Cut, paste and forward ‒ just as the boss instructed. But Lorenzo’s email to two clients was misleading, so the SEC filed an enforcement action. The ALJ held Lorenzo liable for violating anti-fraud provisions and imposed a C&D plus a $15,000 penalty. The full Commission reviewed the case de novo and imposed a permanent industry bar along with the $15,000 fine.
On appeal, a split panel of the D.C. Circuit affirmed on liability but remanded to the Commission for reconsideration of the penalty. The majority held Lorenzo was not a “maker” of a Rule 10b-5(b) “false statement,” but his knowing dissemination of his boss’s false statements made him a “schemer” “employing a deceptive device,” thus liable under Rules 10b-5(a, c) and Section 17(a)(1).
Section 10(b) of the ’34 Act makes it unlawful for any person, directly or indirectly, to use the means of interstate commerce to “use or employ, in connection with the purchase or sale of any security … any manipulative or deceptive device or contrivance in contravention of [SEC] rules ….” 15 U.S.C. § 78j(b).
Rule 10b-5, however, further specifies three subsections:
“It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,
in connection with the purchase or sale of any security.”
17 C.F.R. § 240.10b-5.
Not a Janus “Maker”
At his boss’s behest, Lorenzo cut, pasted and forwarded an email to two potential investors about his BD’s investment-banking client, a waste-to-energy start-up. The email reassured them about “3 layers of protection” on the deal, but omitted an intervening wholesale write-down of the firm’s intangible IP assets. It specifically indicated it was sent at his boss’s request.
In Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011), the Supreme Court held that one couldn’t be Rule 10b-5(b) statement “maker” without having “ultimate authority over the statement, including its content and whether and how to communicate it.” Id. at 142. Thus, an investment adviser, having merely assisted in preparing a mutual-fund’s prospectus, didn’t have the control necessary to be a “maker.”
The Panel held Lorenzo was not a “maker” under Rule 10b-5(b), because Lorenzo’s boss requested the statement, was the source of its content, and was ultimately responsible for (“approved”) the emails. Lorenzo, Slip Op. at 13-17 (Part III(A)).
But just because Lorenzo didn’t “make” the statement, didn’t preclude him from having “employ[ed] any device, scheme or artifice to defraud,” Rule 10b-5(a), or engaged in “any act, practice, or course of business” that’s deceitful, Rule 10b-5(c). Lorenzo, Slip Op. at Part III(B). And the same is true under ’34 Act § 10(b) and ’33 Act § 17(a)(1), which don’t have the Rule’s more specific sub-sections.
The policy considerations from Janus and Central Bank didn’t counsel otherwise, because (a) this was a Commission action in which aider still applies even after Central Bank, (b) Lorenzo directly and knowingly (scienter) disseminated the email, and (c) had a direct role in them (distinguishing Stoneridge).
Dissent: SEC Process “Not Fair,” “Stinks”
Even as SCOTUS considers the Lucia and Bandimere cert petitions over the (un)constitutionality of the SEC’s administrative forum, the dissent blistered the Commission’s decision as fundamentally unfair.
The case was tried to an ALJ, and with just one witness: Lorenzo. Assessing his credibility, the ALJ found the boss drafted the emails and told Lorenzo to send them; he “sent the emails without even thinking about the contents.” But then the ALJ held Lorenzo willfully violated the anti-fraud laws. “The [ALJ’s] factual findings and legal conclusion do not square up” and his “decision in this case contravenes basic due process” because it flunks “Mens Rea 101.” Dissent at 2-3.
Next, Judge Kavanaugh blasted the Commission’s reliance on “alternative facts:”
“How did the Commission magically explain its decision to discard the [ALJ’s] findings of fact? Easy. In a footnote, the Commission said that it did not need to ‘blindly’ accept the [ALJ’s] factual findings and credibility judgments. [cit’n omitted] Voila.”
“The Commission’s handiwork in this case is its own debacle. Faced with inconvenient factual findings that would make it hard to uphold the sanctions against Lorenzo, the Commission – without hearing any testimony — simply manufactured a new assessment of Lorenzo’s credibility and rewrote the judge’s factual findings. So much for a fair trial.”
Dissent at 5.
Circuit Split on Scheme Liability?
The dissent pointed out the majority’s opinion
“creates a circuit split by holding that mere misstatements, standing alone, may constitute the basis for so-called scheme liability under the securities laws – that is, willful participation in a scheme to defraud – even if the defendant did not make the misstatements.”
Dissent at 9. Instead, other circuits require conduct greater than merely preparing misstatements or omissions made by others. See, e.g., Public Pension Fund Group v. KV Pharmaceutical Co., 679 F. 3d 972, 987 (8th Cir. 2012); WPP Luxembourg Gamma Three SARL, v. Spot Runner, Inc., 655 F. 3d 1039, 1057 (9th Cir. 2011); Lentell v. Merrill Lynch & Co., 396 F. 3d 161, 177 (2nd Cir. 2005); see also SEC v. Kelly, 817 F. Supp. 2d 340, 3430-44 (S.D.N.Y. 2011).
Judge Kavanaugh concluded by opining that Lorenzo’s case “casts substantial doubt on [the] premise” that administrative adjudications “at least operate with efficiency and with fairness to the parties involved.” “[Lorenzo] has not received a fair process in this case.” Dissent at 12.
The opinion in Lorenzo v. SEC, No. 15-1202 (D.C. Cir. Sept. 29, 2017) is here.
Thomas K. Potter, III (firstname.lastname@example.org) is a partner in the Securities Litigation Practice Group at Burr & Forman, LLP. Tom is licensed in Tennessee, Texas and Louisiana. He has over 31 years’ experience representing financial institutions in litigation, regulatory and compliance matters. See attorney profile. © 2017 by Thomas K. Potter, III (all rights reserved).
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