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 benefit asset managers and service providers — such as researchers — with longer, more dependable track records, according to lawyers and a broker-dealer executive.
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).
“Brokers and advisors should be very mindful about the source of the material they pass along,” says New York-based lawyer Jonathan Brennan.
“If a source is not known to the advisor, is less than reputable, or has a history of being close to the line, Lorenzo should give them even more of a reason to stop and think carefully before passing such information along,” adds Brennan, who was previously Merrill Lynch’s head of wealth management litigation before setting up his own practice last year.
Christopher Cooke, Indianapolis-based partner and senior institutional consultant at Cooke Financial Group, believes the Lorenzo ruling could benefit well-known and reliable investment providers and custodians — but disadvantage newer companies pitching new investment products or services.
“It’s going to push firms like mine toward well-established groups or product partners. It’s going to remove or it’s going to reduce my interest in looking at someone who’s new or doesn’t have a long track record,” Cooke says.
“I think reputational risk is going to be a highlight here of how people respond. We already have a habit of saying no before saying yes. A lot of new ideas might not get off the ground [in terms of products from new players]. The 'no, no, no, no, no' mentality is going to get stronger,” Cooke adds.
Sticking with well-known asset managers or service providers will help brokers and advisors avoid passing on fraudulent information, according to Cooke. “It’s really hard to catch fraudulent behavior until it’s happened,” he says.
Recalling his previous experience as a Certified Public Accountant, Cooke says even auditors at the biggest auditing firms in the country say they believe the information they disseminate to be true to the best of their ability. “To claim something is 100% true, that’s a really high standard,” he says.
Cooke hopes a balance will be established between protecting investors and holding financial professionals accountable for sharing information.
“Over time, I trust that court cases and how they are decided will establish that balance,” he says.
Meanwhile, Brennan says the Lorenzo ruling is a “big win for the SEC” because of the expansion of liability to individuals sharing false information.
Following a firm’s well-established policies and procedures about communications with clients and the public is “now more important than ever,” according to Brennan.
If a firm is thinking about adopting a new policy on communicating with clients and the public, or enhancing what it has, the Lorenzo ruling should be factored into those changes, he says.
Brennan believes the ruling could also impact other forms of information delivery.
“Given the rise of social media over the past 10 years, the industry should be alarmed with the Court’s focus on dissemination,” Brennan says.
“While Lorenzo himself sent an email at the behest of his boss, it is not so much of a leap to see liability in future cases based on reposting, retweeting, and potentially even just liking statements that turn out to be untrue,” he adds.
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.
Dennis Concilla, Columbus, Ohio-based head of Carlile, Patchen & Murphy’s securities litigation and regulation practice group, says firms that are involved in selling securities or investment products that have good due diligence procedures should not worry.
“Legitimate brokerage firms do extensive due diligence when they’re offering a security. You can’t walk into Merrill Lynch and say, ‘I have this security; I want you to sell it.’ There’s a huge vetting process,” Concilla says. “It sometimes takes over a year to get a firm to ultimately agree to sell a particular product. And it’s because of all the due diligence that has to take place.”
Concilla stresses that individuals will only get in trouble under the SEC’s Rule 10b-5(b) “if you knowingly pass on false information.”
The onus to prove that an individual “knowingly” shared false information still lies with the SEC, according to Concilla.
“Every case is fact sensitive. In order to be found guilty, they have to show that you knowingly did it and that your intent was to defraud,” he says. “You’re innocent until proven guilty.”
Concilla acknowledges, however, that the Lorenzo ruling has given the SEC “a new avenue to look carefully at every situation” involving the sharing of information.