In 2019, the Supreme Court set the stage for expansive “scheme liability” under Exchange Act Rule 10b-5(a) and (c) in Lorenzo v. SEC. Unlike primary liability under Rule 10b-5(b), scheme liability under subsections (a) and (c) can attach to someone who didn’t “make” the misrepresentation or omission. When the 10th Circuit applied Lorenzo later that year, it put an exec on the hook for “disseminating” false and misleading statements.
In what’s good news for those involved with preparing disclosures and supporting documentation, the 2nd Circuit — which has been called the “Mother Court” of securities law in another SCOTUS decision, according to a recent Paul Weiss memo — recently held that an actionable claim under subsections (a) and (c) must be based on more than alleged misrepresentations and omissions alone. There must be “something extra.”
A Morrison Foerster memo summarizes the holding of the new case, SEC v. Rio Tinto. Here’s an excerpt:
“individuals who helped draft, research, print, or wordsmith [a] statement at some point in time, but who lacked ultimate control, cannot be primarily liable.” Read alongside the Supreme Court’s Janus decision, the Rio Tinto Court explained, Lorenzo “signaled that it was not giving the SEC license to characterize every misstatement or omission as a scheme.” The Second Circuit reasoned that Janus would be undermined if scheme liability were expanded to encompass mere participation.
The Rio Tinto Court further cautioned that expanding scheme liability to reach actors other than the “makers” of misstatements would lower the bar for private plaintiffs, who face a heightened pleading standard for Rule 10b-5(b) cases under the Private Securities Litigation Reform Act that does not apply to scheme liability cases.
Similarly, limiting statements cases to subsection (b) would maintain the distinction between cases the SEC could pursue from those private plaintiffs could bring — i.e., the SEC, but not private plaintiffs, may pursue aiders and abettors of Section 10(b) violations. Embracing the “SEC’s reading of Lorenzo,” the Second Circuit explained, would be contrary to Supreme Court precedent and would undermine “Congress’ determination that this class of defendants should be pursued by the SEC and not private litigants.”
While this is encouraging news in the short term, the “something extra” that can trigger scheme liability remains undefined. The MoFo memo emphasizes that more cases are in the hopper. Corruption of the audit process or concealment of info from auditors could be examples of actions that would trigger liability under these provisions. Stay tuned to our “Securities Litigation” Practice Area for instructions on how these complex cases could affect your processes for preparing SEC filings and your guidance to clients.
— Liz Dunshee, TheCorporateCounsel.net, July 25, 2022