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Lorenzo v. Securities and Exchange Commission

United States Court of Appeals, District of Columbia Circuit

September 29, 2017

Francis V. Lorenzo, Petitioner
v.
Securities and Exchange Commission, Respondent

          Argued September 15, 2016

         On Petition for Review of an Order of the Securities & Exchange Commission

          Robert G. Heim argued the cause for petitioner. With him on the briefs were Stephanie Rapp-Tully and Steven L. Herrick.

          Martin V. Totaro, Attorney, Securities and Exchange Commission, argued the cause for respondent. On the brief were Anne K. Small, General Counsel, Michael A. Conley, Solicitor, and Benjamin L. Schiffrin, Senior Litigation Counsel.

          Before: Griffith, Kavanaugh, and Srinivasan, Circuit Judges.

          OPINION

          SRINIVASAN CIRCUIT JUDGE.

         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 securities-fraud 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.

         I.

         A.

         In February 2009, Francis Lorenzo became the director of investment banking at Charles Vista, LLC. Charles Vista was a registered broker-dealer owned by Gregg Lorenzo, no relation to Francis. (For clarity of reference, we will refer to Francis Lorenzo as "Lorenzo" and will use Gregg Lorenzo's first name when referring to him.)

         Charles Vista's biggest client, and Lorenzo's only investment-banking client at the time, was a start-up company named Waste2Energy Holdings, Inc. (W2E). W2E claimed to have developed a "gasification" technology that could generate electricity by converting solid waste to gas. W2E's business model relied on the technology's living up to its potential. If it failed to do so, the great majority of W2E's assets-the "intangibles, " in balance-sheet lingo-would have to be written off entirely.

         W2E's conversion technology never materialized. In September 2009, W2E sought to escape financial ruin by offering up to $15 million in convertible debentures. (Debentures are "debt secured only by the debtor's earning power, not by a lien on any specific asset." Black's Law Dictionary 486 (10th ed. 2014)). Charles Vista would serve as the exclusive placement agent for W2E's debenture offering.

         W2E's most recent SEC filing at the time, its June 3, 2009 Form 8-K (used to notify investors of certain specified events), contained no indication of any possible devaluation of the company's intangible assets. Rather, the form stated that W2E's intangibles were worth just over $10 million as of the end of 2008. On September 9, 2009, W2E issued a Private Placement Memorandum as a guidebook for potential investors in the debentures. That guidebook, like the June 2009 Form 8-K, included no mention of any devaluation of the company's intangibles.

         Following a lengthy audit, however, W2E changed its public tune. On October 1, 2009, the company filed an amended Form 8-K in which it reported a total "impairment" of its intangible assets because "management made a determination that the value of the assets acquired were of no value." J.A. 703. As of March 31, 2009, W2E now clarified, its gasification technology should have been valued at zero, and its total assets at only $370, 552. On the same day it filed its amended Form 8-K, October 1, 2009, W2E also filed a quarterly Form 10-Q in which it valued its total assets at $660, 408 as of June 30, 2009.

         Later on October 1, Lorenzo's secretary alerted him (via email) about W2E's amended Form 8-K filing. The next day, Lorenzo emailed all Charles Vista brokers links to both of W2E's October 1 filings. On October 5, he received an email from W2E's Chief Financial Officer explaining the reasons for "[t]he accumulated deficit we have reported." Id. at 740. The CFO reiterated that W2E had written off "all of our intangible assets . . . of about $11 million" due to "our assessment of the value of what those asset[s] are worth today." Id.

         On October 14, Lorenzo separately emailed two potential investors "several key points" about W2E's pending debenture offering. Id. at 794, 796. His emails, however, omitted any mention of the wholesale devaluation of W2E's intangibles. On the contrary, Lorenzo's emails assured both recipients that the offering came with "3 layers of protection: (I) [W2E] has over $10 mm in confirmed assets; (II) [W2E] has purchase orders and LOI's for over $43 mm in orders; (III) Charles Vista has agreed to raise additional monies to repay these Debenture holders (if necessary)." Id. One of Lorenzo's messages said it had been sent "[a]t the request of Gregg Lorenzo, " id. at 796, and the other stated it had been sent "[a]t the request of Adam Spero [a broker with Charles Vista] and Gregg Lorenzo, " id. at 794. In both messages, Lorenzo urged the recipients to "[p]lease call [him] with any questions." Id. at 794, 796. And he signed both messages with his name and title as "Vice President - Investment Banking." Id.

