Supreme Court Considers Who Bears Responsibility for Security Fraud

December 3, 2018 Updated: December 3, 2018

An investment banker who sent deceptive emails dramatically overstating the financial health of a failing clean energy company shouldn’t be held responsible for securities fraud because he was only following his supervisor’s directions, the man’s attorney told a skeptical Supreme Court.

U.S. securities laws forbid those offering securities for sale from making false statements or participating in fraudulent schemes. Whether a person who merely passes the bad information along is legally liable is at issue in this case.

The company, Waste2Energy Holdings Inc. of Neptune Beach, Florida, founded in 2007, went out of business in 2013 after filing for Chapter 11 bankruptcy. The company had hoped to develop technology to convert waste into energy but failed to do so.

In 2009 Francis V. Lorenzo, then the director of investment banking at the brokerage Charles Vista LLC, emailed prospective investors offering for sale $15 million in debentures secured only by W2E’s earning capacity.

The emails indicated that W2E had $10 million in assets and purchase orders north of $40 million, and that the brokerage was willing to raise money to repay investors if needed.

But at the time the emails were sent, the company had already acknowledged that an audit had determined its assets were worth much less than $1 million.

Lorenzo’s boss and the brokers settled the claims the U.S. Securities and Exchange Commission (SEC) brought but Lorenzo refused. An SEC administrative law judge found Lorenzo’s superior drafted the emails but that Lorenzo had nonetheless broken the law by sending them because they contained false information about W2E’s financial situation.

The SEC banished Lorenzo from the securities industry for life and imposed a $15,000 civil penalty.

A three-judge panel of the U.S. Court of Appeals for the District of Columbia Circuit ruled against Lorenzo in 2017, finding that he participated in a scheme to defraud investors by sending the misleading emails even though he was not deemed to have made the untrue statements himself.

Lorenzo disagreed with the circuit court and the Supreme Court decided June 18 to hear his appeal. He argues that at most he may have aided and abetted a fraudulent scheme as a “secondary” violator of securities laws.

Borrowing language from the Supreme Court’s ruling in the 2011 case, Janus Capital Group Inc. v. First Derivative Traders, Lorenzo argued that because he did not have “ultimate authority over the statement, including its content and whether and how to communicate it,” he cannot be held liable under Rule 10-5(b) of the Securities Exchange Act. The rule forbids fraudulent schemes or devices, making false statements, and engaging in fraud that harms investors.

Justice Brett Kavanaugh, who sat on the circuit court panel at the time, dissented from its majority opinion, writing that Lorenzo hadn’t violated securities laws. “How could [petitioner] have intentionally deceived the clients when he did not draft the emails, did not think about the contents of the emails, and sent the emails only at his boss’s direction?”

Kavanaugh recused himself from the Supreme Court case, leaving the other eight justices to participate in oral arguments Dec. 3.

Justices Have Doubts

During those oral arguments, Lorenzo’s attorney, Robert Heim, said that sending the email was not an inherently deceptive act. Justice Neil Gorsuch appeared to agree that Lorenzo was not the author of the false statements in the emails.

But Justices Ruth Bader Ginsburg, Samuel Alito, and Sonia Sotomayor seemed to disagree with Heim.

Ginsburg asked Heim why it wasn’t “inherently deceptive to send a succession of untruths?”

“Lorenzo is essentially a conduit,” Heim replied. “He’s somebody that’s transmitting statements … on behalf of another … simply sending an e-mail is not enough to transform Frank Lorenzo into a primary violator from, perhaps, somebody who gave substantial assistance.

The language of the statutes and the rules make “a clear distinction between statements and … conduct.”

Alito asked why Lorenzo’s behavior wouldn’t “fall squarely” within the language of the rule used by the SEC.

Sotomayor was just as blunt, telling Heim: “I’m having a problem from the beginning. Once you concede … that you’re not challenging that your client acted with an intent to deceive or defraud, that you aren’t challenging the D.C. Circuit’s conclusion to that effect? Is that correct?”

Heim replied, “Yes, Your Honor.”

Sotomayor continued: “I don’t understand, once you concede that mental state, and he has the act of putting together the email and encouraging customers to call him with questions, not to call his boss with questions, how could that standing alone give away your case?

“That makes him both the maker of a false statement, but it’s also engaging in an act, practice, or course of conduct which operates or would operate as a fraud or deceit.”

The Trump administration argues the treatment Lorenzo received at the hands of the SEC was just.

“I don’t think you’re likely to see a … more egregious fraud than this,” Christopher Michel, assistant to the solicitor general, told the justices.

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