Securities Law Alert
In This Edition:• Supreme Court: Considers Applicability of Rules 10b-5(a) and (c) to an Individual Who Was Not the“Maker” of a Fraudulent Statement• Delaware Supreme Court: Affirms Chancery Court Decision Finding a “Material Adverse Effect” forthe First Time• Delaware Chancery Court: Forum Selection Provisions Requiring Federal Securities Act Claims to
Be Brought in Federal Court Are “Ineffective and Invalid”• Delaware Chancery Court: A Brophy Insider Trading Claim May Be Premised on Trades by an
Entity Affiliated With and Controlled by a Director
December 2018

Supreme Court: Considers
Applicability of Rules 10b-5(a)and (c) to an Individual Who
Was Not the “Maker” of a
Fraudulent Statement
SimpsonThacher “enjoys
gold-standard status”
in securities litigation.
–Benchmark Litigation
2019

On December 3, 2018, the Supreme Court
heard oral arguments in Lorenzo v. SEC (No.
17-1077), a case in which the Court will decide
whether an individual who merely distributed
a material misstatement or omission, andwas not the “maker” of the statement under
the test set forth in Janus Capital Groupv. First Derivative Traders, 564 U.S. 135(2011), can nonetheless be held liable underthe “fraudulent scheme” provisions of Rule10b-5(a) and (c).1 The circuit courts are split
on this issue: The Second, Eighth, and Ninth
Circuits have held that a misstatement cannot
be the sole basis for a fraudulent scheme
claim, while the D.C. Circuit and the Eleventh
Circuit have held that a misstatement,
1. Please click here to read our discussion of the Supreme Court’s
decision in Janus.

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standing alone, can be the basis for sucha claim.2

Background
SEC Rule 10b-5 enables the SEC—or private
plaintiffs—to bring civil actions to enforce
three types of securities fraud violations:those committed by (a) employing any“device, scheme or artifice to defraud;”(b) making a false statement or omitting
2. Compare Lentell v. Merrill Lynch, 396 F.3d 161 (2d Cir.
2005) (holding that plaintiffs cannot successfully assert “amarket manipulation claim under Rule 10b-5(a) and (c)” if“the sole basis for such claims is alleged misrepresentations
or omissions”), Public Pension Fund Grp. v. KV Pharm., 679
F.3d 972 (8th Cir. 2012) (“[A] scheme liability claim must be
based on conduct beyond misrepresentations or omissions
actionable under Rule 10b-5(b).”), and WPP Luxembourg
Gamma Three Sarl v. Spot Runner, 655 F.3d 1039 (9th Cir.
2011) (“A defendant may only be liable as part of a fraudulent
scheme based upon misrepresentations and omissions under
Rules 10b-5(a) or (c) when the scheme also encompasses
conduct beyond those misrepresentations or omissions.”)with Lorenzo v. SEC, 872 F.3d 578 (D.C. Cir. 2017)(holding defendant liable under Rules 10b-5(a) and (c) for
disseminating a statement he did not make), and SEC v. Big
Apple Consulting USA, 783 F.3d 786 (11th Cir. 2015) (“[E]ven
a person . . . who is not the ‘maker’ of an untrue statement of amaterial fact, nonetheless could be liable as a primary violatorof Rule 10b-5(a) and (c).”).

information that would be misleading to an
investor; or (c) engaging in fraudulent or
deceitful conduct.
Francis Lorenzo, a registered representativeof a broker-dealer, sent two emails topotential investors containing material
misstatements. The emails indicated they
were sent “at the request” of Lorenzo’s boss,and Lorenzo testified that he copied andpasted content that was supplied by his
boss. The SEC initiated an administrative
enforcement action against Lorenzo, charging
violations of, inter alia, all three Rule 10b-5
provisions. An SEC Administrative Law Judgefound that Lorenzo’s conduct amounted tooffenses under all three provisions of Rule10b-5. The Commission affirmed this ruling,issuing a lifetime bar on Lorenzo working inthe securities industry, as well as imposing a$15,000 monetary penalty.
A divided panel of the D.C. Circuit
reversed the Commission in part, findingthat Lorenzo’s tenuous connection to thestatements was insufficient to find that
Lorenzo was the “maker” of the statements
under Janus, as required to impose
fraudulent misstatement liability under Rule10b-5(b). Lorenzo v. SEC, 872 F.3d 578 (D.C.
Cir. 2017). In reaching this conclusion, theD.C. Circuit emphasized that under Janus,
Lorenzo’s boss was the one with control andthe “ultimate authority” over when and how
to communicate the information.
However, the D.C. Circuit affirmed the SEC’s
decision to impose fraudulent scheme liability
on Lorenzo under Rules 10b-5(a) and (c) due
to his role in disseminating the misstatements
to potential investors. The Court reasoned
that although Lorenzo was not the “maker”
of the misstatement, he “conveyed materiallyfalse information to prospective investors
about a pending securities offering backed
by the weight of his office as director ofinvestment banking,” thereby using thestatements to defraud investors. The Court
took an expansive view of the securities laws
and found that Rules 10b-5(a) and (c) could
be employed to find liability in connection
with false statements even where thedefendant’s conduct was outside the scope ofRule 10b-5(b). In a dissenting opinion, thenJudge Kavanaugh—who is not participatingin the decision at the Supreme Court—argued
that “scheme liability must be based on
conduct that goes beyond a defendant’s role inpreparing mere misstatements or omissions
made by others.”
Lorenzo petitioned the Supreme Court for awrit of certiorari, which was granted on June18, 2018.

