Paul, Weiss Wins Important Second Circuit Decision Limiting Scheme Liability Claims

Paul, Weiss and co-counsel won an important decision at the Second Circuit in SEC v. Rio Tinto PLC, et al. that limits the scope of scheme liability claims under SEC Rules 10b-5(a) and (c). A Second Circuit panel rejected the SEC’s attempt to revive certain securities fraud claims that the district court had thrown out in 2019, in a major win for our client, former Rio Tinto CFO Guy Elliott, as well as for the company and its former CEO.

The lawsuit, filed in October 2017, stemmed from an SEC investigation of the company over its $3.7 billion acquisition of a coal mining operation in Mozambique in 2011. In its complaint, the SEC alleges that the company, the former CEO and our client fraudulently concealed the decline of the Mozambique coal business’ value and allowed Rio Tinto to release misleading financial statements days before a series of $5.5 billion in U.S. debt offerings. Rio Tinto ultimately sold the Mozambique assets for $50 million. The SEC alleged numerous claims, including scheme liability claims brought under Rule 10b-5(a) and (c), as well as Section 17(a)(1) and (a)(3), misstatements and omissions claims brought under Rule 10b-5(b), and record-keeping requirements under Section 13(a) and (b).

In 2019, U.S. District Judge Analisa Torres dismissed all but a handful of those claims, including the scheme liability claims at issue on appeal. With regard to the latter, Judge Torres found that the SEC’s only allegations were misstatements or omissions, which are insufficient for “scheme liability” claims under Rule 10b-5(a) and (c), citing precedent in the Second Circuit’s decision in Lentell v. Merrill Lynch & Co. The judge left standing certain claims regarding statements by the former CEO and regarding a single financial report in 2012; she dismissed primary and secondary fraud claims against Guy Elliott, leaving only negligence-based claims.

Soon after her decision, however, the Supreme Court in Lorenzo v. SEC held that individuals who disseminated but did not “make” misstatements under Rule 10b-5(b) nevertheless may be liable under Rule 10b-5(a) and (c). The SEC filed a motion for reconsideration, which Judge Torres denied, prompting the SEC to file an interlocutory appeal with the Second Circuit, arguing that Lorenzo had abrogated Lentell and so the fraud claims should be reinstated. Trial was stayed pending the appeal, and oral arguments were held on May 19, 2022.

The Second Circuit disagreed, echoing our arguments that the SEC’s interpretation of the Lorenzo decision was far too expansive, and that misstatements or omissions alone could not form the basis for scheme liability under 10b-5. “The SEC has exerted substantial effort to shoehorn its allegations into a claim for scheme liability,” the panel wrote. By expanding the scope of scheme liability to include false statements and omissions alone, the SEC would render Rule 10b-5(b) wholly superfluous, evading Supreme Court precedent recognizing that only the “makers” of such statements and omissions may be liable under that provision. The SEC’s position also would have the effect of nullifying the heightened pleading standard for private plaintiffs that applies only to Rule 10b-5(b), and would muddle the distinction between primary and secondary liability by allowing primary liability for those who only participated in the preparation of alleged misstatements.

“Until further guidance from the Supreme Court (or in banc consideration here),” the panel concluded, “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 Paul, Weiss team includes litigation partners Walter Ricciardi, Geoffrey Chepiga, Kannon Shanmugam (who argued the appeal) and Ted Wells.