Several years ago, in the landmark case of Janus Capital Group v. First Derivative Traders, 564 U.S. 135 (2011), the Supreme Court held only the author of a misstatement, its maker, could be held liable under Securities and Exchange Commission Rule 10b-5(b), promulgated under Section 10(b) of the Exchange Act of 1934. In the intervening years, many courts accepted that the statutory anti-fraud provisions of Section 10(b) of the Exchange Act of 1934 and Rule 10b-5 thereunder encompassed two different kinds of misconduct. Rule 10b-5(b) addressed misstatements and omissions while subsections (a) and (c) addressed fraud by conduct—e.g., wash sales, painting the tape, various forms of manipulative trading, and so on, that did not have a misstatement component.

It became accepted that a scheme claim could not be asserted if the basis was a misstatement or omission. Indeed, just last month, in SEC v. Rio Tinto PLC, 2019 U.S. Dist. LEXIS 43986, *51-52 (March 18, 2019), the U.S. District Court for the Southern District of New York ruled that “in order to state a claim based on scheme liability, the SEC must allege conduct beyond misrepresentations and omissions.” See also Alpha Capital Anstalt v. Schwell Wimpfheimer & Assocs., 2018 U.S. Dist. LEXIS 54594, * 34 (S.D.N.Y. March 30, 2018) (“subsections (a) and (c) may not be sued as a 'back door into liability for those who help others make a false statement or omission … '”); SEC v. Wey, 246 F. Supp. 3d 894, 917-18 (S.D.N.Y. 2017) (listing cases holding that scheme liability hinges on the performance of an inherently deceptive act or conduct distinct from alleged misrepresentations or omissions); SEC v. China Northeast Petroleum Holdings Ltd., 27 F. Supp. 3d 379, 391-92 (S.D.N.Y. 2014) (scheme liability requires conduct beyond misrepresentations or omissions); In re Smith Barney Transfer Agent Litig., 884 F. Supp. 2d 152, 161 (S.D.N.Y. 2012) (“[T]he three subsections of Rule 10b-5 are distinct, and courts must scrutinize pleadings to ensure that misrepresentation or omission claims do not proceed under the scheme liability rubric.”). At the SEC, it was widely accepted that one did not assert scheme liability claims under Rule 10b-5(a) and (c) based on misstatements or omissions, and that such theories were unlikely to be approved by senior management.

This well-accepted distinction between misstatement fraud and manipulative and deceptive conduct was sharply eroded, if not erased, on March 27, 2019, by the Supreme Court's decision in the case of Lorenzo v. Securities and Exchange Commission, 139 S. Ct. 1094 (2019), by a 6-2 vote (Justice Brett Kavanaugh did not participate). Lorenzo addressed the question of whether or not a non-author—someone who merely disseminated the fraudulent statements made by another—could be held liable under subsections (a) and (c) of Rule 10b-5.

The relevant facts are as follows. Francis Lorenzo was the director of investment banking at a registered broker-dealer. One of his clients—in fact, his only client—was a company that purported to have technology that would convert waste to clean renewable energy. Lorenzo's firm had been hired to sell $15 million in debentures to investors. Although he knew that its total assets were comparatively negligible, Lorenzo sent to investors, at the direction of his boss, two emails describing the offering. Lorenzo's emails, which he signed with his own name, identifying himself as “Vice-President—Investment Banking,” inflated the company's assets from less than $400,000 to at least $10 million, and invited the recipients to call him with any questions.

Surprising many who expected a contrary result, the Supreme Court held in Lorenzo that, even if disseminating the statements of another would not establish liability under subsection 10b-5(b), it would count as a “device, scheme or artifice to defraud” under 10b-5(a) (and under Section 17(a)(1) of the Securities Act as well) in addition to as engaging in “an act, practice or course of business” that operates “as a fraud or deceit” under Rule 10b-5(c).

