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September 5, 2019

Tenth Circuit Broadly Interprets Scheme Liability


On August 13, 2019, in Malouf v. Securities and Exchange Commission, the Tenth Circuit became the first circuit court to apply the United States Supreme Court's holding in Lorenzo v. Securities and Exchange Commission, 139 S. Ct. 1094 (2019).1 The Tenth Circuit held that the defendant in Malouf violated Rules 10b-5(a) and (c) under the Securities Exchange Act of 1934 (Exchange Act) and Sections 17(a)(1) and (a)(3) of the Securities Act of 1933 (Securities Act) for knowingly failing to correct another's material misstatements in connection with a securities transaction. This decision serves as an early indicator of how circuit courts will likely grapple with the interplay of the Supreme Court's decisions in Lorenzo and in Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011), about the scope of liability under Section 10b-5.


In Janus, the Supreme Court previously held that, for purposes of liability under Rule 10b-5(b), the "maker of a statement is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it."2 In that case, the Supreme Court concluded that an investment adviser who had participated in the drafting of a false statement "made" by another did not have ultimate authority over the statement and therefore could not be held liable in a private action brought under Rule 10b-5(b).

On March 27, 2019, the Supreme Court in Lorenzo considered whether those who disseminate as opposed to "make" false or misleading statements to potential investors with the intent to defraud can be found to violate subsections (a) and (c) of Rule 10b-5 as well as related portions of the securities laws, which prohibit fraudulent schemes and artifices.3 The Court held that they could be held liable "even if the disseminator did not 'make' the statements." The Supreme Court affirmed the DC Circuit's holding that Lorenzo—the vice president of an investment banking company who sent deceptive emails written by his supervisor to investors knowing that they contained false information—could be charged with a primary violation of Exchange Act Rules 10b-5(a) and (c) and Section 17(a)(1) of the Securities Act even though he was not the "maker" of the misstatements in the emails sent to investors.

The Supreme Court observed that Lorenzo was not a borderline case, such as a mailroom clerk tangentially involved in dissemination and for whom liability would typically be inappropriate. Instead, Lorenzo disseminated another's false statement with scienter (a holding which he did not challenge on appeal), and the Supreme Court concluded that it was appropriate to impose liability because Lorenzo "sent the false statements directly to investors, invited them to follow up with questions, and did so in his capacity as a vice president of an investment banking company." The Supreme Court reasoned that the holding in Janus would remain relevant and preclude liability "where an individual neither makes nor disseminates false information—provided, of course, that the individual is not involved in some other form of fraud."

The Tenth Circuit's Decision

In Malouf, the Tenth Circuit applied Lorenzo to hold that the defendant's knowing failure to correct material misstatements in connection with a securities transaction violated Exchange Act Rules 10b-5(a) and (c) and Sections 17(a)(1) and (a)(3) of the Securities Act. In that case, Dennis Malouf served as an executive at both a securities brokerage and an investment adviser. He subsequently sold his interest in the brokerage in a transaction in which he continued to receive installment payments based on the commissions the brokerage collected from securities sales. Malouf facilitated these installment payments by routing client trades through the brokerage without disclosing his financial interest to clients or to the investment adviser and despite knowing that the investment adviser represented that Malouf did not have any conflicts of interest.

The Securities and Exchange Commission (SEC) brought an enforcement action against Malouf, and the Tenth Circuit affirmed an administrative law judge's finding that Malouf had violated Exchange Act Rules 10b-5(a) and (c) and Sections 17(a)(1) and (a)(3) of the Securities Act. The Tenth Circuit reasoned that Malouf had engaged in an unlawful fraudulent scheme because he knew that a conflict existed while the investment adviser was telling clients that he was independent and, despite this knowledge, failed to take steps to correct the misstatements or to disclose the conflict. The Tenth Circuit rejected Malouf's argument that the SEC had "obliterated[d] the distinction" between Rule 10b-5 subsections (b) on one hand and (a) and (c) on the other because, as the Court in Lorenzo expressly held, defendants could be liable under sections of the Securities Act and Rule 10b-5 dealing with fraudulent schemes in connection with misstatements without having been the "maker" of misstatements.

Significance of the Tenth Circuit's Recent Decision

Much remains to be seen about the scope of liability under Rule 10b-5 post-Lorenzo. The Tenth Circuit is the first circuit court to apply its holding, and its decision in Malouf constitutes an aggressive interpretation of Lorenzo applying it in a situation involving inaction (failure to correct misstatements/omissions) rather than active participation in a scheme. It is unclear whether other courts will follow the Tenth Circuit's lead in holding that such conduct falls within the ambit of Lorenzo or whether they will instead conclude that Janus precludes liability in such circumstances. Either way, the SEC is likely to continue to pursue antifraud charges against individuals who are not "makers" of statements under Janus in cases going forward.

Further, it is possible that, as in Malouf, the SEC will continue to pursue scheme claims under Section 17(a)(3), which does not require a showing of scienter. Finally, while Lorenzo and Malouf arose in the context of SEC enforcement actions and do not address private securities class actions, it remains to be seen whether private plaintiffs in securities class actions can successfully extend Lorenzo to private rights of action under 10b-5(a) and (c) against individuals involved in disseminating corporate information.

© Arnold & Porter Kaye Scholer LLP 2019 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.

  1. Malouf v. Securities and Exchange Commission, No. 16-9546, 2019 WL 3788225 (10th Cir. Aug. 13, 2019).

  2. For more background on the Janus decision, see: Arnold & Porter Advisory, The Supreme Court Adopts a Bright Line Attribution Test for Liability Under Section 10(b) of the Securities Exchange Act; Securities Law360Notwithstanding Janus ..., December, 2011.

  3. For more background on the Lorenzo decision, see: Arnold & Porter Advisory, Supreme Court Determines That the SEC Can Assert Fraudulent Scheme Claims Even When the Janus Test Is Not Met; Arnold & Porter Advisory, Supreme Court Hears Argument on SEC's Ability to Pursue Fraudulent Scheme Claims Where the Janus Test Is Not Met; Arnold & Porter Advisory, Supreme Court to Decide Whether the SEC Can Pursue Fraudulent Scheme Claims Where the Janus Test Is Not Met.