         B.

         On February 15, 2013, the Commission commenced cease-and-desist proceedings against Lorenzo, Gregg Lorenzo, and Charles Vista. It charged each with violating three securities-fraud provisions: (i) Section 17(a)(1) of the Securities Act of 1933, 15 U.S.C. § 77q(a)(1); (ii) Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j; and (iii) Securities Exchange Act Rule 10b-5, 17 C.F.R. § 240.10b-5. Gregg Lorenzo and Charles Vista settled the charges against them, but the claims against Lorenzo proceeded to resolution before the agency.

         An administrative law judge concluded that Lorenzo had "willfully violated the antifraud provisions of the Securities and Exchange Acts by his material misrepresentations and omissions concerning W2E in the emails." Gregg C. Lorenzo, Francis V. Lorenzo, and Charles Vista, LLC, SEC Release No. 544, 107 SEC Docket 5934, 2013 WL 6858820, at *7 (Dec. 31, 2013). The ALJ deemed "[t]he falsity of the representations in the emails . . . staggering" and Lorenzo's mental state with respect to those misstatements at least "reckless." Id. As a result, the ALJ ordered Lorenzo to: (i) cease and desist from violating each securities-fraud provision giving rise to the charges against him; (ii) forever refrain from participating in the securities industry in several enumerated respects; and (iii) pay a civil monetary penalty of $15, 000. Id. at *10.

         Lorenzo petitioned the Commission for review. Following "an independent review of the record, " the full Commission sustained the ALJ's decision, including her "imposition of an industry-wide bar, a cease-and-desist order, and a $15, 000 civil penalty." Francis V. Lorenzo, SEC Release No. 9762, 111 SEC Docket 1761, 2015 WL 1927763, at *1 (Apr. 29, 2015) (Lorenzo). The Commission found that Lorenzo "knew each of [the emails' key statements] was false and/or misleading when he sent them." Id. It concluded that the sanctions were "in the public interest to deter Lorenzo and others in similar positions from committing future violations." Id. at *17. The Commission later denied Lorenzo's motion for reconsideration.

         Lorenzo filed a timely petition for review in this court. He challenges only the Commission's imposition of an industry-wide bar and a $15, 000 civil penalty, not the cease-and-desist order.

         II.

         We first consider Lorenzo's challenges to the Commission's findings that the relevant statements in his email messages were false or misleading and were made with the requisite mental state. The three pertinent statements are the three "layers of protection" enumerated in both of Lorenzo's October 14, 2009, email messages to potential investors about the debenture offering. Lorenzo challenges the Commission's determination that two of the three statements were false or misleading, and he also challenges the Commission's conclusion that he possessed the requisite intent with respect to all three of the statements.

         With regard to his intent, establishing a violation of Section 17(a)(1) of the Securities Act, Section 10(b) of the Exchange Act, or Exchange Act Rule 10b-5 "requires proof of scienter." Dolphin & Bradbury, Inc. v. SEC, 512 F.3d 634, 639 (D.C. Cir. 2008). That standard in turn requires demonstrating "an intent to deceive, manipulate, or defraud." Id. (quoting SEC v. Steadman, 967 F.2d 636, 641 (D.C. Cir. 1992)). The scienter requirement can be satisfied by a showing of "[e]xtreme recklessness, " which exists when "the danger was so obvious that the actor was aware of it and consciously disregarded it." Id.

         The question whether Lorenzo acted with scienter, like the question whether the statements were false or misleading, is a question of fact. Id. at 639. The Commission's "factual findings are conclusive if supported by substantial evidence." Seghers v. SEC, 548 F.3d 129, 132 (D.C. Cir. 2008). Although "[s]ubstantial evidence is more than a mere scintilla, " Kornman v. SEC, 592 F.3d 173, 184 (D.C. Cir. 2010), we have repeatedly described the standard as a "very deferential" one, e.g., Siegel v. SEC, 592 F.3d 147, 155 (D.C. Cir. 2010); Dolphin & Bradbury, 512 F.3d at 639; Nat'l Ass'n of Sec. Dealers v. SEC, 801 F.2d 1415, 1419 (D.C. Cir. 1986). Applying that standard here, we conclude that the Commission's findings as to falsity and scienter are supported by substantial evidence with regard to each of the three pertinent statements in Lorenzo's emails.

         A.

