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From Securities Regulation Daily, February 1, 2018

Petition argues scheme liability cannot be based on misstatements alone

By Anne Sherry, J.D.

A broker who was found to have defrauded two clients even though he did not "make" false statements has asked the Supreme Court to intercede. In a 2-1 decision, the court of appeals for the D.C. Circuit held that while the broker did not violate Rule 10b-5(b), his conduct in producing and sending emails containing false statements constituted a deceptive device, act, or artifice to defraud for purposes of other antifraud provisions. In his petition for certiorari, the broker argues that this holding sidesteps Janus by "repackaging" an inadequate claim based on misstatements into a claim based on misconduct (Lorenzo v. SEC, January 26, 2018).

Not a maker, but scheme liability applies. The petitioner worked as an investment banker at Charles Vista, LLC. Charles Vista was placement agent for an offering by Waste2Energy Holdings, Inc. (W2E), a startup energy company, of $15 million in convertible debentures. At the direction of his supervisor, the petitioner sent two nearly identical emails to two clients related to the offering. The emails said that they were sent at the request of the supervisor and requested that the recipient read the offering memorandum, including risk factors. They then went on to state that the offering had "3 layers of protection"—each of which, the SEC concluded in its initial decision, was false. The emails were sent from the petitioner’s account and included his email signature line. One of the two recipients eventually invested $15,000 in the offering, resulting in a $150 commission to the petitioner.

The D.C. Circuit majority largely upheld the SEC’s findings, but determined that the broker did not "make" the statements in the emails for purposes of Exchange Act Rule 10b-5(b). Unlike Rule 10b-5(b), the court noted, Rules 10b-5(a) and (c) and Securities Act Section 17(a)(1) do not speak in terms of an individual’s "making" a false statement. Lorenzo's conduct in producing and sending the emails thus constituted employing a deceptive "device," "act," or "artifice to defraud" for purposes of liability under those provisions. The dissenting judge took the minority to task for disregarding factual conclusions demonstrating a lack of mens rea and for creating a circuit split by holding that mere misstatements may constitute the basis for scheme liability.

Petition for certiorari. The petitioner picks up this thread from the dissent, quoting it heavily in the first portion of the petition. First, he argues that other courts require some conduct beyond mere misstatements or omissions before imposing scheme liability. While Rule 10b-5(b) proscribes making untrue statements, he argues, Section 17(a)(1) and Rule 10b-5(a) and (c) proscribe deceptive conduct. By holding that misstatements can provide the sole basis for a misconduct claim, the appeals court "eviscerated" the Supreme Court’s holding in Janus with respect to maker liability. "The D.C. Circuit’s decision allows both the SEC and private plaintiffs to sidestep the carefully laid out standards for fraudulent statement claims by repackaging the claims—with nothing more—as claims for fraudulent schemes," the petition argues.

Along with the Eighth and Ninth, the Second Circuit is one of the appeals courts that have held that misstatements alone cannot form the basis for scheme liability; the Eleventh Circuit is on D.C.’s side of the split. The broker urges the Supreme Court to take the case in part because the circuit split would encourage forum shopping. Had the SEC brought action in federal court in New York, where the broker lives, the Second Circuit decision would have controlled. The stakes are high, the petitioner argues: the issue in question arises frequently in both SEC enforcement proceedings and in private securities litigation, including class actions. These proceedings often involve significant liability, and in the case of SEC enforcement, an industry bar may be on the table.

Finally, the petition maintains that the D.C. Circuit opinion was wrongly decided. It removes any meaningful distinction between claims for false statements and claims for fraudulent schemes, rendering the statutory and regulatory structure of the applicable antifraud provisions meaningless. "Under the D.C. Circuit’s approach, all claims for false statements can be brought as fraudulent scheme claims, and, vice-versa, claims for nondisclosure of a defendant’s fraudulent conduct become viable claims for misstatements and omissions." The decision also erases the distinction between primary and secondary liability, the petitioner argues. Under the securities laws, private plaintiffs cannot bring aiding-and-abetting claims against secondary actors. The Court in Janus narrowed the scope of actors who can qualify as primary defendants, but the D.C. Circuit decision allows plaintiffs to sidestep these limitations by labeling their claims as fraudulent scheme claims.

The case is No. 17-1077.

Attorneys: Robert G. Heim (Meyers & Heim LLP) for Francis V. Lorenzo. Noel J. Francisco, U.S. Department of Justice, for the SEC.

Companies: Waste2Energy Holdings, Inc.; Charles Vista, LLC

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