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July 20, 2018

Awaiting Supreme Court Clarification on Fraudulent Scheme Claims

Harvard Law School Forum on Corporate Governance and Financial Regulation

On June 18, 2018, the Supreme Court granted Francis V. Lorenzo's petition for certiorari in Lorenzo v. S.E.C., No. 17-1077, to decide whether an action that does not meet the requirements for a misstatement claim "can be repackaged and pursued as a fraudulent scheme claim." The Supreme Court's decision to review this case implicates the scope and applicability of its decision in Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011) and its ruling may affect the ability of the US Securities and Exchange Commission (SEC) to enforce the antifraud provisions of the federal securities laws and could limit shareholders' ability to pursue private claims against certain individuals.

Case Background

The case arises from emails sent by Lorenzo, who was the director of investment banking at Charles Vista, LLC, to two potential investors, which included "several key points" about then-client W2Energy Holdings, Inc.'s convertible debenture offering. The emails failed to mention recent material devaluation of W2Energy's intangible assets. Lorenzo's boss asked him "to send the emails, supplied the central content, and approved the messages for distribution."1 Lorenzo claimed that he "cut and pasted" his boss's email into the emails that he sent.2

The SEC issued an order charging Lorenzo, his boss, and Charles Vista with fraud in violation of Securities Act Section 17(a)(1), Exchange Act Section 10(b), and Rule 10b-5. The firm and Lorenzo's boss settled. Lorenzo fought the charges, but the SEC administrative law judge (ALJ) ultimately found that he acted willfully with the intent to deceive, manipulate, or defraud. The ALJ issued a cease and desist order, and imposed a civil penalty and a lifetime bar from the securities business. On appeal to the SEC, the Commission affirmed.

Decision Below

On appeal to the DC Circuit, Lorenzo argued that, because he did not supply the content of the message, he was not the "maker" of the false statement for purposes of Rule 10b-5(b), which prohibits the "mak[ing of] any untrue statement of material fact." Central to Lorenzo's argument was the Supreme Court's decision in Janus, which held that (i) in order for a defendant to be held liable as the "maker" of a misleading statement, the defendant must be "the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it" and (ii) "[o]ne who prepares or publishes a statement on behalf of another is not its maker."3

The DC Circuit concluded that Lorenzo did not have "ultimate authority" and was not the "maker" of the statement and therefore could not be held liable under Rule 10b-5(b) pursuant to Janus, but that he nonetheless "infringed Section 10(b), Rules 10b-5(a) and (c), and Section 17(a)(1), regardless of whether he was 'maker' of the false statements for purposes of Rule 10b-5(b)."4

The majority distinguished Janus, explaining that Lorenzo "transmitted misinformation directly to investors, and his involvement was transparent to them" whereas, in Janus, the false information was disseminated "only through the intervening act of 'another person.'"5

Rejecting Lorenzo's argument that "if he could be found to have violated [Section 10(b), Rules 10b-5(a) and (c), and Section 17(a)(1)], the decision in Janus would effectively be rendered meaningless," the DC Circuit noted the Janus court's concerns that it not interpret the term "make" in a manner that would undermine the Court's prior holding in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994) that "private actions under Rule 10b-5 cannot be premised on conceptions of secondary (i.e., aiding-and-abetting) liability." The DC Circuit explained that Lorenzo's "self-attributed communications sent directly to investors (and backed by scienter)" could still constitute a fraudulent scheme for purposes of Rules 10b-5(a) and (c), as well as Sections 10(b) and 17(a)(1), while still "leaving ample room for 'distinction between those who are primarily liable . . . and those who are secondarily liable'" under Central Bank.

Judge Kavanaugh dissented, reasoning that the "majority opinion creates a circuit split by holding that mere misstatements, standing alone, may constitute the basis for scheme liability . . . that is, willful participation in a scheme to defraud—even if the defendant did not make the misstatements."6

Judge Kavanaugh wrote that "scheme liability must be based on conduct that goes beyond a defendant's role in preparing mere misstatements or omissions made by others."7

In his petition for certiorari, Lorenzo argued that the SEC cannot circumvent Janus by repackaging a misstatement claim against a defendant who cannot be liable as the "maker" of the statement into a fraudulent scheme claim, and he pointed to decisions from the Second, Eighth, and Ninth Circuits in support of his argument. Lorenzo also argued that allowing the SEC to bring scheme liability claims against him for statements he did not make would eliminate the distinction between the subsections of Rule 10b-5 and between primary and secondary liability.


The Supreme Court's grant of certiorari provides the Court with an opportunity to address questions that have been open since Janus. There has been uncertainty regarding the implications of Januswith respect to Rule 10b-5 claims alleging scheme liability. The SEC and private plaintiffs have argued that Janus is limited to subsection (b) of Rule 10b-5 (which deals with misleading statements) and does not apply to subsections (a) and (c) (which deal with scheme liability). Courts in the Seventh and Eleventh Circuits have adopted this limitation of Janus, while the Second, Eighth, and Ninth Circuits have rejected it.

In addition, following the 2011 Supreme Court decision, there were arguments that Janus, which dealt with the implied private right of action under Rule 10b-5, should be inapplicable to SEC enforcement actions. Over the last two terms, the Supreme Court has issued decisions that have reduced the extent of the SEC's power (i.e., Kokesh v. S.E.C., 137 S. Ct. 1635 (2017) and Digital Realty Trust, Inc. v. Somers, 138 S. Ct. 767 (2018)) and the Supreme Court could use this case as an opportunity to further limit the agency's reach by making clear that Janus applies to SEC enforcement actions.

  1. Lorenzo v. Securities and Exchange Commission, 872 F.3d 578, 588-89 (D.C. Cir. 2017).

  2. Id.

  3. Id. at 142; For more background on the Janus decision, see "The Supreme Court Adopts a Bright Line Attribution Test for Liability Under Section 10(b) of the Securities Exchange Act" (15 June 2011) and "Notwithstanding Janus" (9 December 2011).

  4. Lorenzo v. Securities and Exchange Commission, 872 F.3d 578, 588-89 (D.D.C. Cir. 2017).

  5. Id. at 591.

  6. Id. at 600.

  7. Id.