Lorenzo's Oil Slick
by Aegis J. Frumento, Partner, Stern Tannenbaum & Bell
The slippery slope is true in skiing because gravity is inexorable. But logic is not gravity. We use logic to help us get along in the world, but only to that extent. When it no longer helps us, we discard it like yesterday's Trump-tweet. The Slippery Slope argument assumes we are too stupid to know when to get off. G.K. Chesterton said that the crazy person has not "lost his reason;" he has lost everything but. The Slippery Slope is all too often the crazy person's argument.
A Slippery Slope works because logic is largely a language game (as Wittgenstein pointed out). The logic of a statement depends on how you define the words you use. But words can never be so precisely defined that all other meanings are always excluded. Word-written laws are never fully understood because the meanings of words are inherently slippery. Arguing what various words mean in new contexts is how I spend much of my lawyering day.
Ever since the Supreme Court's 1994 decision in Central Bank of Denver, http://cdn.loc.gov/service/ll/usrep/usrep511/usrep511164/usrep511164.pdf, the federal courts have tried to draw "bright lines" around the words used to describe securities fraud. The more clearly we can define what's illegal, the better market participants can predict when they would cross the line and the more quickly courts can decide when they have. This has led to a lot fewer securities fraud litigations over the years, but that hiatus may be over. Last week, the Supreme Court, in Lorenzo v. SEC, left us on some pretty slick ground.
Frank Lorenzo was the "Head of Investment Banking" of a firm (he described it as a "small boiler room") owned by Gregg Lorenzo (don't get confused, the SEC says they're not related). Gregg told Frank to cut and paste some fraudulent text about an investment into Frank's own email and send it to a couple of prospective investors. As Frank put it, "I just didn't give it much thought at the time. My boss asked me to send these emails out and I sent them out." The investor then paid and lost $15,000, from which Frank got $150 in commissions. As he said, it was a "small" boiler room.
SEC Rule 10b-5, the starting point of most federal securities fraud claims, has three subparts. The middle subpart (b) prohibits "making" fraudulent statements. Did Frank "make" the fraudulent statement when he sent that email? You will be forgiven for thinking he did, as did the SEC. https://www.sec.gov/litigation/opinions/2015/33-9762.pdf.
But the SEC also ruled that Frank violated the other subparts of Rule 10b-5. He violated subpart (a) because sending the email was a "device, scheme, or artifice to defraud," and subpart (c) because it was an "act" that would operate as a fraud. That's where this gets slippery.
Frank appealed the SEC's decision up to the federal Court of Appeals. That court ruled that Frank didn't "make" the fraudulent statement, and so didn't violate subpart (b), because only the person with the final authority over a statement can be considered its "maker." http://brokeandbroker.com/PDF/LorenzoDCCir.pdf. Or at least that's how the Court of Appeals interpreted the Supreme Court's 2011 decision in Janus Capital Group. https://www.supremecourt.gov/opinions/10pdf/09-525.pdf.
But my article -- and Janus -- only dealt with private securities litigation, not SEC enforcement matters. Because under Central Bank of Denver, aiders and abettors can't be sued for securities fraud by private plaintiffs, it is important -- for private securities fraud cases -- to be able to distinguish between primary actors and aiders and abettors. That doesn't really matter to the SEC because it can bring enforcement actions against aiders and abettors under other provisions not available to private plaintiffs. That's the first mystery of all this.
Although the Court of Appeals struck down the SEC's sanctions based on subpart (b) of Rule 10b-5, it agreed with the SEC that Frank's sending the fraudulent emails violated subparts (a) and (c). Frank then argued to the Supreme Court that those other parts didn't apply, because only subpart (b) deals with misstatements. Frank argued that if the SEC and the Court of Appeals were right to say that helping to make a statement was also a "device, scheme, or artifice to defraud" and an "act" that would operate as a fraud, then the whole second part of Rule 10b-5 is superfluous, and so is Janus.
This is a very slippery result. As the author of the original article that articulated the theory of these cases, I tell you that the SEC got it right on subpart (b) and wrong on subparts (a) and (c), the Court of Appeals got it wrong all around, and the Supreme Court just made a muddle of it all. Janus doesn't say that a fraudulent statement can only have one "maker." "Dissemination" is a meaningless idea when it comes to statements. How else do you "make" a statement than by "disseminating" it? An un-disseminated statement is a nothing, it's the tree falling in the forest that no one hears! Frank edited the email, sent it from his account over his name, and he knew perfectly well that it was fraudulent. He made that fraudulent statement as much as Gregg did, and it's just silly to pretend otherwise.
And let's be practical for just one minute: Every registered rep is required to have customer communications "approved" by their branch manager. Does that mean that now only the branch manager can be held primarily liable for lying to customers? Conversely, is any twenty-something intern who is ordered to send an email and knows that it's sketchy liable for "disseminating" fraudulent statements, so that Central Bank's ring-fencing of aiders and abettors is now meaningless?
There was a reason for cases like Central Bank and Janus. By establishing clearly stated and understood bright lines to define wrongful conduct, they allowed us to walk on solid ground. Without those bright lines, the law can become slippery indeed. Without even a slope, we all too easily slip from one thing to another, until we end up jumbling all the way.
ABOUT THE AUTHOR