By expanding the scope of liability for those who are involved in disseminating misrepresentations even if they are not the authors or originators of them, Lorenzo conceivably could have a vast impact on both SEC enforcement, as well as private lawsuits. Indeed, soon after the opinion came out various SEC enforcement staff, giddy with a decision they see gifting them with an expansive writ, were widely reported to have stated at the annual “SEC Speaks” CLE program that the Division of Enforcement anticipates the opinion will be applied “broadly”—for example, not only to people who distribute a false statement but those that direct others to draft or distribute false statements.

Private plaintiffs have also been given extra ammunition. As Justice Clarence Thomas pointed out in the dissent, the fear that Lorenzo's wrongful conduct lacked an enforcement remedy was misplaced, since his conduct could also have been charged as aiding and abetting another's fraud. This avenue would not, however, be available to a private plaintiff, as there is no private right of action for aiding and abetting a securities fraud. By effectively converting such a claim to a direct claim, Lorenzo added a powerful arrow to the quiver of the plaintiffs' bar.

However, the floodgates might not be propped open as widely as some fear. A practitioner has several avenues available for keeping her client out of trouble, some based on a strict reading of the Lorenzo decision, others on the pragmatic realities of the SEC enforcement regime.

The first line of defense is to distinguish one's client's conduct from that of Mr. Lorenzo, and to limit Lorenzo's scope to its specific facts. Arguably, the Supreme Court recognized that Lorenzo might be construed as overly expansive, and cautioned against such a reading, specifically excluding “actors tangentially involved in dissemination—say, a mailroom clerk—for whom liability would typically be inappropriate.” Nor is there much support in the text of the decision for expanding Lorenzo beyond dissemination, as SEC enforcement staff seems to think. In fact, in every single instance in which the decision refers to misconduct at issue, it is either some version of the word “disseminate” (15 times) or its synonym “send” (four times). As the Court explicitly noted, it only intended to make liable “those who disseminate false statements with the intent to cheat investors.” Moreover, the opinion notes that the preclusion of Janus would still apply “where an individual neither makes nor disseminates false information—provided, of course, that the individual is not involved in some other form of fraud.”

It is also important to point out that although he might not have been the “maker” of the misstatements, Mr. Lorenzo's conduct effectively “vouched” for them. He held himself out to investors as someone in a position of authority, using his title in his emails to them. He invited the recipients to contact him if they had any questions, “and did so in his capacity as vice president of an investment banking company” further adding to his implied authority and bolstering the idea that he was the person with knowledge. He had direct contact with investors. Moreover, Mr. Lorenzo knew the statements were false, and intended to defraud investors.

Thus, a persuasive argument can likely be made that the Supreme Court meant to inculpate only the most egregious of offenders, and to limit the scope of the decision to those who knowingly disseminate false information directly to investors with the intent to defraud. (Of course, these arguments can be made whether the adversary is the SEC or a private plaintiff).

Furthermore, there are practical considerations that might limit a radical expansion of SEC enforcement activity. First, the SEC lacks the resources and staff to investigate and prosecute every instance of securities fraud (and that was true before Lorenzo) and has to make pragmatic assessments of which conduct to prosecute. Defense counsel should communicate to staff that their client's conduct is not of a sufficient severity to warrant the expenditure of scarce enforcement resources, especially if there are risks that it falls outside the narrow area of “dissemination” targeted by the Lorenzo decision.

Second, regardless of what some senior staff at the Division of Enforcement might believe about the breadth of the Lorenzo decision, the fact remains that it is not the enforcement staff that makes the final decision as to whether or not to bring charges. That decision is left to the full Commission, after consultations with the various divisions. A sizable portion of the current Commission is skeptical about expansive claims of liability. Reference to that skepticism in pre-charge negotiations with the staff might be a useful method for whittling down charges.

Given the limiting language of the Lorenzo decision, the resource limitations at the SEC, and the currently conservative Commission, a practitioner has significant room to argue against wide theories of liability and for a more limited reading of the decision. The next few years should see some fascinating judicial decisions determining which side of the argument prevails.

Howard Fischer is a partner at Moses & Singer and a former senior trial counsel at the New York Regional Office of the Securities & Exchange Commission.