Gregory Ballard and Ludwig von Rigal authored this bylined article discussing the US Supreme Court’s decision in Lorenzo v. S.E.C. and its practical implications.
In March 2019, the U.S. Supreme Court held that the SEC may discipline an individual for disseminating misstatements made by someone else. The case, Lorenzo v. S.E.C., 139 S. Ct. 1094 (2019), marked the first time in a decade that the court has wrestled with “scheme” liability—so called in reference to the word contained in subsection (a) of Rule 10b-5, but not found in §10(b). But the justices struggled to find a principled way of explaining what types of conduct (beyond the making of misstatements or omissions and manipulation) may be actionable under §10(b), Rule 10b-5, and other provisions of the federal securities laws.
In its first “scheme” liability decision, Stoneridge Inv. Partners v. Scientific-Atlanta, 552 U.S. 148 (2008), a majority of the court found no primary liability for a customer and supplier that entered into sham arrangements designed to allow a company to inflate revenues. This drew a heated protest from three dissenters who lamented “the Court’s continuing campaign to render the private cause of action under §10(b) toothless.” In their view, Congress enacted §10(b) “with the understanding that federal courts respected the principle that every wrong would have a remedy.” The majority and dissent did agree on one thing though—they both rejected the categorical assertion that only misstatements, omissions, and manipulation are actionable. The majority described the proposition as “erroneous” as “[c]onduct itself can be deceptive,” and the dissent agreed that “the statute covers nonverbal as well as verbal deceptive conduct.” This left open the question of exactly what other forms of conduct §10(b) might reach.
With Lorenzo, the court has now made clear that dissemination of someone else’s false statements can be actionable conduct, at least in some circumstances. While the Stoneridgecourt had observed that the first element of a “typical” private §10(b) claim is “a material misrepresentation or omission by the defendant,” Lorenzo may be read to expand this to “a material misrepresentation or omission made or disseminated by the defendant.” But Lorenzo did not answer the question of whether other types of conduct, if any, beyond misstatements (made or disseminated), omissions, or manipulation can give rise to liability, and on the question of exactly when a person may be liable for disseminating another person’s misrepresentation, the court left many questions unanswered.
To the Lorenzo majority, it was “obvious” that the defendant’s conduct in sending emails with misleading content supplied by his boss, with scienter, was unlawful. At the same time, the majority “readily” imagined that imposing liability on a “mailroom clerk” for disseminating another person’s false statements would “typically be inappropriate.” The majority balanced its remarks about the likely non-liability of “actors tangentially involved in dissemination” with the admonition elsewhere in its opinion that even a “bit participant” can be liable if all of elements of the claim are present.
The Lorenzo dissent protested that the facts the majority believed distinguished Mr. Lorenzo’s conduct from that of mailroom clerks or secretaries—e.g., he sent emails directly to investors, his title was vice president of investment banking—do not withstand scrutiny: “I can discern no legal principle in the majority opinion that would preclude the secretary from being pursued for primary violations of the securities laws.”
Aside from mailroom clerks and secretaries, many people regularly play a role in disseminating information to investors. It is these people who should be most interested in Lorenzo.
Could the person who operates the slide projector for an earnings announcement be charged with securities fraud? The person has a role in disseminating information to investors. Let’s say the person sat in on management preparation meetings and heard discussions of financial results that cast doubt on assertions in the slide deck, which might cause a regulator or plaintiff to say that she knew that the slides contained misrepresentations. Still, Lorenzo contains ample bases for arguing against this person’s liability. Unlike Mr. Lorenzo, she does not attach her name to the alleged statement and likely does not have a title that implies responsibility for the slides’ contents. To be sure, by flipping on the projector and advancing the slides, this person is involved in transmitting the misinformation to investors, but the role is tangential to the substance of the communication.
The same kind of analysis could apply to an IT professional who arranges for filings to be made available on a company’s website. The person is merely involved in the mechanical process of making the documents electronically available for investors, not in personally communicating their contents. Just as the Lorenzo majority found it “difficult to see how [Mr. Lorenzo’s] actions could escape the reach of those provisions” of the securities laws, it is difficult to see how this person’s action could fall within the reach of those laws.
How about an attorney or paralegal tasked with filing a Form 8-K on the SEC’s EDGAR website? Imagine that this person has been privy to internal communications indicating that the filing may be inaccurate. A regulator could argue that this person had the requisite state of mind to support liability and was involved in disseminating the misinformation. But this person is not attaching his name to the offending communication and is only indirectly involved in the process, posting the document to the website. The act of uploading a required filing to a public database seems much more tangential than what was at issue in Lorenzo, where the defendant sent emails directly to investors.
What about an investor relations professional who forwards copies of annual reports or other public disclosure documents to shareholders? Again, assuming there is a basis for alleging this person came into contact with information in documents or meetings that betrays the accuracy of the disclosures, this person also could be at risk of being accused of securities fraud. Here, the person’s formal role and responsibilities for investor relations might heighten the risk, and the individual is directly communicating with investors. On the other hand, this person is merely distributing pre-existing disclosure documents that have presumably been made available publicly elsewhere, which should militate against personal exposure.
All of these circumstances may be relevant—whether the person’s name is on the communication, whether the person helped draft the misleading content, whether the person has a title and responsibilities that suggest to the recipients of the communication that she has a substantive role in communicating information to investors and is doing more than merely transmitting it, whether the person invited questions or follow-up, how directly or tangentially the person was involved in communicating with investors—but Lorenzo fails to supply a ready principle that can be used to separate those who may be liable from those who may not be liable for disseminating false statements made by others to investors.
In an effort to define and contain the scope of potential liability, venerable Supreme Court opinions (Cent. Bank of Denver, N.A., v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994), for example) have zeroed in on §10(b), and noted pointedly that Rule 10b-5 promulgated pursuant to its authority—no matter its subsections and jumble of overlapping words and phrases—could not be interpreted to reach conduct not already captured by the language of the statute. Lorenzo marks a different approach—the language of §10(b) has been relegated to an appendix to the majority’s opinion, which focuses instead on the language of Rule 10b-5, aided by dictionary definitions such as “device” (something that “is devised”) and “scheme” (“something to be done”). In the end, the reader is left with little guidance beyond the court’s conclusion that these words must capture some forms of conduct beyond the making of misstatements.
The law ought to be clear enough that people whose jobs involve communicating with investors (and anyone else) can know what conduct might get them into trouble. In fairness, people should be able to know in advance what the law forbids. Unfortunately, outside the typical contexts (misstatements, omissions, manipulation), uncertainty remains. Acknowledging as much, the Lorenzo majority observed that the provisions “capture a wide range of conduct,” and borderline cases “may present difficult problems of scope,” and “[p]urpose, precedent, and circumstance could lead to narrowing their reach in other contexts.” That is a remarkable thing to say 85 years after the leading statute was enacted, that the scope of prohibited conduct will continue to be the subject of case-by-case development depending on, for example, “circumstance.”
Even the mailroom clerk is not completely safe. While offering this as an example of someone whose non-liability is self-evident, the justices were careful not to rule out the possibility that a mailroom clerk could do something that offends them and warrants liability—it would only “typically” be inappropriate to hold the clerk liable, in the majority’s words. Apparently, the court wanted to make clear that there might be that odd, atypical case where even this poor soul could be punished under §10(b).