Securities Industry Commentator by Bill Singer Esq

[A]s you would expect, we have many goals and obligations. For example, ensuring that trading -- a largely institutional exercise -- is fair and efficient is a critical part of our mission. Although it is a largely institutional market -- and certain aspects of it are almost exclusively institutional (e.g., high yield bonds) --  I believe the right question to ask is: are we seeking fairness and efficiency in this largely institutional market in a way that best serves the interests of our long term retail investors. Is there a disconnect here? Why should we have retail on our minds when we are regulating an institutional market? There is no disconnect. Those institutions are holding and trading, in large part, the funds of retail investors. That perspective, or lens as we sometimes call it, should substantially inform how we regulate trading.

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Here is where culture comes in. The law may not prohibit all forms of lying, but your culture should reject it. Said another way, if any financial institution thinks behavior of this type is acceptable or does not require prompt, clear and significant action, that financial institution has a cultural problem. To me, there is no debate on that score. Faced with this or a similar scenario, the financial institution should not be asking "Do we have a problem?" It should be asking "What do we do to address this problem in a way that is clear, consistent with, and reinforces, our cultural goals?"

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When this behavior occurs, key questions a firm should ask include whether the conduct represented a clear breach of the firm's controls and culture as well as whether the firm's remediation efforts, in addition to any controls enhancements, sent an appropriate and lasting cultural message. Turning back to my hypothetical, do the controls now make it clear that lying is unacceptable and that communications around mark-ups will be monitored. And, were the offending parties dismissed or otherwise meaningfully sanctioned. The actions we chose in these types of scenarios say a great deal about who we are -- and what our culture is.

The antifraud provisions of the federal securities laws prohibit two well-defined categories of misconduct. One category is the use of fraudulent statements in connection with the offer and sale of securities. The other category is employing fraudulent schemes in connection with the offer and sale of securities. In Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011), this Court considered the elements of a fraudulent statement claim and held that only the "maker" of a fraudulent statement may be held liable for that misstatement under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5(b). 

The question presented is whether a misstatement claim that does not meet the elements set forth in Janus can be repackaged and pursued as a fraudulent scheme claim. The Circuits have split 3-2 on this question. The Second, Eighth and Ninth Circuits have held that a misstatement alone cannot be the basis of a fraudulent scheme claim, while the DC Circuit and the Eleventh Circuit have held that a misstatement standing alone can be the basis of a fraudulent scheme claim. 

The Securities and Exchange Commission found that Francis Lorenzo sent email messages to investors containing misrepresentations about key features of a securities offering. The Commission determined that Lorenzo's conduct violated various securitiesfraud provisions. We uphold the Commission's findings that the statements in Lorenzo's emails were false or misleading and that he possessed the requisite intent. 

We cannot sustain, however, the Commission's determination that Lorenzo's conduct violated one of the provisions he was found to have infringed: Rule 10b-5(b). That rule bars the making of materially false statements in connection with the purchase or sale of securities. We conclude that Lorenzo did not "make" the false statements at issue for purposes of Rule 10b-5(b) because Lorenzo's boss, and not Lorenzo himself, retained "ultimate authority" over the statements. Janus Capital Grp., Inc. v. First Derivative Traders, 564 U.S. 135, 142 (2011). 

While Lorenzo's boss, and not Lorenzo, thus was the "maker" of the false statements under Rule 10b-5(b), Lorenzo played an active role in perpetrating the fraud by folding the statements into emails he sent directly to investors in his capacity as director of investment banking, and by doing so with an intent to deceive. Lorenzo's conduct therefore infringed the other securities-fraud provisions he was charged with violating. But because the Commission's choice of sanctions to impose against Lorenzo turned in some measure on its misimpression that his conduct violated Rule 10b-5(b), we set aside the sanctions and remand the matter to enable the Commission to reassess the appropriate penalties.

Suppose you work for a securities firm. Your boss drafts an email message and tells you to send the email on his behalf to two clients. You promptly send the emails to the two clients without thinking too much about the contents of the emails. You note in the emails that you are sending the message "at the request" of your boss. It turns out, however, that the message from your boss to the clients is false and defrauds the clients out of a total of $15,000. Your boss is then sanctioned by the Securities and Exchange Commission (as is appropriate) for the improper conduct. 

What about you? For sending along those emails at the direct behest of your boss, are you too on the hook for the securities law violation of willfully making a false statement or willfully engaging in a scheme to defraud? 

According to the SEC, the answer is yes. And the SEC concludes that your behavior - in essence forwarding emails after being told to do so by your boss - warrants a lifetime suspension from the securities profession, on top of a monetary fine. 

That is what happened to Frank Lorenzo in this case. The good news is that the majority opinion vacates the lifetime suspension. The bad news is that the majority opinion - invoking a standard of deference that, as applied here, seems akin to a standard of "hold your nose to avoid the stink" - upholds much of the SEC's decision on liability. I would vacate the SEC's conclusions as to both sanctions and liability. I therefore respectfully dissent. 

• Securities Industry Commentato
• Bill Singer