Oral Argument Highlights
The oral argument focused heavily on whether
permitting liability under Rule 10b-5(a) and(c) would allow for an end run around the
Court’s ruling in Janus. In addressing thisissue, the Justices also explored whether theprovisions of Rule 10b-5 were intended to be
mutually exclusive, or whether the provisions
were in fact intended to operate together tobroadly prohibit fraudulent conduct in the
securities industry.
Lorenzo’s counsel argued that imposing
fraudulent scheme liability in this case, where
an individual only distributed someone else’s
false statement, would essentially reduce
Janus to a case of incorrect pleading. After
receiving some pushback from Justice Kaganon the idea that Rules 10b-5(a) and (c)are meant to operate separately from Rule10b-5(b), Lorenzo’s counsel did admit that
there could be a situation where additional
deceptive conduct could take a misstatement
into fraudulent scheme territory; however,
Lorenzo’s counsel reiterated that the act ofsending an email, as was the case here, would
be insufficient to do so because such an act is
not “inherently deceptive.”
Justice Alito asked: “Why doesn’t his conduct
fall squarely within the language of (c)?” Hequestioned how an individual could violate
Rule 10b-5(c) without a misstatement of some
type: “I don’t quite know how you’re goingto engage in a fraud . . . without saying some2

words.” Lorenzo’s counsel argued that liability
under Rule 10b-5(c) is “a type of fraud
that’s categorically different than merely
misstatements or omissions.”
Justice Gorsuch seemed to be convinced
by Lorenzo’s arguments, as he challenged
the government’s insistence that sending
the email itself was an act of fraud. Instead,
Justice Gorsuch appeared to be of the opinion
that the misstatement was the sole act offraud, and Lorenzo could not be held liable
as he did not “make” the statement. The
government continued to rely on the factthat Janus was decided exclusively within
the context of fraudulent misstatement
allegations under Rule 10b-5(b) and argued
that the “maker” standard was not relevant toan interpretation of Rule 10b-5(a) or (c).

Argument also focused on the Supreme
Court’s decision in Central Bank of Denver,v. First Interstate Bank of Denver, 511
U.S. 165 (1994), which drew a distinction
between primary and secondary liability.
Lorenzo’s counsel argued that if the Court
were to affirm the D.C. Circuit’s decision,
essentially holding Lorenzo liable for conduct
amounting to aiding and abetting his boss’s
misstatement, such a holding would blur thelines between primary and secondary liability,
opening a new avenue of lawsuits to private
plaintiffs. Lorenzo’s counsel acknowledgedthat Section 17(a)(2), which makes it unlawful
to obtain money or property by means of
any untrue statement of material fact, would
have been a better mechanism throughwhich the SEC could have sought liability for
Lorenzo’s conduct that would not jeopardize
the distinction made in Central Bank, as
enforcement under Section 17(a)(2) is only
available to the government.
A decision in Lorenzo is expected before next
summer.

