In SEC v. Rio Tinto PLC, No. 21-2042, 2022 U.S. App. LEXIS 19577 (2d Cir. July 15, 2022) (Jacobs, J.), the United States Court of Appeals for the Second Circuit declined to impose “scheme liability” under subsections (a) and (c) of the Securities & Exchange Commission Rule 10b-5 (17 C.F.R. § 240.10b-5) where the challenged conduct amounted solely to the making of a material misstatement or omission. The Rio Tinto decision is noteworthy because it limits the U.S. Supreme Court’s decision in Lorenzo v. SEC, 139 S. Ct. 1094 (2019) (blog article here), which potentially expanded “scheme liability” to defendants who may have been tangentially involved in the issuance of a misleading statement.

SEC Rule 10b-5 makes it “unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any of any facility of any national exchange, (a) [t]o employ any device, scheme, or artifice to defraud, or (b) [t]o make any untrue statement of a material fact or to omit to state a material fact necessary in order to make statements made, in light of the circumstances under which they were made, not misleading, or (c) [t]o engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.” Subsections (a) and (c) of SEC Rule 10b-5 apply to claims for scheme liability, while subsection (b) applies to claims alleging a misleading statement or omission. 

In Rio Tinto, the SEC brought claims against Rio Tinto plc, Rio Tinto Limited and the companies’ CEO and CFO for scheme liability and also alleged that defendants made material misstatements and omissions regarding the value of a coal mine it purchased in Mozambique. The SEC alleged that defendants knew the value of the mine was significantly impaired, but nevertheless approved public statements overstating the value of the mine, incorporated those allegedly misleading public statements into certain securities offerings, and provided misleading information to the Audit Committee of Rio Tinto’s board of directors. The SEC’s claims under Rule 10b-5(b) were premised upon the allegedly misleading public statements. The claims for scheme liability under Rule 10b-5, subsections (a) and (c), were based upon defendants’ alleged “corruption of the auditing process” as a result of their failure to correct misstatements made to Rio Tinto’s Audit Committee and auditors. 

Defendants moved to dismiss the claims for scheme liability citing to Lentell v. Merrill Lynch & Co., 396 F.3d 161 (2d Cir. 2005), which holds that conduct that amounts solely to misstatements and omissions cannot form the basis for scheme liability. The district court granted defendants’ motion to dismiss the claims for scheme liability. Subsequently, the SEC urged the district court to reconsider its dismissal in light of the U.S. Supreme Court’s decision in Lorenzo, which the SEC argued allowed claims for scheme liability premised on allegations of misstatements and omissions alone. The district court disagreed with the SEC and confirmed the dismissal of the scheme liability claims. The Second Circuit accepted plaintiff’s interlocutory appeal.

The Second Circuit affirmed the district court’s dismissal: 

  • While Lorenzo acknowledges that there is leakage between and among the three subsections of each provision, the divisions between the subsections remain distinct. Until further guidance from the Supreme Court (or in banc consideration here), Lentell binds: misstatements and omissions can form part of a scheme liability claim, but an actionable scheme liability claim also requires something beyond misstatements and omissions, such as dissemination.

The Second Circuit noted that the SEC’s effort to expand the scope of scheme liability would undermine the U.S. Supreme Court’s decision in Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011), which limits primary liability under SEC Rule 10b-5(b) to the “maker” of the alleged misstatement (i.e., the person with ultimate authority over the content of the statement). The SEC’s expansive reading of Lorenzo, however, could “revive in substance the implied cause of action against all aiders and abettors” who participate in the issuance of an alleged misleading statement despite the determination of Congress that this class of defendants should only be pursued by the SEC and not private litigants. 

In addition, the Second Circuit expressed concern that a broad reading of Lorenzo would undermine the heightened pleading standard applicable to claims for securities fraud arising from a misstatement or omission under the Private Securities Litigation Reform Act (“PSLRA”) because the PSLRA’s heightened pleading requirements do not apply to claims for scheme liability.

The Supreme Court’s decision in Lorenzo has the potential to undermine the distinctions between scheme liability and liability for making misstatements or omissions. The Supreme Court created potential ambiguity when it stated that Janus would preclude liability where an individual neither makes nor disseminates false information—“provided . . . that the individual is not involved in some other form of fraud.” It remains an open question what “other form[s] of fraud” could form the basis for scheme liability in connection a claim alleging misleading statements or omissions. The Second Circuit’s decision in Rio Tinto weighs in favor of preserving the distinction between scheme liability and classic claims arising from alleged material misstatements and omissions. Rio Tinto is in-line with most decisions that have applied Lorenzo because it requires something more than a misstatement or omission to support a claim for scheme liability.