(Reuters) - For corporate America, there’s no bogeyman more reliable than the threat of securities class actions. So it’s no surprise that when a challenge to an enforcement action by the Securities and Exchange Commission went to the U.S. Supreme Court, the business lobby emphasized the case’s potential impact on private shareholder suits, arguing that the SEC’s position would expose all kinds of people previously shielded by Supreme Court precedent to liability in shareholder suits.
On Wednesday, the Supreme Court sided with the SEC in Lorenzo v. Securities and Exchange Commission (2019 WL 1369839). Does the ruling mean we’re suddenly going to see a spike in shareholder suits that otherwise wouldn’t have been brought?
Probably not, according to the four lawyers I talked to – two securities defense counsel and two plaintiffs’ lawyers. The Lorenzo ruling may allow shareholders’ lawyers to rope in individual defendants under newly available theories. But it’s not going to change the contours of securities class action litigation.
“It’s of limited utility,” said shareholders’ lawyer Laura Posner of Cohen Milstein Sellers & Toll. “I’d be surprised to see more than a handful of cases” citing the decision.
In Wednesday’s ruling, the justices held that investment banker Francis Lorenzo was liable for securities fraud for knowingly emailing false information about a client’s debt offering to potential investors. Lorenzo did not create the false statements he passed along in the emails – he cut and pasted information he’d gotten from his boss. He did not contest at the Supreme Court that he knew he was passing along misinformation from his boss. But Lorenzo argued that under the Supreme Court’s 2011 ruling in Janus Capital Group v. First Derivative Traders (131 S.Ct. 2296), he was not responsible under the Securities and Exchange Act’s prohibition against making untrue statements.
The justices disagreed. The six justices in the majority acknowledged that Lorenzo was not liable under Janus for making false statements. But the Supreme Court said the investment banker could be held to account, under two different anti-fraud provisions, for participating in a fraud scheme and for engaging in deceptive acts.
Disseminating someone else’s false statements, according to the majority opinion by Justice Stephen Breyer, means you have participated directly in a fraud. To hold otherwise – to allow people to evade liability for knowingly spreading lies they didn’t originate – would defy the whole intention of securities fraud laws and the text of the SEC’s rule to enforce the Exchange Act. “Using false representations to induce the purchase of securities would seem a paradigmatic example of securities fraud,” Justice Breyer wrote. “We do not know why Congress or the (SEC) would have wanted to disarm enforcement in this way.”
Lorenzo’s case involved only an SEC enforcement action. But as I’ve written, private shareholder litigation has always loomed in the background. Lorenzo’s lawyers at Meyers & Heim, as well as Lorenzo amici from the U.S. Chamber of Commerce and the Securities Industry and Financial Markets Association, told the justices that if they held Lorenzo directly liable for fraud – rather than tagging him with responsibility just for aiding and abetting – they would be encouraging plaintiffs’ lawyers to sue defendants who would otherwise be protected under the Supreme Court’s 1994 decision in Central Bank of Denver v. First Interstate Bank of Denver (114 S.Ct. 1439). (Central Bank, you will recall, precludes private securities suits against alleged aiders and abettors.)
Justice Clarence Thomas highlighted those fears in a dissent joined by Justice Neil Gorsuch. (Justice Brett Kavanaugh, who expressed reservations about the SEC’s scheme liability theory when he was on the D.C. Circuit, was recused from the case at the Supreme Court.) The Lorenzo majority, Thomas said, had effectively erased the line between primary and secondary liability for false statements, creating new exposure to shareholder class actions. “If Lorenzo’s conduct here qualifies for primary liability,” the dissent said, “then virtually any person who assists with the making of a fraudulent misstatement will be primarily liable and thereby subject not only to SEC enforcement, but private lawsuits.”
But the lawyers I talked to, including Lorenzo counsel of record Robert Heim, said that as a practical matter, this newly created liability won’t have broad impact in securities fraud class actions.
In part, said defense lawyer Susan Hurd of Alston & Bird, that’s because of the unusual facts in Lorenzo’s case. Lorenzo, remember, was not accused of publicly spreading lies but of emailing a handful of potential investors. Securities class actions against public companies typically involve public misstatements that impacted the company’s share price. (Otherwise, shareholders can’t invoke the Basic v. Levinson presumption that they relied on the false representations.) The companies themselves, Hurd said, are almost always alleged to have “made” the false public statements. In that context, Hurd said, shareholders don’t need to claim the “distributor” theory the SEC asserted against Lorenzo.
At most, said Lorenzo counsel Heim, the Supreme Court decision opens up class action liability against individual defendants who claim they weren’t responsible for a company’s alleged misstatements. Sometimes investors may be able to rope in high-ranking executives like CEOs and CFOs under Lorenzo precedent, Heim said. But the ruling won’t expose companies that couldn’t otherwise be sued.
Shareholders’ lawyers Posner of Cohen Milstein and Darren Robbins of Robbins Geller Rudman & Dowd agreed that Lorenzo liability theories will be the exception, not the rule. Robbins told me the Supreme Court decision gave teeth to the idea of scheme liability and may embolden shareholders’ lawyers to assert claims against defendants previously considered untouchable abettors. But he pointed out that shareholders will still have to establish that defendants who distributed false information intended to deceive investors – a point Lorenzo conceded at the Supreme Court.
Posner is actually litigating a class action alleging scheme liability and deceptive acts – the rules Lorenzo violated – against Credit Suisse. The law on these theories has been relatively underdeveloped, she said, and investors may, in isolated cases, decide it makes sense after Lorenzo to allege them. Posner predicted, however, that the Supreme Court’s ruling will be more useful to regulators than to securities class action plaintiffs.
For Lorenzo, of course, the ruling’s impact on private litigation is beside the point. Heim said his client, who has not been able to find work in the securities industry after the SEC brought its case, was disappointed in the Supreme Court ruling but hopeful that the SEC will consider Justice Thomas’ dissent when his case goes back to the commission on remand.