Friday, March 29, 2019
Earlier this week, the Supreme Court issued its opinion in Lorenzo v. SEC, and the thing that strikes me the most about it is that the dissenters do more to undermine Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011), than the majority does.
I previously posted about Lorenzo here; the remainder of this post assumes you’re familiar with the problem posed by Lorenzo and its relationship to the earlier Janus decision.
[More under the jump]
The dilemma for the Court in Lorenzo was that the conduct here was clearly fraudulent, but it also fell outside of the narrow definition of what it means to “make” a statement under Janus. That, of course, meant that the Court either had to conclude it fell outside of Section 10(b)’s prohibitions altogether, or the Court would have to look to Rule 10b-5(a) and 10b-5(c) to find the necessary prohibitions. But if it did that, it would trigger the question whether the Janus defendants also violated 10b-5(a) and (c) (a question never engaged by Janus itself), and if the Janus defendants violated 10b-5(a) and (c), does the Janus decision have any practical significance?
And basically, the Court chose to resolve it all by holding that the exact thing Lorenzo did is prohibited, and leave for another day what else might be prohibited, to be resolved on – apparently – a case by case basis.
The headline holding is that 10b-5(a) and 10b-5(c) prohibit a broader set of actions than does 10b-5(b), and – critically – the sections may overlap. Therefore, defendants may violate 10b-5(a) and (c) with frauds that are accomplished verbally—via misstatement—even if they don’t actually “make” a statement under 10b-5(b). This holding basically erases lower court decisions that hold that frauds accomplished solely through misstatements may trigger liability only under 10b-5(b), such that if the conduct does not satisfy the narrow definition of “making” a statement, there can be no primary liability at all. See, e.g., SEC v. KPMG, LLP, 412 F. Supp. 2d 349 (S.D.N.Y. 2006).
With respect to Lorenzo specifically, the Court described his actions as “disseminat[ing] false or misleading statements to potential investors with the intent to defraud.” That, the Court reasoned, constitutes a “device, scheme, or artifice to defraud” under Rule 10b-5(a), and “an act, practice, or course of business that operated as a fraud or deceit” under 10b-5(c) (alterations omitted). What else might constitute a “device, scheme, or artifice to defraud” in another case? The Court declined to say:
These provisions capture a wide range of conduct. Applying them may present difficult problems of scope in borderline cases. Purpose, precedent, and circumstance could lead to narrowing their reach in other contexts. But we see nothing borderline about this case…
Janus is therefore left technically undisturbed, because the Janus defendants did not, themselves, disseminate anything; they simply drafted the false statements and left dissemination to their (captured) entities. Whether that conduct violates 10b-5(a) and (c), well, the reader can only speculate. The Janus case suggests not, because of its invocation of Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164 (1994), implying that the conduct of the Janus defendants at most amounted to aiding-and-abetting; however, the Lorenzo decision made little attempt to distinguish between primary and secondary liability, other than to hold the same conduct may be a primary violation while simultaneously aiding another’s fraud.
Justice Thomas, joined by Justice Gorsuch, dissented, offering very narrow interpretations of both 10b-5(a) and 10b-5(c) that would exclude Lorenzo’s actions here. But in their haste to absolve him personally of wrongdoing, I fear they may have inadvertently put a nail in the coffin of the Janus defendants.
According to the dissenters, Rule 10b-5(a) is violated by those who engage in “some form of planning, designing, devising, or strategizing” a fraud. Lorenzo, they reason, did not mastermind the actions here – he was only following orders, and thus “at best assisted in a scheme” – and therefore cannot be said to have run afoul of the rule.
That logic may or may not be persuasive, but even taking it at face value, the Janus defendants absolutely planned, designed, devised, and strategized the alleged fraud in that case. So as I read the dissenters’ interpretation of Rule 10b-5(a), the Janus defendants could have been held liable, if only the plaintiffs had alleged a violation of 10b-5(a) and not 10b-5(b).
So where are we now?
Well, practitioners apparently don’t think this moves the needle much in terms of likely to impact which cases are brought, but I do think it broadens the universe of potential defendants responsible for a single fraud (which could result in additional cases being brought, of course, if the more obvious defendants are bankrupt or judgment-proof and thus would not be targeted for a lawsuit). The difficulty that Central Bank always posed was that there was no obvious way to distinguish primary from secondary liability, which meant the question of what conduct was enough constantly had to be litigated anew. Janus may have been a flawed decision, but it did offer a clear line. And now that line is gone again, putting us (almost) back where we started (though there still remains Stoneridge).