Since the Second Circuit’s holding in Lentell v. Merrill Lynch & Co., 396 F.3d 161 (2005) (“Lentell”), it has been settled law in the Second Circuit that misstatements and omissions alone do not suffice to impose scheme liability on individuals who did not “make” alleged misstatements under Rule 10b-5(a) and (c) of Section 10(b) of the Securities Exchange Act.
Recently, in SEC v. Rio Tinto PLC, 41 F.4th 47, 49 (2022), the SEC asked the Second Circuit to consider whether Lentell should be abrogated in light of the Supreme Court’s decision in Lorenzo v. SEC, 139 S. Ct. 1094 (2019) (“Lorenzo”). The SEC argued that Lorenzo had expanded the scope of the scheme subsections of Rule 10b-5a by ruling that an individual who disseminated a false statement (but did not make it) could be liable under the scheme subsections. Rio Tinto, 41 F.4th at 48-49, 52. For that reason, the SEC maintained that its scheme liability claims against Rio Tinto’s CEO and CFO should be allowed to proceed even though the only fact it had alleged to support their participation in a scheme was defendants’ “fail[ure] to prevent misleading statements from being disseminated by others.” Id. at 52. According to the SEC, “misstatements and omissions alone” should be enough to “form the basis for scheme liability,” so its pleading was more than sufficient. Id.
The Second Circuit disagreed, finding that the SEC’s overly broad reading of Lorenzo would undermine two key features of Rule 10b-5(b).
First, the Supreme Court’s holding in Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135, 142 (2011), limits primary liability under Rule 10b-5(b) to the “maker” of a statement. Rio Tinto, 41 F.4th at 52. An expanded scope of scheme liability like that proposed by the SEC would enable a plaintiff to prove that a defendant is primarily liable under the scheme subsections for mere “participation in the making of [] misstatements,” for example by helping to prepare them or, in this case, failing to prevent their dissemination. Id.
Second, misstatements and omissions claims brought by private plaintiffs under Rule 10b-5(b) are subject to a heightened pleading standard. Rio Tinto, 4 F.4th at 52. This heightened standard does not apply to allegations of scheme liability because scheme liability does not require an allegation that the defendant made a statement. Id.
In addition, the Second Circuit found that Lorenzo did not abrogate Lentell because the two decisions are consistent with each other. Rio Tinto, 4 F.4th at 53. Though Lorenzo held that the “dissemination of false or misleading statements with intent to defraud” does come within the scheme subsections, the mere fact of the misstatements or omissions was not the sole basis for scheme liability in Lorenzo (as Lentell requires). Id. The defendant’s act of disseminating those misstatements constituted the “act” or “conduct” sufficient to invoke scheme liability. Id.
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Please contact Alto Litigation partners Bahram Seyedin-Noor (bahram@altolit.com) or Bryan Ketroser (bryan@altolit.com) if you require counseling on a securities litigation matter.
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