Fourth Circuit Holds that Criminal Enforcement of Rule 10b-5 Violation is not Limited to “Makers” of Statements

05/22/2014

On May 7, the Fourth Circuit held that the Supreme Court’s decision in Janus Capital Group, Inc. v. First Derivative Traders, 131 S. Ct. 2296 (2011), did not apply in the context of a criminal prosecution for a violation of Rule 10b-5. See Prousalis v. Moore, No. 13-6814, 2014 U.S. App. LEXIS 8584 (May 7, 2014). Thus, under the Fourth Circuit’s interpretation of Janus, persons who are not the “maker” of a statement for purposes of private liability under Rule 10b-5 may nonetheless be subject to criminal prosecution for violations of Rule 10b-5.

Background

Rule 10b-5(b) prohibits “mak[ing] any untrue statement of a material fact . . . in connection with the purchase or sale of a security.” In Janus, the Supreme Court adopted a narrow definition of who may qualify as the “maker” of an untrue statement of material fact. Specifically, in private suits, the maker of an untrue statement is limited to “the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it.” Under that definition, those who contribute to an untrue statement but do not ultimately control the statement are not subject to private 10b-5 liability. (See our previous coverage of Janus here.) The Janus decision has been an often-cited defense in government investigations, including the Department of Justice and the Securities and Exchange Commission, as well as private litigation. But, as a result of the Prousalis decision, the government is unlikely to limit its actions solely to the “makers” of statements and likely will extend charges, when appropriate, to others who contribute to the dissemination of false or misleading information.

The Fourth Circuit’s Decision

Prousalis, a securities lawyer, pled guilty to violations of Rule 10b-5 arising from his orchestration of a scheme to defraud investors of his client, Busybox.com, Inc. (“Busybox”), in connection with an initial public offering of Busybox. Following Prousalis’s conviction based on his guilty plea, the Supreme Court issued its decision in Janus. Prousalis then filed a habeas petition with the district court pursuant to a federal statute that provided for relief if the conduct for which Prousalis was convicted was no longer deemed criminal. The district court denied Prousalis’s motion. The Fourth Circuit affirmed, though one justice concurred in the result.

The Rule 10b-5 language at issue in Prousalis was the same language that the Supreme Court had interpreted in Janus. However, unlike Janus, which was decided in the context of a judicially-created private right of action under Rule 10b-5, the Prousalis case was decided in the context of a criminal action alleging violations of statutory provisions that subject violators of Rule 10b-5 to criminal penalties.

In support of its holding, the Fourth Circuit in Prousalis observed that Janus is premised on, and “meshes seamlessly with,” other recent Supreme Court cases that limit the availability of a private right of action under Rule 10b-5. The Fourth Circuit further observed that Janus evinces a general desire to circumscribe judicially-created private causes of action that Congress has not expressly authorized. The court concluded that “[t]hese concerns are specific to the dangers of judicially implied causes of action. Nowhere is there the suggestion that criminal sanctions for security [sic] fraud violations would be similarly imperiled.”

The Fourth Circuit also stated that its interpretation of Janus is supported by considerations of “legislative primacy.” Specifically, the court observed that congressional control of the elements of federal criminal offenses has long been respected. In other words, the concern espoused in Janus regarding implied rights of action “is absent when Congress has in fact acted. . . . Explicit congressional prohibitions simply operate in a different universe than the one inhabited by Janus.”

Chief Judge Traxler issued a separate opinion that concurred in the result of Prousalis’s conviction but not in the majority’s reasoning. Judge Traxler concluded that the term “make” in Janus “has the same meaning in the criminal context as it does in the context of a private right of action.” Nevertheless, Judge Traxler concluded that the conduct underlying Prousalis’s conviction was illegal under 18 U.S.C. § 2(b), which provides for criminal liability against whomever “willfully causes an act to be done which if directly performed by him or another” would be a federal offense.

Implications of the Decision

The Prousalis decision illustrates that persons who assist issuers in preparing SEC filings and other public statements may be subject to criminal prosecution by DOJ for violations of Rule 10b-5 even though they do not possess the “ultimate authority” over the issuer’s statements, as would be required by Janus to impose Rule 10b-5 liability in a private civil action. Moreover, Prousalis likely will cause the SEC to charge individuals who are “contributors” to false statements and contend that Janus does not apply to civil enforcement actions alleging violations of Rule 10b-5.

 

David A. Dodds
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Kit Addleman
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Ronald W. Breaux
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Thad Behrens
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Nicholas Even
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Carrie L. Huff
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David Siegal
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Odean Volker
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