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Second Circuit Cabins Scheme Liability for Securities Fraud

July 26, 2022

Reining in Scheme Liability

In a significant defeat for the SEC, the Second Circuit recently rejected the agency’s aggressive attempt to expand “scheme” liability under the anti-fraud laws. The court of appeals held that mere misstatements or omissions are insufficient to form the basis for a “scheme” under the antifraud provisions of the federal securities laws; more than just a misstatement or omission is required to link people together in a scheme. See SEC v. Rio Tinto plc, No. 21-2042, 2022 WL 2760323 (2d Cir. July 15, 2022). That development is significant because the Second Circuit has outsized importance as the court that presides over the nation’s financial center. And the decision may have provoked a circuit conflict over the reach of the Supreme Court’s decision in Lorenzo v. SEC, 139 S. Ct. 1094 (2019), which could set the stage for Supreme Court review.

Lorenzo held that an individual who disseminated a false statement (but did not make it) could face scheme liability. In the wake of Lorenzo, the SEC had argued that material misstatements alone may form the basis for scheme liability. In rejecting the SEC’s arguments, the Second Circuit in Rio Tinto required allegations of “something extra” beyond material misstatements to plead a scheme. This decision affects private securities plaintiffs as well because they too must identify and properly plead “something extra” to avoid dismissal of scheme-based claims, at least in the Second Circuit. The decision thus preserves a key tool for companies and individuals to hold the SEC’s feet to the fire before the agency seeks to impose wide-ranging liability for asserted misstatements — but it remains to be seen whether the Supreme Court will agree. 

The Case

The SEC alleged that Australian mining company Rio Tinto concealed its improper valuation of an exploratory coal mine it purchased for $3.7 billion in 2011. Several months after acquiring the mine, Rio Tinto and its officers allegedly realized their assumptions about the mine were incorrect, thus significantly diminishing its market value. Nonetheless, Rio Tinto and its officers allegedly continued to make false or misleading statements and omissions to the public about the mine’s value. 

In October 2017, the SEC charged Rio Tinto and two executives with violating various securities laws, including Section 10(b) of the Securities Exchange Act of 1934 and Exchange Act Rules 10b-5(a) and (c), as well as Section 17(a)(1) and (3) of the Securities Act of 1933, subsections that are normally alleged together to capture “schemes.” The SEC could not proceed against the two executives under Rule 10b-5(b) or Section 17(a)(2) of the Securities Act, which makes it unlawful to make a false or misleading material statement or omission knowingly, recklessly, or (in the case of Section 17(a)(2)) negligently, because primary liability under those provisions is limited to the “maker” of the statement and neither executive made the statements. See Janus Cap. Grp. v. First Derivative Traders, 564 U.S. 135, 143 (2011). For the scheme allegations, the SEC alleged that the defendants perpetrated a scheme against Rio Tinto stock purchasers by failing to timely disclose the mine’s impaired value and urged the district court to adopt a broad interpretation of scheme liability. The SEC argued that the Supreme Court in Lorenzo had abrogated the Second Circuit’s ruling in Lentell v. Merrill Lynch & Co., 396 F.3d 161 (2d Cir. 2005), that material misrepresentations alone are insufficient to form the basis of scheme liability. The district court rejected this argument and dismissed the scheme allegations in the SEC’s complaint. 

On appeal, the SEC argued again that Lorenzo abrogated Lentell. The Second Circuit disagreed, finding that “Lentell remains vital.” 2022 WL 2760323, at *5-6. The court reconciled Lorenzo and Lentell by observing that Lorenzo did not answer whether the making of the misstatement or omission itself could create scheme liability. Id. at *5. While “the SEC [had] exerted substantial effort to shoehorn its allegations into a claim for scheme liability,” scheme liability required “something extra” beyond mere alleged misstatements and omissions. Id. at *4, *6. For example, in Lorenzo, the “dissemination of those misstatements was key.” Id. at *5. In Rio Tinto, there was nothing “extra”; the defendants were alleged only to have made materially false or misleading statements and omissions.


By rejecting the SEC’s interpretation of the Securities Act’s and Exchange Act’s scheme provisions, the Second Circuit prevented a broad expansion of scheme liability for public companies and their employees in that circuit. Without a requirement of “something extra” beyond alleged material misstatements and omissions, the SEC would have been free to charge a broad array of company officers, employees, or contractors, including those loosely connected to the alleged misstatements and omissions at issue, based on their alleged participation in a fraudulent “scheme.” And without such a requirement, private plaintiffs also would have been able to assert scheme-based claims against those same individuals, many of whom are often unreachable for private litigants who are barred from asserting claims of aiding and abetting material misstatements. See Stoneridge Inv. Partners, LLC v. Sci.-Atlanta, 552 U.S. 148, 162 (2008).

The Supreme Court may eventually address the appropriate scope of scheme liability as circuit courts take divergent approaches. At least until Lorenzo, other circuits had followed the Second Circuit’s approach in Lentell. See, e.g., Pub. Pension Fund Grp. v. KV Pharm., 679 F.3d 972, 987 (8th Cir. 2012) (“We join the Second Circuit and Ninth Circuits in recognizing a scheme liability claim must be based on conduct beyond misrepresentations and omissions actionable under Rule 10b-5(b).”). But in Lorenzo’s wake, the Tenth Circuit has held that a failure to correct false or misleading statements can trigger scheme liability. See Malouf v. SEC, 933 F.3d 1248, 1260 (10th Cir. 2019). Other circuits may follow the Second Circuit, or the Tenth Circuit, or craft their own novel approaches. 

It remains to be determined if the government will seek review in the Supreme Court. If the Court were to grant certiorari in Rio Tinto, the support that existed for the Lorenzo opinion could be slimmer. Only four of the six Justices who formed the Lorenzo majority remain on the Court, and dissenting Justices Thomas and Gorsuch would presumably continue to favor a narrow application of scheme liability. Justice Kavanaugh, who dissented in the D.C. Circuit’s Lorenzo decision, likely would take a similar approach. Thus, the Court’s majority on these issues may hinge on Justices Barrett and Jackson, whose views on scheme liability are less well known.

In the Second Circuit, it remains to be seen what facts would satisfy the “something extra” required for scheme liability. In particular, the Rio Tinto panel declined to explain whether allegations that corporate officers corrupted an auditing process or concealed information from auditors would be sufficient. Rio Tinto, 2022 WL 2760323, at *6. For now, defendants and those facing actions or potential actions based on scheme liability should continue to argue that the facts do not support the “something extra” requirement described in Rio Tinto.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Michael Dreeben, an O’Melveny partner licensed to practice law in the District of Columbia, Danny Ashby, an O’Melveny partner licensed to practice law in Texas, Andrew Geist, an O'Melveny partner licensed to practice law in New York, Jorge deNeve, an O'Melveny partner licensed to practice law in California, Bill Martin, an O'Melveny counsel licensed to practice law in New York, David Iden, an O'Melveny counsel licensed to practice law in California, and Kevin Day, an O’Melveny associate licensed to practice law in New York, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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