         The first of the three statements at issue advised potential investors that the "Company has over $10 mm in confirmed assets." J.A. 794, 796. Lorenzo does not directly dispute the falsity of that statement. Nor could he: by the time Lorenzo sent the October 14, 2009, email messages containing that statement, W2E had entirely written off its intangibles and disclosed that its remaining assets were worth far less than $1 million. And Lorenzo himself testified that W2E "would be lucky to get a million" for its intangibles after they had been marked down. Id. at 128.

         As to the question of scienter, Lorenzo contends that, when he sent the emails, he held a good-faith belief that W2E had over $10 million in confirmed assets. The Commission concluded otherwise, and its finding of scienter is supported by substantial evidence.

         One of Lorenzo's chief duties involved conducting due diligence on his clients, including reviewing their financial statements and public SEC filings. During the relevant time, W2E was Lorenzo's sole investment-banking client. He knew that W2E's financial situation was "horrible from the beginning" and that its gas-conversion technology had not worked as planned. Id. at 124. He also knew that he stood to gain seven to nine percent of any funds he raised from the debenture offering.

         The record shows that, when Lorenzo viewed W2E's June 2009 Form 8-K, he disbelieved the Form's valuation of the company's intangible assets at $10 million. He agreed that the intangibles were a "dead asset" that would be "hugely discounted, " id. at 127-28, and that W2E would be "lucky [to] get a million dollars for that asset, " id. at 128-29. He also thought it significant that the $10 million valuation had not been audited, because without such scrutiny, "there is way too much risk for investors." Id. at 126. He acknowledged that he had warned Gregg Lorenzo as early as April 2009 to refrain from collateralizing a debenture offering with W2E's intangibles, because those assets "provided no protection" to investors. Id. at 159. Lorenzo understood that, if a default occurred, "clients would not be able to recoup their money based on a liquidation of this asset." Id. He instead viewed the debenture offering as a "toxic convertible debt spiral." Lorenzo, 2015 WL 1927763, at *5.

         Evidence concerning Lorenzo's state of mind can also be gleaned from his actions in helping prepare Charles Vista's Private Placement Memorandum for the debenture offering. On August 26, 2009, he asked W2E's principals to value the company's intangibles at $10 million in the upcoming Memorandum. He received no response. He broached the subject again on September 1, this time leaving the intangibles' value blank, because he "w[asn't] sure what [it] was worth anymore." J.A. 135, 739. The final Memorandum assigned no concrete value to W2E's intangibles; it instead divulged that the company had experienced "significant operating losses" and did "not expect to be profitable for at least the foreseeable future." Lorenzo, 2015 WL 1927763, at *3.

         In its October 1 SEC filings, W2E publicly disclosed the wholesale write-off of its intangibles. It did so in a tri-column chart entitled "Goodwill and Technology, " and it followed that numerical presentation with a textual explanation for the mark-down. Lorenzo acknowledged that he read the amended Form 8-K on October 1 (although, according to him, "[p]robably not as closely as I should have"). J.A. 140. And he received an email from W2E's CFO on October 5 succinctly contextualizing the massive devaluation of W2E's intangible assets.

         The evidence therefore supports concluding that, at least by October 5, Lorenzo knew that W2E's intangibles were valueless. He gave testimony on the issue as follows: "Q. So it is fair to say . . . that on October 5, 200[9], you were aware that the $10 million asset had been written off by [W2E]. Correct? A. Okay. I will agree to that. That's correct. Q. That is a fair statement? A. Yes." Id. at 151. That admission is difficult to reconcile with Lorenzo's statement that he "unintentional[ly] miss[ed]" the import of the October 5 email. Id. at 148. The Commission justifiably credited his more inculpatory rendition of events, especially in light of his broader, scienter-related concession: "Q. [D]id you know that those statements were inaccurate and misleading? A. Yes. Q. You knew at the time? A. At the time? I can't sit here and say that I didn't know." Id. at 158.

         According to the Commission, "[t]hat Lorenzo could have looked at [W2E's] filings, which was his job, and missed what was one of the most pertinent facts in them-the valuation of the company's assets-is either untrue or extreme recklessness." Lorenzo, 2015 WL 1927763, at *9. The Commission considered it "at least extremely reckless" for Lorenzo to have sent email messages claiming that W2E had over $10 million in "confirmed" assets, given his "longstanding concern about the legitimacy" of those assets. Id. We perceive no basis for setting aside the Commission's conclusions as unsupported by substantial evidence.

