Senate confirmation hearings for U.S. Supreme Court nominee Brett Kavanaugh are scheduled to begin on Sept. 4, right after the Labor Day holiday. If the 53-year-old Kavanaugh, currently a judge on the District of Columbia U.S. Circuit Court of Appeals, is confirmed, his views could shape Supreme Court rulings for decades to come.
But before the Senate even gets to his hearing, Kavanaugh is already shaping arguments in a securities fraud case the Supreme Court will hear this term. Recently-filed briefs by onetime investment banker Francis Lorenzo and his amici from the U.S. Chamber and the Securities Industry and Financial Markets Association (SIFMA) urge the justices to overturn the D.C. Circuit’s 2017 liability ruling against Lorenzo and instead adopt the reasoning Judge Kavanaugh advanced in his dissent from the majority’s decision.
The Lorenzo case stems from a fateful email Lorenzo sent to two potential investors in 2009, when he was the director of investment banking at a brokerage called Charles Vista, LLC. The firm’s only investment banking client was a company called Waste2Energy Holdings, which was in the midst of a debt offering. In early October 2009, Lorenzo learned from SEC filings and an email from W2E’s CFO that W2E had written off $11 million in intangible assets. Nevertheless, on Oct. 14, he emailed two potential investors, touting W2E’s debt offering. The email not only failed to mention the company’s $11 million devaluation of intangible assets but actually hailed W2E for having “over $10 mm in confirmed assets.”
In 2013, the Securities and Exchange Commission brought a securities fraud proceeding against Lorenzo, his boss Gregg Lorenzo (who is not a relation) and Charles Vista. Gregg Lorenzo and Charles Vista settled. Francis Lorenzo went to trial before an administrative law judge, arguing, among other things, that his emails to the potential investors just cut-and-pasted language from Gregg Lorenzo. Under the Supreme Court’s 2011 ruling in Janus Capital v. First Derivative Traders, Francisco Lorenzo claimed he cannot be liable for passing on someone else’s allegedly false statements.
The D.C. Circuit majority ended up agreeing that Lorenzo was not liable for making false statements. But Judge Sri Srinivasan and Thomas Griffith said he was culpable, under two other provisions of the SEC’s rule interpreting securities fraud, for knowingly engaging in a scheme to defraud investors, even if he did not himself make the false statements at the heart of the deception. “At least in the circumstances of this case, in which Lorenzo produced email messages containing false statements and sent them directly to potential investors expressly in his capacity as head of the investment banking division - and did so with scienter - he can be found to have infringed Section 10(b), Rules 10b-5(a) and (c) … regardless of whether he was the ‘maker” of the false statements,” the majority held.
Judge Kavanaugh’s dissent said the majority was basically endorsing “the SEC’s persistent efforts to end-run the Supreme Court” by expanding the scope of primary liability for securities fraud. How can it be, Kavanaugh asked, that Lorenzo is liable for scheming to defraud investors just by passing along misstatements from his boss? “That combined holding makes little sense (at least to me),” Kavanaugh wrote. “Nor does it make much sense under the law, which is presumably why the other courts of appeals have rejected that kind of legal jujitsu. In these circumstances, perhaps the alleged offender (here, Lorenzo) could have been charged with aiding and abetting, if the relevant mens rea requirements for aiding and abetting liability were met. But Lorenzo may not be held liable as a primary violator, in my view.”
Judge Kavanaugh pointed out that the distinction between primary liability and aiding and abetting securities fraud is particularly important in private litigation by investors claiming to have been defrauded. The Supreme Court has repeatedly reined in private securities suits against accused aiders and abettors, Kavanaugh said, citing 1994’s Central Bank of Denver v. First Interstate Bank of Denver and 2008’s Stoneridge Investment v. Scientific-Atlanta. Yet the SEC’s scheme liability theory in the Lorenzo case, and the D.C. Circuit majority’s acceptance of it, turns secondary actors into primary fraudsters who can be sued in both SEC enforcement actions and private investor suits.
The U.S. Chamber and SIFMA picked up that point in their amicus brief. The D.C. Circuit’s Lorenzo decision, argued their lawyers at Sidley Austin, has created uncertainty about who can be sued in a private securities action, despite the Supreme Court’s clear directives. Private securities class actions, the Chamber and SIFMA said, are already mushrooming, discouraging companies from going public. The Supreme Court, they said, must correct the D.C. Circuit’s error.
“Of course, (the Lorenzo case) is an action by the commission, not a private suit,” the brief said. “But this does not make the need for clarity any less acute. The court’s decisions delimiting categories of liability under Section 10(b) and Rule 10b-5 do not distinguish between commission enforcement actions and civil suits. What the court decides in this case will apply equally to suits brought by private plaintiffs.”
Lorenzo’s counsel, Robert Heim of Meyers & Heim, also argued that the D.C. Circuit’s alleged expansion of scheme liability will attract private suits. “The D.C. Circuit decision would allow the SEC and private plaintiffs to relabel conduct that was previously deemed aiding and abetting as ‘primary’ participation in a fraudulent ‘scheme,’” Lorenzo’s brief said. “For all practical purposes, Janus and Central Bank would be invalidated by pulling defendants who are at best aiders and abettors into primary liability. This type of broad primary liability was exactly what the Court rejected in Janus.”
There’s yet more discussion of why the D.C. Circuit’s decision supposedly runs afoul of Supreme Court precedent in an amicus brief by seven securities law professors, who also contend the Lorenzo ruling blurs the crucial line between primary and secondary liability (but didn’t quote from Judge Kavanaugh’s dissent!). “Janus reasoned that, for Central Bank to have any meaning, the court must ‘draw a clean line between’ those who are primarily liable and those who may not be pursued in private suits,” the profs argued. “Allowing the SEC and private plaintiffs to do an end-run around the limits established in Janus would render that decision pointless.”
We’ll have to wait and see what the SEC, now led by appointees of President Trump, has to say about expanding the bounds of securities class actions via its theory in the Lorenzo case. But we already know what President Trump’s Supreme Court nominee thinks.