By: Matthew Haan, IAC Student Intern Fall 2018
Hello again, faithful readers! In this six-part series, we are chronicling Francis Lorenzo’s dispute with the SEC as it makes its way through the courts. Last time, you read about the fateful e-mails sent by Lorenzo that got us where we are. In case you missed that, take a look at yesterday’s post. Today you will read about what we in the legal community like to call the procedural history. The procedural history covers everything that happened in the lower courts before the Supreme Court agreed to hear the case. Sounds interesting, right?
Let’s start with the SEC Rule at issue here. Rule 10b-5 is an antifraud provision, meaning that a violation requires proof of “scienter.” Like you, I had no idea what that word meant when I first heard it in my Contracts class. All it really means for this case is the SEC must have shown that Lorenzo had “an intent to deceive, manipulate, or defraud.” It is important to know that scienter can be shown by a high degree of recklessness. In other words, Lorenzo must have wanted to trick people with those e-mails, or at least acted with enough recklessness to show he ignored the potential falsity of the statements. The first part of Rule 10b-5 at issue is subpart (a). Rule 10b-5(a) prohibits employing “any device, scheme, or artifice to defraud” in connection with buying or selling securities. Subpart (b) is not as broad; it prohibits making an untrue statement of material fact or failing to state a material fact in order to make a statement not misleading. A claim under 10b-5(b) here would require proof that Lorenzo made an untrue statement, or failed to include a material fact necessary to make his statements true.
In February 2013, the SEC charged Lorenzo, his boss, and his firm with violating Rule 10b-5 and other securities laws. Lorenzo’s boss and firm ended up settling (the SEC later sought compliance with the settlement order from the firm), but the charges against Lorenzo proceeded to a hearing in front of the Commission. An administrative law judge decided that Lorenzo did not draft the statements at issue. However, the judge determined that because Lorenzo did not read the statements before sending them out, he violated the securities laws. The judge ordered sanctions against Lorenzo, the most significant of which was a lifetime ban from the securities industry and a $15,000 fine.
After the administrative law judge imposed sanctions on Lorenzo, he sought a review from the SEC. The full Commission upheld the administrative law judge’s ruling, with one important addition. The Commission reviewed the record and determined that Lorenzo actually knew that the statements in the e-mails were false.
Lorenzo then appealed to the Court of Appeals for D.C. Circuit. It overturned the Commission’s finding that Lorenzo violated Rule 10b-5(b), but upheld the Commission’s finding that Lorenzo violated Rule 10b-5(a). The Court of Appeals, citing Janus Capital Group, ruled that Lorenzo’s boss, not Lorenzo, “retained ‘ultimate authority’” over the statements in the e-mail. In other words, the Court of Appeals did not believe that Lorenzo made the untrue statements contained in the e-mails. But, it did believe that Lorenzo played an important role in perpetuating the fraud by incorporating these statements in his e-mails in violation of Rule 10-b5(a).
We’re halfway home now. Parts 4 through 6 get a little more in depth, but I think you will enjoy them. In Part 4, I will introduce you to the arguments made by Lorenzo in the Court of Appeals. Until next time!