Delaware Supreme Court:
Affirms Chancery Court
Decision Finding a “Material
Adverse Effect” for the FirstTimeOn December 7, 2018, the Delaware Supreme
Court affirmed the Delaware Chancery Court’s
decision in Akorn v. Fresenius Kabi, 2018 WL
4719347 (Del. Ch. 2018) (Laster, V.C.), which
held that a buyer was justified in terminatinga public company merger agreement on thebasis that a Material Adverse Effect (“MAE”)
had occurred. Akorn v. Fresenius Kabi, 2018
WL 6427137 (Del. 2018) (Strine, Jr., C.J.). An
MAE, one of the key terms in an acquisition
agreement, essentially defines when a buyer
does not have to complete an agreed-uponacquisition as a result of an adverse change toa target’s business during the period between
signing and closing.
Delaware courts to consider this issue havefound that an MAE requires that “unknown
events” threaten earnings potential in a“durationally-significant manner.” IBP
v. Tyson Foods, 789 A.2d 14 (Del. Ch.
2001). In Akorn, the buyer terminatedthe merger agreement on the grounds
that (1) significant declines in the target’s
performance amounted to an MAE (andtherefore, a failure of the standalone MAE
condition), and (2) serious FDA compliance
failures breached the target’s regulatorycompliance representations in a manner that
constituted an MAE (and therefore, a failureof the target’s ability to “bring-down” its
representations and warranties at closing).3
In a brief decision, the Delaware Supreme
Court held that “[t]he factual record
adequately supports the Court of Chancery’s
determination, based on its application ofprecedent such as [IBP] . . . that [the target]
had suffered a material adverse effect . . . thatexcused any obligation on [the buyer’s] partto close.” The Delaware Chancery Court
further held that “[t]he record adequately
supports the Court of Chancery’s declarationthat [the buyer] properly terminated themerger . . . because [the target’s] breach of
its regulatory representations and warranties
gave rise to an MAE and [the buyer] had notitself engaged in a prior, material breach
3. Please click here to read our discussion of the Delaware
Chancery Court’s decision in Akorn.
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of a covenant that would have prevented[the buyer] from exercising its immediate
termination rights under the Merger
Agreement.”

Delaware Chancery Court:
Forum Selection Provisions
Requiring Federal Securities
Act Claims to Be Brought inFederal Court Are “Ineffective
and Invalid”
On December 19, 2018, the Delaware
Chancery Court held that provisions incertificates of incorporation requiring
claims under the Securities Act of 1933 (the“Securities Act”) to be brought in federal court
are “ineffective and invalid.” Sciabacucchi v.
Salzberg, No. 2017-0931-JTL (Del. Ch. 2018)(Laster, V.C.). The court found that its earlier
opinion in Boilermakers Local 154 Ret. Fundv. Chevron Corp., 73 A.3d 934 (Del. Ch.
2013), authored by then-Chancellor Strine,“answers whether a forum-selection provision
can govern claims under” the Securities Act.4
The Boilermakers court held that Section
109(b) of the Delaware General Corporation
Law (“DGCL”) permits a Delaware
corporation to “adopt a forum-selection bylaw
for internal-affairs claims” but “does not
authorize a Delaware corporation to regulate
external relationships.”5 Sciabacucchi,
No. 2017-0931-JTL. Relying on “[t]heBoilermakers distinction between internaland external claims,” the Sciabacucchi court
held that a forum-selection provision cannot
4. Please click here to read our discussion of the Delaware
Chancery Court’s decision in Boilermakers.
5. At the time Boilermakers was decided, Section 109(b)provided in relevant part as follows: “The bylaws may containany provision, not inconsistent with law or with the certificate
of incorporation, relating to the business of the corporation,
the conduct of its affairs, and its rights or powers or the rights
or powers of its stockholders, directors, officers or employees.”
8 Del. C. § 109(b) (2014).

govern Securities Act claims because suchclaims are “external to the corporation.”
The forum selection bylaws at issue in
Boilermakers concerned derivative suits,fiduciary duty suits, suits asserting claims
under the DGCL, and internal affairs suits.
The Boilermakers court found that “[t]hese
are the kind of claims most central to therelationship between those who manage
the corporation and the corporation’s
stockholders.” The court emphasizedthat these types of claims are “brought bystockholders qua stockholders.” The court
contrasted the forum selection laws at issue
with hypothetical forum selection bylaws
governing tort or contract claims, which
would be “beyond the statutory language” ofSection 109(b) because such claims concern“external matters” rather than “the rights
and powers of the plaintiff stockholder as astockholder.” Following the Boilermakers
decision, the Delaware General Assembly
adopted Section 115 of the DGCL, which
specifically authorizes corporations to adopt
forum-selection provisions in their certificatesof incorporation or bylaws providing “thatany or all internal corporate claims shall be
brought solely and exclusively in” Delaware
courts. 8 Del. C. § 115.
In Sciabacucchi, the court found that “thereasoning in Boilermakers applies equally toa charter-based [forum selection] provision”
because “the language of Section 109(b)dealing with the subject matter of bylaws
parallels in large measure the language ofSection 102(b)(1) dealing with what may be
included in a certificate of incorporation.”6
6. Section 109(b) provides that a corporation’s “bylaws may
contain any provision, not inconsistent with law or with thecertificate of incorporation, relating to the business of thecorporation, the conduct of its affairs and its rights or powers
or the rights or powers of its stockholders, directors, officers
or employees.” 8 Del. C. § 109(b). Section 102(b)(1) similarly
provides that a certification of incorporation may include“[a]ny provision for the management of the business and forthe conduct of the affairs of the corporation, and any provision
creating, defining, limiting and regulating the powers of thecorporation, the directors, and the stockholders or any class ofthe stockholders . . . if such provisions are not contrary to thelaws of this State.” 8 Del. C. § 102(b)(1).

