Lentell Remains Good Law After Lorenzo: Implications for Scheme Liability under Rule 10b-5

Lentell Remains Good Law After Lorenzo: Implications for Scheme Liability under Rule 10b-5

Introduction

The Securities and Exchange Commission (SEC) initiated an enforcement action against Rio Tinto plc, Rio Tinto Limited, and their executives, alleging violations of securities laws under Rule 10b-5(a) and (c) of the Securities Exchange Act of 1934, as well as Section 17(a) of the Securities Act of 1933. Central to the case was whether misstatements and omissions alone could support a claim of scheme liability. The United States Court of Appeals for the Second Circuit addressed this issue, affirming the district court's dismissal of the SEC's scheme liability claims based on the precedent set by Lentell v. Merrill Lynch & Co.. This commentary delves into the judgment, analyzing its implications for securities litigation and the enduring relevance of the Lentell decision in light of the Supreme Court's ruling in Lorenzo v. SEC.

Summary of the Judgment

In the case Securities and Exchange Commission v. Rio Tinto plc et al., the SEC sued Rio Tinto and its executives for alleged securities fraud, specifically targeting scheme liability under Rule 10b-5(a) and (c) and Section 17(a)(1) and (3). The district court dismissed the scheme liability claims, relying on the precedent set by Lentell v. Merrill Lynch & Co., which held that misstatements and omissions alone are insufficient to establish scheme liability. The SEC contended that the Supreme Court's decision in Lorenzo v. SEC expanded the scope of scheme liability to encompass such misstatements and omissions. However, the Second Circuit Court of Appeals affirmed the district court's dismissal, maintaining that Lentell remains valid and was not abrogated by Lorenzo.

Analysis

Precedents Cited

  • Lentell v. Merrill Lynch & Co. (396 F.3d 161, 2d Cir. 2005): Established that misstatements and omissions alone do not suffice for scheme liability under Rule 10b-5(a) and (c).
  • Lorenzo v. SEC (139 S.Ct. 1094, 2019): Held that the dissemination of a false statement can sustain a scheme liability claim, expanding the understanding of what constitutes a scheme.
  • Janus Capital Group, Inc. v. First Derivative Traders (564 U.S. 135, 2011): Clarified that only the "maker" of a misstatement bears primary liability under Rule 10b-5(b).
  • Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A. (511 U.S. 164, 1994): Affirmed that Rule 10b-5 does not provide a private right of action for aiding and abetting liability.

Impact

The affirmation of Lentell in light of Lorenzo has significant implications for future securities litigation:

  • Preservation of Legal Standards: By upholding Lentell, courts maintain a higher threshold for establishing scheme liability, preventing the dilution of legal protections against securities fraud.
  • Clarity in Litigation: The decision reinforces the clear distinctions between different types of liability under Rule 10b-5 and Section 17(a), aiding litigants in structuring their claims appropriately.
  • Future Litigation Strategies: Plaintiffs, including the SEC, will need to demonstrate elements beyond misstatements and omissions to successfully argue scheme liability, potentially focusing on actions like dissemination of false information or participation in fraudulent schemes.
  • Protection Against Broad Interpretations: The judgment serves as a safeguard against expansive interpretations of securities laws that could lower the standards for proving fraud, thereby protecting corporate defendants from overly broad claims.

Complex Concepts Simplified

Rule 10b-5 Subsections

Rule 10b-5, established under the Securities Exchange Act of 1934, prohibits fraud and deceit in connection with the purchase or sale of securities. It comprises three subsections:

  • (a) Scheme to Defraud: Addresses broader fraudulent schemes or devices devised to deceive investors.
  • (b) Misstatements and Omissions: Specifically targets the act of making false statements or omitting critical information necessary to prevent statements from being misleading.
  • (c) Deceptive Practices: Covers any acts or practices that would operate as fraud or deceit upon any person in the securities market.

Scheme Liability

Scheme liability refers to holding defendants responsible for participating in a fraudulent scheme or plan designed to deceive investors. Under Rule 10b-5, establishing scheme liability typically requires demonstrating that the defendants engaged in a coordinated plan to defraud, which involves more than just making false statements or omissions.

Misstatements vs. Schemes

- Misstatements: Involves providing false information or omitting necessary facts, potentially misleading investors.
- Schemes: Involves a broader strategy or plan to defraud investors, which may include misstatements as one component among others.

Conclusion

The Second Circuit's affirmation in Securities and Exchange Commission v. Rio Tinto plc et al. reinforces the enduring validity of Lentell v. Merrill Lynch & Co., even in the face of the Supreme Court's Lorenzo v. SEC decision. By upholding the principle that misstatements and omissions alone do not suffice for scheme liability, the court maintains essential boundaries within securities fraud litigation. This judgment ensures that scheme liability remains a tool for addressing comprehensive fraudulent schemes rather than being a catch-all for any misleading conduct. Consequently, the decision preserves the integrity of securities laws by requiring plaintiffs to meet higher standards of proof when alleging scheme liability, thereby safeguarding defendants from unjustified claims based solely on isolated misstatements or omissions.

Case Details

Year: 2022
Court: United States Court of Appeals, Second Circuit

Judge(s)

DENNIS JACOBS, CIRCUIT JUDGE

Attorney(S)

EMILY TRUE PARISE, SENIOR LITIGATION COUNSEL (DAN M. BERKOVITZ, GENERAL COUNSEL; MICHAEL A. CONLEY, SOLICITOR; DOMINICK V. FREDA, ASSISTANT GENERAL COUNSEL; HOPE HALL AUGUSTINI, MARTIN TOTARO, SENIOR LITIGATION COUNSEL, on the brief), Securities &Exchange Commission, Washington, D.C. for Plaintiff-Appellant. THOMAS H. DUPREE JR., GIBSON, DUNN &CRUTCHER LLP, WASHINGTON, D.C. (MARK A. KIRSCH, JENNIFER L. CONN, AVI WEITZMAN, GIBSON, DUNN &CRUTCHER LLP, NEW YORK, NY; MARK A. PERRY, RICHARD W. GRIME, KELLAM M. CONOVER, GIBSON, DUNN &CRUTCHER LLP, WASHINGTON, D.C., on the brief), for Defendants-Appellees Rio Tinto plc and Rio Tinto Limited. SARAH L. LEVINE, JONES DAY, WASHINGTON, D.C. (JAMES P. LOONAM, JONES DAY, NEW YORK, NY; MATTHEW J. RUBENSTEIN, JONES DAY, MINNEAPOLIS, MN, on the brief), for Defendant-Appellee Thomas Albanese. KANNON K. SHANMUGAM, PAUL, WEISS, RIFKIND, WHARTON &GARRISON LLP, WASHINGTON, D.C. (THEODORE V. WELLS, JR., WALTER G. RICCIARDI, GEOFFREY R. CHEPIGA, LIVIA FINE, PAUL, WEISS, RIFKIND, WHARTON & GARRISON LLP, NEW YORK, NY, on the brief), for Defendant Appellee Guy Robert Elliott. Tara S. Morrissey, U.S. Chamber Litigation Center, Washington, D.C.; Carter G. Phillips, Kwaku A. Akowuah, Sidley Austin LLP, Washington, D.C.; Eamon P. Joyce, James R. Horner, Sidley Austin LLP, New York, NY, for Amicus Curiae Chamber of Commerce of the United States of America. Jeffrey S. Bucholtz, Marisa C. Maleck, King &Spalding LLP, Washington, D.C., for Amici Curiae Law Professors Joseph Grundfest, Todd Henderson, Adam Pritchard, Andrew Vollmer, and Karen Woody.

Comments