Sitting en banc, a
divided First Circuit rejected the SEC's
assertion that a person
"made" a statement as used in Rule
10b-5(b) by using or disseminating a
statement without regard to its authorship,
in the alternative, that securities
professionals who directed the offering and
sale of shares on behalf of an underwriter
impliedly "made"
a statement, covered by the rule, to the
effect that the disclosures in a prospectus
were truthful and complete. The court stated
that the SEC's interpretation was
"inconsistent with the
text of the rule and with the ordinary
meanings of the phrase `to make a
statement,' inconsistent with the structure
of the rule and relevant statutes, and in
considerable tension with Supreme Court
precedent."
The case arose from mutual
fund market timing claims. The defendants,
James Tambone and Robert Hussey, were senior
executives of Columbia Funds Distributor,
Inc., a registered broker-dealer. Columbia
Distributor acted as the principal
underwriter and distributor of over 140
mutual funds in the Columbia mutual fund
complex. Direct responsibility for the
representations contained in the
prospectuses rested with the funds' sponsor,
a separate entity named Columbia Management
Advisors, Inc. By 2003, all Columbia fund
prospectuses contained language expressly
barring short-term or excessive trading.
As alleged by the SEC, the
defendants violated Rule 10b-5 by allowing
preferred customers to engage in market
timing trading despite the language in the
prospectuses expressing hostility toward
such practices. The district court dismissed
the SEC claims, as it found that the
Commission's allegations about the
defendants' participation in the drafting
process and their subsequent use of the
prospectuses were too conclusory and
attenuated to support liability.
Before the 1st Circuit, the
SEC claimed that the executives
"made" the
alleged misrepresentations by using the
prospectuses to sell the mutual funds. The
SEC also argued that the defendants
impliedly made false representations to
investors to the effect that they had a
reasonable basis for believing that the key
representations in the prospectuses were
truthful and complete.
The majority critically
examined the meaning of the word
"make" as used in
Rule 10b-5(b), and compared the rule usage
with the statutory language of Section
10(b). The statute contains more inclusive
language, according to the court, such as
"use" and
"employ." The
rule, however, as described by the majority,
used "make," a
"significantly different
(and narrower) verb."
In a concurring opinion
largely focused on policy questions, Circuit
Judge Boudin and Chief Judge Lynch described
the SEC position as
"alarmingly ambitious." They
expressed concern about an extension of
liability with no obvious stopping point,
and noted that the SEC had ample alternate
remedies available. In dissent, Circuit
Judges Lipez and Toruella focused on the
unique role of underwriters in the marketing
of securities and concluded that the
defendants made implied statements to
investors that were actionable as primary
violations of Rule 10b-5(b). The dissenting
judges asserted that if an underwriter knew,
or was reckless in not knowing, that the
statements contained within the prospectus
were false, the underwriter's implied
statement is likewise false. An underwriter
who makes such a statement may properly be
found to have violated Rule 10b-5(b),
according to the dissent.
The majority criticized the
dissent's "metronomic"
reliance on the special role of
underwriters. The SEC has other tools
available to use in such cases, and
according to the majority,
"it is neither necessary
nor wise to attempt to expand the rule by
judicial fiat."
□ SEC v. Tambone
(1stCir) will be published in a forthcoming
Report.