide range of conduct, readily including any artful stratagem. Acknowledging the possibility of borderline cases, the majority could see nothing borderline about disseminating false or misleading information to prospective investors with the intent to defraud.

I expect that the most important part of the opinion will be subpart II(C), the section that rejects Lorenzos argument that the only way to be liable for false statements is through those provisions that refer specifically to false statements. The majority firmly rejects the premise that each of th[e] provisions [of Rule 10b-5] should be read as governing different, mutually exclusive, spheres of conduct. Rather, Breyer recalls the Supreme Courts characterization of the securities law as a first experiment in federal regulation of the securities industry, and notes that the Supreme Court often has thought it best to treat the statute as includ[ing] both a general proscription against fraudulent practices and, out of an abundance of caution, a specific proscription against nondisclosure. The best example of overlap, Breyer explains, is in subsections (a) and (c): It should go without saying that at least some conduct amounts to employ[ing] a device, scheme, or artifice to defraud under subsection (a) as well as engag[ing] in a[n] act which operates as a fraud under subsection (c).

The court plainly is motivated by the sense that accepting Lorenzos view would mean that behavior [like Lorenzo’s], though plainly fraudulent, might otherwise fall outside the scope of the rule. For Breyer, using false representations to induce the purchase of securities would seem a paradigmatic example of securities fraud. We do not know why Congress or the Commission would have wanted to disarm enforcement in this way.

Finally, Breyer considers the argument of Justice Clarence Thomas (joined by Justice Neil Gorsuch in dissent) that the decision renders Janus a dead letter. The majority (which includes Chief Justice John Roberts and Justice Samuel Alito, two of the three remaining members of the Janus majority) develops a timeline of drafting, issuing and disseminating false statements. In that conception, Janus held that an individual did not make statements under subsection (b) if the individual helped draft misstatements issued by a different entity that controlled the statements content. That case said nothing about the dissemination of false statements, and thus would remain relevant (and preclude liability) where an individual neither makes nor disseminates false information.

As I suggested above, this outcome cannot really surprise observers of the oral argument, which centered on Lorenzos dissemination of information that he knew to be false for the purpose of inducing investors to make bad investments. That activity evidently struck a majority of the justices as reprehensibly fraudulent conduct of the kind that should be at the center of securities enforcement efforts. Because most of the justices appeared to see this as a case of core enforcement rather than a stretch, a straightforward decision imposing liability seemed inevitable. It remains to be seen whether the court’s paean to a broad interpretation of securities liability will spur more creative action by the SEC in the years to come.