April 2, 2019
Lorenzo v. SEC, 586 U.S. ___ (2019) (Breyer, J.).
Response by Theresa A. Gabaldon
Geo. Wash. L. Rev. On the Docket (Oct. Term 2018)
Slip Opinion | SCOTUSblog
Crossing the River: Lorenzo v. Securities and Exchange Commission
Section 17(a)(1) of the Securities Act of 1933 provides that it is “unlawful for any person in the offer or sale of any securities . . . to employ any device, scheme, or artifice to defraud.”1 Rule 10b-5(a), adopted by the Securities and Exchange Commission (SEC) under Section 10(b) of the Securities Exchange Act of 1934, is a conscious parallel, making it “unlawful for any person . . . [t]o employ any device, scheme, or artifice to defraud . . . in connection with the purchase or sale of any security.”2 The only real difference (which is not relevant to what follows) is that Rule 10b-5(a) picks up a defendant’s purchases while Section 17(a)(1) does not, and it is well known that prohibiting fraudulent purchases as well as sales was the SEC’s purpose in adopting it.
Francis Lorenzo, a director of investment banking at a brokerage firm, solicited investments in his only client, Waste2Energy Holdings, Inc., by sending emails describing the company’s “confirmed assets” of over $10 million. In fact, as Mr. Lorenzo knew at the time and admitted at trial, Waste2Energy’s assets were worth less than $400,000 since the touted technology designed to turn “solid waste” into “clean renewable energy” “didn’t really work.”3 The language in the email was not electronically penned by Mr. Lorenzo himself, but was provided by, and attributed to, Mr. Lorenzo’s supervisor. The question before the Court in Lorenzo v. Securities and Exchange Commission,4 decided on March 27, was whether Mr. Lorenzo’s intentional conduct in disseminating a material misrepresentation was a “device, scheme, or artifice to defraud.” As one re-reads that last sentence, a more obvious question may leap from the page: just why this matter was consuming the scarce time of the High Nine?
The dissent, as dissents do, provides the explanation. Section 17(a) has a part (2) and Rule 10b-5 has a part (b). With only slight wording variations, they describe the unlawful acts (quoting from Rule 10b-5(b)) of “[making] any untrue statement of a material fact or [omitting] 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.”5 Since the 2011 case of Janus Capital Group, Inc. v. First Derivative Traders,6 liability to private plaintiffs suing under Rule 10b-5(b) has attached only to “makers” —those with “ultimate control” over a misleading statement. According to Janus, in the ordinary case attribution is critical in determining ultimate control. Evidently on the assumption that the same reading would pertain in an enforcement action, Mr. Lorenzo was not charged under either Rule 10b-5(b) or Section 17(a)(2).
Justice Thomas, in dissent, clearly was piqued over the slight to Janus that transpires if a defendant who could not be sued as a “maker” under Section 17(a)(2) or Rule 10b-5(b) can be sued under Section 17(a)(1) or Rule 10b-5(a). He took the position, with which Justice Gorsuch agreed, that if misconduct involves a misrepresentation it can only be pursued under Section 17(a)(2) and Rule 10b-5(b). Any other conclusion arguably renders those provisions (and Janus, in which Thomas authored the 5–4 majority’s opinion) mere “surplusage.” Justice Thomas offered quotes from cases suggesting that such a construction would be offensive to ordinary canons of construction. He also advanced a somewhat scattered “plain language” argument that a “device, scheme, or artifice to defraud” is only a device, scheme, or artifice when employed by its designer and that there is some distinction between “practices” that could be prosecuted under Section 17(a)(1) and Rule 10b-5(a) and misrepresentations, which can be prosecuted only under Section 17(a)(2) and Rule 10b-5(b). (He did seem to concede, however, that a misrepresentation repeated frequently enough might involve a “scheme.”)
The dissent’s most pressing concern, however, was that under Janus Mr. Lorenzo’s conduct could have amounted to no more than secondary liability—aiding and abetting his supervisor—with respect to a violation under Section 17(a)(2) and Rule 10b-5(b). Under Section 17(a)(1) and Rule 10b-5(a), his liability was primary. This has future significance because private parties, under Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A.,7 have no cause of action for aiding and abetting violations of the federal securities laws. They also have had a difficult time suing for “scheme” violations under Section 17(a)(1) and Rule 10b-5(a) that do not involve misrepresentations because, since Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc.,8 it has been too difficult for them to prove reliance on the nonexistence of such a scheme, rendering absent the necessary causal link between the defendant’s bad act and the plaintiff’s claimed injury. In other words, private plaintiffs have had a progressively tougher row to hoe and Lorenzo might soften the dirt.
