On June 18, 2018, the Supreme Court granted cert in Lorenzo v. Securities and Exchange Commission (Lorenzo), a case that presents significant questions about the federal securities laws. Lorenzo also comes with a twist: The underlying D.C. Circuit decision on appeal features an extensive dissent by then-Judge Brett Kavanaugh, the newest Supreme Court justice. As a result, when the Supreme Court issues its decision on Lorenzo in the Spring of 2019, it is likely that he will be recused while the other eight justices sit in review of their new colleague.
In our forthcoming article, “Justice Kavanaugh, Lorenzo v. SEC, and the Future of Deference at the Post-Kennedy Supreme Court,” we analyze the securities regulation issues raised by Lorenzo and further explain why the case provides a unique window into Justice Kavanaugh’s overall judicial philosophy and the impact that he will have on the Supreme Court.
Lorenzo centers around two financial professionals at a registered broker-dealer called Charles Vista LLC: Francis V. Lorenzo, who worked as the firm’s investment banker, and his boss of no relation, Gregg Lorenzo, who owned Charles Vista. The relevant events occurred on a single day, when Gregg Lorenzo drafted a pair of emails summarizing the terms of a bond offering and then had Francis Lorenzo forward them to two Charles Vista clients on his behalf. As it turned out, the emails were highly misleading, because they failed to note that the bond issuer had recently written down its assets to essentially zero and was on the brink of insolvency.
The SEC brought an enforcement action charging both Lorenzos with civil fraud for violation of Rule 10b-5 and related provisions of the securities laws. In an internal proceeding at the SEC, an administrative law judge found Francis Lorenzo liable on all charges and imposed a number of penalties, including a lifetime ban from the securities industry. The full commission then affirmed that decision. On appeal, the D.C. Circuit reversed the SEC in part while leaving intact its overall determination that Lorenzo had violated Rule 10b-5.
The D.C. Circuit Opinions
In its majority opinion written by Judge Srinivasan, the D.C. Circuit applied the “ultimate authority” test set forth in the Supreme Court’s 2011 decision, Janus Capital Group, Inc. v. First Derivative Traders, which governs liability for material misstatements under Rule 10b-5. Contrary to the SEC, Judge Srinivasan concluded that Francis Lorenzo did not “make” any misleading misstatements, as required under subsection (b) of Rule 10b-5. Rather it was his boss, Gregg Lorenzo, who exercised ultimate authority over the emails. The remainder of Judge Srinivasan’s opinion upholds the SEC, however. Most important, the D.C. Circuit held that Francis Lorenzo’s conduct played a sufficient role in the deceptive emails that he was nonetheless liable for fraud under the so-called “scheme liability” provisions found in subsections (a) and (c) of Rule 10b-5.
In dissent, Judge Kavanaugh argued that Lorenzo was not liable under any of the SEC’s charges, observing that the “majority opinion creates a circuit split by holding that mere misstatements, standing alone, may constitute the basis for scheme liability . . . that is, willful participation in a scheme to defraud—even if the defendant did not make the misstatements.” The problem, in the dissent’s view, is that “scheme liability must be based on conduct that goes beyond a defendant’s role in preparing mere misstatements or omissions made by others.” At most, Kavanaugh explained, Lorenzo could have been charged by the SEC for aiding and abetting his boss, which the agency failed to do. The distinction matters, the dissent argues, because unless Lorenzo’s liability is limited to secondary aiding-and-abetting claims, the SEC’s enforcement action would “expand the scope of primary liability under the securities laws.”
Lorenzo at the Supreme Court
Lorenzo’s petition to the Supreme Court tracks the argument laid out in the Kavanaugh dissent. Specifically, it frames the question presented on appeal as whether a fraud action under Rule 10b-5 that does not meet the requirements for a misstatement claim “can be repackaged and pursued as a fraudulent scheme claim.” If the Supreme Court addresses that question head-on, the most likely outcome is a partisan split along the same lines as the 5-4 decision in Janus. With Justice Kavanaugh recused, this would mean Lorenzo ends in a 4-4 stalemate that leaves the D.C. Circuit decision below as the controlling disposition of the case.
The theory of securities fraud articulated in Judge Srinivasan’s majority opinion is unlikely to last long. In the next case that allows similar issues to reach the Supreme Court, the conservative wing will have the votes to effectively overrule Lorenzo. It could do so on one of two grounds. One is to follow the Kavanaugh dissent by drawing a sharp distinction among the subsections of Rule 10b-5 that prevent the “repackaging” of material misstatements as fraudulent schemes. Another approach would be to hold that the “ultimate authority” test in Janus is not limited to false statements and applies in some form to all claims under Rule 10b-5. The practical upshot of either ruling is the same: a narrower definition of primary liability for securities fraud violations that makes it harder for investors to state a claim in private securities litigations.
Yet Kavanaugh’s dissent goes far beyond the interpretative questions that Lorenzo raises for securities fraud, important as they are. As our paper explains, a careful reading of the dissent reveals how the specific legal deficiencies that Kavanaugh identifies in Lorenzo also motivate his broader skepticism towards the constitutional legitimacy of the administrative state as a whole. Despite the attention paid in the nomination hearings to Supreme Court precedents on hot button social issues—and the explosive sexual assault allegations that consumed the process thereafter—most informed commentators acknowledge that Kavanaugh’s critique of regulatory agencies represents his signature contribution as a federal judge. His dissent in Lorenzo therefore presents the defining judicial philosophy of the new Supreme Court Justice.
Our paper further explains why the unique timing and posture of Lorenzo make the Kavanaugh dissent even more intriguing. Simply put, the dissent provides a surprisingly explicit roadmap for where Justice Kavanaugh would like the Supreme Court to go, and it now remains to be seen whether his colleagues are willing to follow. For instance, the dissent describes the SEC’s enforcement action against Lorenzo as the latest of its “persistent efforts to end-run the Supreme Court,” and calls on the federal courts to actively police the agency’s role in the development of securities law doctrine. It then asserts that the adjudication of Lorenzo’s charges at the SEC “casts substantial doubt on” the premise that administrative courts in general will “operate with efficiency and with fairness to the parties involved.” The dissent also takes the D.C. Circuit majority to task for applying a light-touch review of the SEC in a case where the agency’s performance “deserves judicial repudiation, not deference or respect.”
The clear target here is the Chevron doctrine and associated standards for deferential judicial review of agency decisions. Along with justices Gorsuch and Thomas, Kavanaugh no doubt favors overturning Chevron outright. Several other justices, including former Justice Kennedy, have written recent opinions that, at a minimum, express serious misgivings over the scope of the doctrine. By replacing Kennedy, Kavanaugh’s confirmation could mark the tipping point for a precedent already on the retreat. If the sort of critique put forward in his Lorenzo dissent gains traction with Chief Justice Roberts and Justice Alito in particular, Kavanaugh may be able to amplify his third vote in favor of an all-out disavowal of Chevron into a full majority. This is where the special import of Lorenzo ultimately lies—as a bellwether for the potential demise of judicial deference in administrative law at the post-Kennedy Supreme Court.
This post comes to us from Matthew C. Turk and Karen E. Woody, both assistant professors of business law at Indiana University’s Kelley School of Business. It is based on their recent paper, “Justice Kavanaugh, Lorenzo v. SEC, and the Future of Deference at the Post-Kennedy Supreme Court,” forthcoming in the Administrative Law Review, available here.