         In resisting that conclusion, Lorenzo relies in part on a $14 million valuation of W2E's assets in a W2E research report emailed by Charles Vista's Chief Compliance Officer to the firm's brokers on the same day Lorenzo sent his pertinent emails (October 14, 2009). The Commission sensibly reasoned that "the mere fact that, for whatever unknown reason, a compliance officer sent an inaccurate research report internally to the firm's brokers is neither analogous to, nor an excuse for, Lorenzo's knowingly sending misleading emails to prospective investors." Id. at *9 n.23.

         B.

         The second contested statement is the assertion in Lorenzo's emails that "[t]he Company has purchase orders and LOI's for over $43 mm in orders." J.A. 794, 796. He maintains that the Commission erred in deeming that statement false or misleading. He notes that, at one point, Charles Vista did in fact receive a $43 million letter of intent from a potential customer in the Caribbean, and that W2E's CEO "put a lot of confidence" in such letters. Id. at 160. But as the Commission rightly notes, the Caribbean letter did not obligate its drafter to do anything, and the transaction proceeded no further. By the time Lorenzo sent his emails on October 14, 2009, W2E had no outstanding purchase orders. Lorenzo's emails nonetheless assured the recipients that W2E had over $43 million in "purchase orders and LOI's." The Commission thus was fully justified in finding that statement false or misleading. See Lorenzo, 2015 WL 1927763, at *6.

         Lorenzo also disputes the Commission's finding of scienter concerning the extent of W2E's anticipated cash flow. Asked whether he knew at the time that the $43 million figure was misleading, Lorenzo testified as follows: "I can't say that with a hundred percent because they did have LOI's for 43 million." J.A. 160. As his other testimony revealed, however, Lorenzo understood that W2E's sole letter of intent was "non-binding, " a mere potentiality that the company "hoped would materialize." Id. at 162. And by September 2009, he "didn't think that the 43 million LOI was ever going to turn into purchases." Id. at 164. Lorenzo testified repeatedly to that effect. See id. at 163-64 ("Q. And by September 2009 you didn't think it was ever going to come through, right? A. . . . That is correct."); id. at 164 ("Q. So sometime in September you lost confidence that this 43 million was ever going to happen? A. Yes.").

         The clear implication of the statement in Lorenzo's email messages was that W2E anticipated a $43 million influx of capital from past and future orders. Yet the record reveals grave doubts on Lorenzo's part that "$43 mm in orders" (or any orders) would actually occur. Substantial evidence therefore supports the Commission's finding of scienter as to that statement.

         C.

         The third statement at issue is the assertion in Lorenzo's email messages that "Charles Vista has agreed to raise additional monies to repay these Debenture holders (if necessary)." Id. at 794, 796. Lorenzo disputes the Commission's conclusion that the statement was false or misleading. He contends that Gregg Lorenzo could have made such an agreement for Charles Vista, had done so on prior occasions for debenture holders, and had allegedly met with additional brokers about raising funds for W2E. The Commission permissibly regarded those assertions as "establish[ing] only the theoretical possibility that Charles Vista could have raised additional money to repay investors, not that it had agreed to do so (as Lorenzo's emails claimed)." Lorenzo, 2015 WL 1927763, at *7.

         With regard to scienter, Lorenzo observes that the Commission included no specific citations to the record in support of its finding. It is true that, although the Commission quoted the evidentiary record at length, it did not cite the particular page numbers on which certain arguments and quotations appeared. But we "uphold a decision of less than ideal clarity if the agency's path may reasonably be discerned." Motor Vehicle Mfrs. Ass'n v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43 (1983) (quoting Bowman Transp., Inc. v. Arkansas-Best Freight Sys., 419 U.S. 281, 286 (1974)). That standard is readily satisfied here.

         Lorenzo allowed, at least in hindsight, that "you can interpret this [statement] as being misleading." J.A. 167. Moreover, according to his own testimony, at the time he sent the emails, he did not believe Charles Vista could raise enough money to repay debenture holders. For instance, he testified that, as of October 2009, "it is accurate to say that Charles Vista would not have the buying power or the resources to properly fund [W2E] in order to repay the debentures." Id. at 172. Given Lorenzo's knowledge that Charles Vista could not have repaid debenture holders, the Commission could certainly conclude that Lorenzo believed that no such agreement existed. As a result, ...


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