The majority in Lorenzo, comprised of the four dissenters in Janus plus Chief Justice Roberts and Justice Alito, read the plain language of Section 17(a)(1) and Rule 10b-5(a) differently, and countered the “surplusage” point with a litany of cases upholding overlapping liability under various securities acts provisions, all of which could render one or another the occasional surplus. For instance, it quoted SEC v. Capital Gains Research Bureau, Inc.9 to the effect that it was “thought prudent ‘to include both a general proscription against fraudulent and deceptive practices and, out of an abundance of caution, a specific proscription against nondisclosure’ even though ‘a specific proscription against nondisclosure’ might in other circumstances be deemed ‘surplusage.’”10
One of the majority’s most compelling points on the “surplusage” issue is that Section 17(a)(3) and Rule 10b-5(c) also are on the books (and in fact Mr. Lorenzo was convicted under the latter, as well as under Section 17(a)(1) and Rule 10b-5(a)). These two provisions impose liability for “[engaging] in any act, practice, or course of business which operates or would operate as a fraud or deceit . . . .”11 It is difficult to deny that conduct “to defraud” in violation of Section 17(a)(1) and Rule 10b-5(b) also (if successful) will violate Section 17(a)(3) and Rule 10b-5(c) by “operat[ing] as a fraud.” As noted by Justice Breyer’s majority opinion, “The dissent, for its part, offers no account of how the superfluity problems that motivate its interpretation can be avoided where subsections (a) and (c) are concerned.”12
There are three aspects of Lorenzo that offer particular fun. One is the exchange between Justice Breyer and Justice Thomas on the subject of overlapping prohibitions and the complications of primary v. secondary liability. Justice Breyer describes the following case: “John, for example, might sell Bill an unregistered firearm in order to help Bill rob a bank, under circumstances that make him primarily liable for the gun sale and secondarily liable for the bank robbery.”13 Justice Thomas responds: “But this case [Lorenzo] does not involve two distinct crimes.”14 This sets the curious to the task of coming up with other examples—perhaps involving arsonists for hire, murderous clients and the like—that clearly do involve both primary and secondary liability. Enough thought experiments may (or may not) lead one to conclude that Lorenzo really does involve two different crimes that simply have different elements and that what Justice Thomas must have meant is that “this case [unlike that of John and Bill] does not involve two distinct acts.” In any event it is, as noted, fun to think about.
The second thing that is fun to think about is the image of Justices Alito and Roberts holding up their robes and wading naked-shanked across a stream to join, in Lorenzo, the Janus dissenters. Janus, in which both were members of the majority, was a case that sharply limited the ability of private plaintiffs to sue peripheral violators. Both Justices also were part of the majority in Stonebridge, another case that made private plaintiffs’ claims significantly more difficult. Given the distinct possibility that Lorenzo will ease the burdens of advancing those claims, the image is quite intriguing. One should not forget, however, that Lorenzo involves SEC enforcement and not private litigation; a later case well might plumb this distinction and prompt a reverse trip across the river.
The third thing that is fun (at least for a grizzled teacher) is to sit back and observe the sound and fury inherent in the dissent’s attempt to discern a clear meaning that excludes conduct from a catch-all securities law prohibition on the basis that it is specifically referred to elsewhere in the same statute or rule. The Securities Act of 1933 famously was drafted over a single weekend that (perhaps apocryphally, perhaps not) involved a case of whiskey. Rule 10b-5 was just as famously patterned in a single day to follow the language of Section 17 of the 1933 Act in order to pick up fraudulent purchases as well as sales. The idea that there might be multiple provisions prohibiting the same type of conduct is simply so unremarkable as to make one smile.
Theresa A. Gabaldon is the Lyle T. Alverson Professor at The George Washington University Law School. Before joining the faculty of the law school in 1990, she was a member of the law faculties of the University of Colorado and the University of Arizona. Before entering academia, she was an associate and then a partner with the law firm of Snell & Wilmer in Phoenix. Her areas of specialization are corporate and securities law, contract law, and professional responsibility. Her primary research interests are in the field of securities regulation. She has served as a member of a number of committees and task forces, including the Colorado Supreme Court’s Task Force on Gender Bias and the committee responsible for drafting the Association of American Law Schools’ Statement of Good Practices by Law Professors in the Discharge of Their Ethical and Professional Responsibilities.
- 15 U.S.C. § 77q(a) (2012).
- 17 C.F.R. § 240.10b-5 (2018).
- See Lorenzo v. SEC, No. 17–1077, slip op. at 2 (Mar. 27, 2019).
- No. 17-1077 (U.S. Mar. 27, 2019).
- 17 C.F.R. § 240.10b-5(b).
- 564 U.S. 135, 142–43 (2011).
- 511 U.S. 165 (1994).
- 552 U.S. 148 (2008).
- 375 U.S. 180, 198 (1963).
- See Lorenzo, slip op. at 8.
- See 17 C.F.R. § 240.10b-5(c). Section 17(a)(1) imposes liability for engaging in “any transaction, practice, or course of business which operates or would operate as a fraud or deceit . . . .” 15 U.S.C. § 77q(a)(3) (2012) (emphasis added).
- Lorenzo, slip op. at 9.
- Id. at 11.
- Id. at 10 (Thomas, J., dissenting).
Recommended Citation
Theresa A. Gabaldon, Response, Crossing the River: Lorenzo v. SEC, Geo. Wash. L. Rev. On the Docket (Apr. 2, 2019), https://www.gwlr.org/crossing-the-river-lorenzo-v-sec/.
