The First Circuit threw out the SEC’s 10b-5(b) claim in SEC v. Tambone. This time it was the entire court after an earlier decision of a three judge panel reached the opposite decision.
The SEC alleged that James Tambone and Robert Hussey engaged in fraud in connection with the sale of mutual fund shares tied to market timing claims. The two were senior executives of a registered broker dealer, Columbia Funds Distributor, Inc. The prospectuses for the funds told investors that market timing was not permitted. Unfortunately, Tambone and Hussey permitted a number of customers to engage in market timing transactions. The SEC took the position that Tambone and Hussey were responsible for the false statements in the prospectuses since they commented on the market timing passages prior to their inclusion in the documents.
This case presents the two-part question of whether a securities professional can be said to “make” a statement, such that liability under Rule 10b-5(b) may attach, either by (i) using statements to sell securities, regardless of whether those statements were crafted entirely by others, or (ii) directing the offering and sale of securities on behalf of an underwriter, thus making an implied statement that he has a reasonable basis to believe that the key representations in the relevant prospectus are truthful and complete. The answer to each part of this two-part question is “no.”
Rule 10b-5(b), promulgated by the Securities and Exchange Commission under of section 10(b) of the Securities Exchange Act of 1934, renders it unlawful “[t]o make any untrue statement of a material fact . . . in connection with the purchase or sale of any security.” 17 C.F.R. § 240.10b-5(b).
The Tambone case turns on the meaning of the word “make” as used in Rule 10b-5(b). The SEC advocated “an expansive definition, contending that one may “make” a statement within the purview of the rule by merely using or disseminating a statement without regard to the authorship of that statement or, in the alternative, that securities professionals who direct the offering and sale of shares on behalf of an underwriter impliedly “make” a statement, covered by the rule, to the effect that the disclosures in a prospectus are truthful and complete.”
The court rejected the SEC’s position.
In 1994 the US Supreme Court held that private civil liability does not an aiding and abetting suit under Rule 10b-5 in the case of Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164. So private parties can only bring a suit against primary violators of Rule 10b-5. As a result of that decision, Congress amended the Exchange Act to make it clear that the SEC can bring a suit againstanyone who provides substantial assistance to a primary violator of securities laws. That is, the SEC can impose secondary liability.
The First Circuit decided that the SEC was trying to impose primary liability on Tambone and Hussey for conduct that would be a secondary violation (at most). The Court acknowledged that there is a split in the courts over the right test, but held that the facts of this case would fail both tests.
“If Central Bank is to have any real meaning, a defendant must actually make a false or misleading statement in order to be held liable [as a primary violator] under section 10(b). Anything short of such conduct is merely aiding and abetting.” Shapiro v. Cantor, 123 F.3d 717, 720 (2d Cir. 1997).
The next step is up to the SEC. They need to decide if they will appeal to the Supreme Court and use this case to try to reconcile the law in this area.