Second Circuit Confirms The Scope Of Scheme Liability Under Rule 10b-5

• Published date: 31 August 2022
• Subject Matter: Corporate/Commercial Law, Litigation, Mediation & Arbitration, Corporate and Company Law, Trials & Appeals & Compensation, Securities
• Law Firm: Akin Gump Strauss Hauer & Feld LLP
• Author: Mr Peter I. Altman, Michael Asaro, James J. Benjamin Jr., Paul W. Butler, Charles F. Connolly, Estela Diaz, Katherine Rachel Goldstein, Neal Marder, Ian Patrick McGinley, Claudius B. Modesti, Parvin Daphne Moyne and Sina S. Safvati

Key Points

• The United States Court of Appeals for the 2nd Circuit held that Lorenzo did not alter existing case law holding that scheme liability under ' 10(b) of the Exchange Act and ' 17(a) of the Securities Act requires more than alleged misstatements and omissions.
• The 2nd Circuit left for another day clarifying the specific parameters of an actionable deceptive or manipulative scheme.

Background

In April 2011, Rio Tinto acquired an exploratory coal mine based on the understanding that it would produce quality coal, which could then be transported down the Zambezi River, and then by rail infrastructure. After acquiring the coal mine, Rio Tinto learned the quality of the coal was poorer than expected and that it could not obtain proper government permitting to transport the coal by river.

In October 2017, the U.S. Securities and Exchange Commission (SEC) brought an enforcement action against Rio Tinto and its CEO and CFO, alleging that Rio Tinto should have taken an impairment on the coal mine sooner than it did and, in relevant disclosures to the public, the company, CEO and CFO had failed to timely disclose these problems or to correct the valuation of the coal mine. The SEC brought misstatements and omissions claims under Rule 10b-5(b), as well as a scheme liability claim under Rule 10b-5(a) and (c) for Rio Tinto's alleged "corruption of the auditing process," i.e., its alleged failure to correct the statements made to the audit committee and auditors.

In March 2019, the Honorable Analisa Torres of the Southern District of New York dismissed the scheme liability claim,¹ reasoning that all of the alleged "actions" and "conduct" underlying it were misstatements or omissions, which under Lentell v. Merrill Lynch & Co., 396 F.3d 161 (2d Cir. 2005), was insufficient to confer scheme liability under Rule 10b-5(a) and (c). About a week later, the U.S. Supreme Court issued its decision in Lorenzo v. SEC, 139 S. Ct. 1094, 1100 (2019), holding that those who disseminate false statements with the intent to defraud are primarily liable under Rules 10b-5(a) and (c) even if they are not primarily liable under Rule 10b-5(b).

The SEC then asked the district court to reconsider the dismissal in light of Lorenzo, arguing that Lorenzo had abrogated the 2nd Circuit's decision in Lentell by expanding the scope of scheme liability. The district court, however, denied reconsideration, concluding that the SEC had failed to "allege that Defendants disseminated [the] false...