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Kavanaugh Holds Key to Supreme Court 10b-5 Case

Kavanaugh Holds Key to Supreme Court 10b-5 Case

A case holding serious repercussions for the enforcement of U.S. securities law is coming to the Supreme Court this term, and none other than Brett Kavanaugh is right in the middle of it. As a judge on the federal court of appeals in D.C., Kavanaugh heard the case last year and filed a dissent to the court’s ruling. Now, his possible presence (or lack thereof) on the panel that hears the appeal at the Supreme Court could prove decisive.

The case is Lorenzo v. SEC, and it will require the court to interpret the biggest tool that the SEC and private litigants use to combat securities fraud: Rule 10b-5. In Lorenzo, the SEC used the rule against investment banker Francis Lorenzo, securing a lifetime ban on his participation in the securities business. Lorenzo received the harsh punishment for sending “fraudulent” emails to potential investors that contained a “staggering” amount of false information about the opportunity in question, according to the SEC judge who first heard the case. The twist here is that the false information was cut and pasted from text that Lorenzo’s boss sent him and asked him to pass along.

So did Lorenzo’s cut-and-paste job violate Rule 10b-5? The rule has three subparts, and the SEC determined that Lorenzo violated all three of them. The appellate court on which Kavanaugh sits reversed that finding with respect to subpart (b), which prohibits the “making” of materially false statements about securities. The Supreme Court has previously determined that in order to “make” a statement, one must retain “ultimate authority” over it. Using that standard, the court found that Lorenzo’s boss, not Lorenzo, made the statements at issue.

Even so, the court agreed that Lorenzo had violated the other two subparts of Rule 10b-5. The question of whether or not subparts (a) and (c) sweep in Lorenzo’s conduct presents an intricate problem of statutory interpretation. One critical issue is whether there exists a flavor of securities fraud that amounts to less than “making” a materially false statement, but more than simply aiding and abetting a fraud. The federal appellate court answered that question in the affirmative.

Judge Kavanaugh disagreed wholeheartedly, and made his case in a vigorous, 12-page dissent. In Kavanaugh’s view, Lorenzo had to do something beyond “preparing mere misstatements or omissions made by others” in order to be held liable under subparts (a) and (c).

The issue has split the federal appellate courts, and now it heads to the Supreme Court. The case could have severe implications for the SEC as well as shareholder classes that regularly use Rule 10b-5 in private actions. And Kavanaugh could tip the scales. We can presume how he would vote if he were to be seated on the court and participate in Lorenzo. As the lawyers at Cleary Gottlieb have noted, however, “If he is confirmed and recuses himself on the basis of having heard the case below, any attempt to limit the ability of the SEC or private plaintiffs to bring scheme liability claims could meet resistance from the Court’s four more liberal Justices.” A 4-4 tie, notably, would leave the ruling that Kavanaugh dissented from in place.

Make Lorenzo v. SEC, then, just one more reason to watch the fate of Judge Kavanaugh’s Supreme Court nomination very closely.

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