Why You Could be the Next Target of an SEC Probe After SCOTUS Ruling
A recent U.S. Supreme Court ruling that has effectively expanded the scope of liability for false statements under an SEC rule will most likely embolden the regulator to target more individuals and conduct more enforcement actions, according to lawyers.
As reported, the U.S. Supreme Court ruled on March 27 in Lorenzo v. SEC that an individual who distributes false statements — whether or not the individual is the “maker” of the statement — can be liable for that statement under the SEC’s Rule 10b-5(b).
Law firm King & Spalding’s takeaway from the Supreme Court ruling is “an emboldened SEC enforcement program.”
King & Spalding believes the SEC’s victory in the case is “something of a return to form for an agency that had suffered numerous Supreme Court losses of late.”
For example, recent key Supreme Court decisions called into question the viability of the SEC’s administrative forum, imposed previously unapplied statutes of limitations on both civil penalties and disgorgement, and significantly restricted the agency’s definition of a whistleblower, according to King & Spalding.
The previous relevant Supreme Court decision in Janus Capital Group, Inc. v. First Derivative Trader on June 13, 2011 may have had the most significant impact on the SEC’s enforcement program because it restricted “the universe of potential defendants” and led the regulator “to more reflexively bring aiding-and-abetting charges” instead of primary liability charges, according to King & Spalding.
That ruling stated that the "maker of a statement” under SEC Rule 10b-5 “is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it."
“But Lorenzo’s broad, almost prudential reading of the securities law … may well lead to an SEC that is far more willing to aggressively push the margins of the securities laws through its enforcement program,” King & Spalding says.
The Supreme Court ruling is likely “to lead to the SEC bringing new counts charging primary liability, especially under Rules 10b-5(a) and (c), which have rarely been used on a stand-alone basis in the past,” King & Spalding says.
“These additional primary anti-fraud violations could result in the SEC obtaining even more significant sanctions against future defendants,” the law firm adds.
SEC Rule 10b-5 — or Employment of Manipulative and Deceptive Practices — says 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.
Law firm DLA Piper says the Supreme Court’s ruling “somewhat surprisingly” expands the scope of federal securities fraud law and widens the set of individuals who may be held liable for material misrepresentations.
“As a practical matter, the Court’s opinion should be seen as a warning to all participants in securities markets to be especially cautious and careful when working with or disseminating statements made by others,” DLA Piper says.
“If a broker, banker, lawyer, or other individual knows or recklessly disregards that a statement is untrue before sending it to prospective investors, and the SEC is able to establish sufficiently an intent to defraud based on that knowledge, that person could be subject to liability for securities fraud,” DLA Piper adds.
Meanwhile, King & Spalding says the Supreme Court ruling could also impact private securities class actions “by encouraging shareholders to bring claims against a broader range of actors who did not make false statements, but allegedly disseminated those statements.”
The Supreme Court previously has held that private securities litigants cannot bring Rule 10b-5 claims against secondary actors who aided and abetted, the law firm notes.
“An emboldened SEC with greater sanctions potentially at its disposal and an opportunity for private plaintiffs to more aggressively pursue their claims directly impacts the risk to financial services firms and public market issuers,” King & Spalding says.
Law firm Steptoe & Johnson believes the “most potentially significant implications” of the Supreme Court ruling will likely surface in private litigation.
“Although Lorenzo occurred in the context of a SEC action, private plaintiffs are likely to seek to apply the reasoning of the decision to expand the scope of individuals who may be held liable in private actions under Rule 10b-5,” Steptoe & Johnson says.
But for those claims to be successful, plaintiffs must still plead a strong inference of intent to deceive or defraud under the federal securities laws as well as reliance on the alleged misstatements, according to Steptoe & Johnson.
Law firm Sullivan & Cromwell says future litigation can be expected to focus on what kinds of factual differences from the Supreme Court ruling are material enough to warrant “narrowing” the scope of liability under Rule 10b-5(a) and (c).
The Supreme Court acknowledges this about its ruling, stating: “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.”
Sullivan & Cromwell says “fact patterns that do not reflect as clear an intention to deceive by a defendant disseminating false statements may cause courts to act on the Court’s acknowledgment that different circumstances may call for a different approach.”
The Lorenzo case involves Francis Lorenzo, who was the director of investment banking at Charles Vista, a registered broker-dealer in Staten Island, N.Y.
Lorenzo sent two emails to potential investors that contained false information about a debenture offering, according to the initial petition to the U.S. Court of Appeals for the District of Columbia circuit. The emails stated that the issuer had $10 million in confirmed assets when the assets were in fact worth less than $400,000. Despite knowing the statements were false, the director sent the emails at the direction of his boss, who supplied the content and approved the messages.