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The court determined that under
Boilermakers, “a Delaware corporation does
not have the power to adopt in its charteror bylaws a forum-selection provision thatgoverns external claims.”
The Sciabacucchi court found that “a federal
claim under the [Securities Act] is a clear
example of an external claim.” Such a claim“does not turn on the rights, powers, orpreferences of the shares, language in thecorporation’s charter or bylaws, a provisionin the DGCL, or the equitable relationshipsthat flow from the internal structure of thecorporation.” The court noted that a plaintiff
may assert a Securities Act claim against
a broad range of defendants regardless ofwhether those defendants have “internalrole[s] with the corporation.” Moreover,“shares of a Delaware corporation are only
one subset” of one type of security governedby the Securities Act. Finally, the court
underscored that a Securities Act claim “doesnot arise out of or relate to the ownershipof the share, but rather from the purchaseof the share.” The court explained that “[a]tthe moment the predicate act of purchasing
occurs, the purchaser is not yet a stockholder
and does not yet have any relationship withthe corporation that is governed by Delaware
corporate law.” The court found it significant
that the purchaser does not have to “continue
to own the security to be able to assert a[Securities Act] claim.” The court concluded
that a Securities Act “claim resembles a tort
or contract claim brought by a third-party
plaintiff who was not a stockholder at thetime the claim arose,” and is therefore “anexternal claim that falls outside the scope ofthe corporate contract.”

The Sciabacucchi court further found that“[t]he constitutive documents of a Delaware
corporation cannot bind a plaintiff to aparticular forum when the claim does not
involve rights or relationships that were
established by or under Delaware’s corporate
law.” The court stated that Delaware law
cannot govern claims brought under the
Securities Act because “[f]ederal law createsthe claim, defines the elements of the claim,and specifies who can be a plaintiff or adefendant.” Consequently, the court held that
forum selection laws governing Securities Act
claims are “ineffective and invalid.”

Delaware Chancery Court:
A Brophy Insider Trading
Claim May, Depending on the
Circumstances, Be Premisedon Trades by an Entity
Affiliated With and Controlled
by a Director
On December 14, 2018, the Delaware
Chancery Court held that plaintiffs adequately
alleged demand futility by pleading that amajority of the company’s directors faced asubstantial likelihood of liability for insider
trading under Brophy v. Cities Service Co.,
31 Del. Ch. 241 (Del. Ch. 1949).7 In re Fitbit
Stockholder Derivative Litig., 2018 WL
6587159 (Del. Ch. 2018) (Slights, V.C.). In acase of first impression, the court considered
whether “a fiduciary may be held liable ona Brophy claim for trades that an entity or
fund associated with that fiduciary executedin its name.” The court declined “to state a
hard and fast rule,” but found that plaintiffs
adequately alleged that trades by entities
affiliated with two of the directors could be
attributed to those directors.
Plaintiffs alleged that one of the directors
was a founder and managing memberof a venture capital firm, while anotherdirector was a partner at a different venture
capital firm. Both firms sold millions of
the company’s shares during the relevanttime period. The court noted that thedirectors were “not simply board designees
7. A Brophy claim “permits a corporation to recover from its
fiduciaries for harm caused by insider trading.” In re Fitbit
Stockholder Derivative Litig., 2018 WL 6587159 (Del. Ch.
2018).
5for their funds.” Rather, plaintiffs allegedthat “[b]oth directors share voting anddispositive power over the [company] stock
owned by their respective funds.” The court
found plaintiffs adequately alleged thatthe directors “personally and materially
profited from the challenged stock sales
through their ownership and control of theiraffiliated funds.”
Given these allegations, the court determinedthat “finding ipso jure that the [venture
capital firms’] trades cannot be attributed
to [the directors affiliated with those firms]
would frustrate the policy that animates
Brophy.” The court reasoned that such aruling “would permit a director to tradeon inside material information without
consequence just because the director did
not trade personally but rather passed theinformation to an entity with which heis affiliated (and over which he exercised
control) to do the trading.” The court foundthat this “is not and cannot be our law.” Thecourt stated that “to allow these directors,
through their controlled funds, to profit frominside information without recourse would beinconsistent with the policy of extinguishingall possibility of profit flowing from a breachof the confidence imposed by the fiduciary
relation that undergirds Delaware’s insider
trading law.”

This edition of the
Securities Law Alert was edited byPeter E. Kazanoffpkazanoff@stblaw.com / +1-212-455-3525,
Cheryl J. Scarboro
cscarboro@stblaw.com / +1-202-636-5529,
George S. Wang
gwang@stblaw.com / +1-212-455-2228,
and Jonathan K. Youngwood
jyoungwood@stblaw.com / +1-212-455-3539.

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