In SEC v. Tambone, 550 F.3d 106 (1st Cir. 2008) the SEC filed a complaint against James R. Tambone and Robert Hussey, executives of Columbia Funds Distributor, Inc., for violations of § 17(a)(1) of the Securities Exchange Act of 1933, § 10(b) of the Securities Exchange Act of 1934, and SEC Rule 10(b)-5.  Both worked for the underwriter and both distributed prospectus that the SEC alleged they knew were misleading.  Neither, however, actually made a fraudulent statement.  The case, therefore, once again tested the boundaries of primary liability under the antifraud provisions and the circumstances where liability extended to an actor who did not actually make a false statement. 

Columbia Funds, Inc. (“Columbia”), was a broker-dealer registered with the SEC, and the principal underwriter and distributor for a group of mutual funds. It was primarily responsible for selling those securities and disseminating informational materials on the funds, including prospectuses to investors and potential investors. Mr. Tambone was the Co-president and underwriter for Columbia, and Mr. Hussey was responsible for selling funds to investment advisors and other clients. The complaint alleged that defendants made false statements in the prospectuses

The SEC alleged that the defendants violated § 17(a)(2) because they directed efforts to sell Columbia to investors with false prospectuses, and that the defendants “obtained money or property by means of an untrue statement of material fact.” The defendants argued that they were not liable under § 17(a)(2) because the section’s language to “obtain money or property by means of any untrue statement of material fact” was identical to language in Rule 10(b)-5 that required defendants to make an affirmative misstatement.  As the First Circuit described:  "In other words, to be liable under section 17(a)(2), a securities seller must make a false or misleading statement in the course of selling or offering to sell a security to an investor." 

The district court agreed with the defendants, holding that the SEC did not allege actionable statements publicly attributable to the defendants as a distinct element of § 17(a)(2). Furthermore, the district court dismissed the SEC’s claim under § 10(b), Rule 10(b)-5, § 206 of the Investment Advisors Act, and § 15(c) of the Exchange Act, because the SEC did not meet the pleading requirement under the Private Securities Litigation Reform Act (“PSLRA”).

On appeal, the First Circuit disagreed that Section 17(a)(2) and Rule 10b-5 could be read to contain identical requirements.

• [Secton 17(a)(2)] prohibits an individual from "obtain[ing] money or property by means of any untrue statement." It does not state, however, that the seller must himself make that untrue statement. Indeed, the text suggests that the opposite is true -- that it is irrelevant for purposes of liability whether the seller uses his own false statement or one made by another individual. Liability attaches so long as the statement is used "to obtain money or property," regardless of its source.

The court found that the defendants were primarily responsible for distributing the prospectuses to potential investors, that they knew the prospectuses contained false representations, and that they used those prospectuses to sell the mutual funds. Therefore, the court found that the defendants had “obtain[ed] money or property by means of an untrue statement of material fact” in violation of §17(a)(2).

In regard to primary violations of §10(b) and Rule 10(b)-5, the court held the defendants had a duty to confirm the accuracy and completeness of the prospectuses, and as a consequence, the defendants did make implied statements to potential investors through the prospectuses.

• we agree with the Commission that the text of section 10(b) and Rule 10b-5(b), the statutory duties of underwriters, their role in the securities market, and case law support the Commission's argument that Tambone and Hussey made implied statements to investors, within the purview of Rule 10b-5(b), that they had a reasonable basis to believe that the statements in the prospectuses regarding market timing were accurate and complete. Given this conclusion that Tambone and Hussey made implied statements of their own about the prospectuses, we do not reach the Commission's argument that Tambone and Hussey also made false statements within the purview of Rule 10b-5(b) by adopting the statements of others when they distributed the prospectuses containing false statements on market timing practices.

The court concluded that investors had a reasonable basis to believe the statements regarding market timing were accurate because of the defendants’ duty to ascertain the accuracy of those statements.

Finally, the First Circuit held that the SEC’s allegations did meet the required elements for § 10(b), Rule 10(b)-5, § 206 of the Investment Advisors Act, and § 15(c) of the Exchange Act because the SEC is not held to PSLRA’s heightened pleading standards, unlike a private actor. The court reversed and remanded the case for further proceedings.

The primary materials for the post are available on the DU Corporate Governance website.