The First Circuit’s en banc ruling in SEC v. Tambone rejected the SEC’s expansive interpretation of Rule 10b-5(b), vacating part of a prior ruling by a three-judge panel. No. 07-1384, 2010 WL 796996 (1st Cir. Mar. 10, 2010). The court held that the SEC’s interpretation is inconsistent with the text and structure of the rule and U.S. Supreme Court precedent. 

As background, in early 2005 the SEC announced that it had reached a $140 million settlement with Columbia Management Advisors, Columbia Funds Distributors and three former employees relating to alleged undisclosed market timing arrangements in the Columbia funds. As the principal underwriter and distributor of the Columbia mutual funds, Columbia Funds Distributors sold shares in the funds and disseminated fund prospectuses to investors. Columbia Management Advisors drafted the prospectuses, which included representations that the Columbia funds prohibited market timing. On May 19, 2006, the SEC filed a civil complaint in the District of Massachusetts against defendants James Tambone and Robert Hussey, who were officers of Columbia Funds Distributors, Inc. The defendants were not alleged to have spoken or authored direct mis-statements, but the SEC brought suit based on an “implied representation” theory. The SEC alleged that despite the defendants’ awareness of the market timing prohibitions contained in the prospectuses, the defendants distributed the prospectuses while allowing certain preferred customers to engage in market timing in the Columbia funds. 

In its complaint, the SEC alleged that the defendants had violated Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. In addition, the SEC alleged that the defendants had aided and abetted primary violations of Section 10(b) and Rule 10b-5 by Columbia Management Advisors and Columbia Funds Distributors, primary violations of Section 15(c) of the Exchange Act by Columbia Funds Distributors and primary violations of Section 206 of the Investment Advisers Act of 1940 by Columbia Management Advisors. The defendants moved to dismiss the complaint. In 2006, the district court dismissed all of the SEC’s claims en banc, holding that the SEC did not allege that the defendants made untrue statements or material omissions to investors and therefore did not plead fraud with particularity under Rule 9(b) of the Federal Rules of Civil Procedure. 

The SEC appealed the dismissal of its Rule 10b‑5(b), Section 17(a)(2) and aiding and abetting claims. In late 2008, a divided panel of the First Circuit reversed and reinstated all of the SEC’s primary and aiding and abetting claims. After the First Circuit’s initial opinion, upon petition by the defendants, the court ordered the case to be reheard en banc to determine whether primary liability under Rule 10b‑5(b) could extend to defendants under the theories advanced by the SEC. On en banc rehearing, a four-judge majority rejected the panel’s reasoning and affirmed the district court’s decision to dismiss the SEC’s primary violator claims under Section 10(b) and Rule 10b-5(b).¹

In rejecting the SEC’s interpretation of Rule 10b‑5(b), the court examined what it means to “make a statement” under Rule 10b-5(b). Based on the ordinary meaning of the word “make” and the absence of evidence that the drafters intended to attach any “exotic meaning” to the word, the court concluded that the SEC’s proposed reading was inconsistent with the text of both the statute and the rule. The court further supported its conclusion with a contextual analysis of other statutory provisions of the federal securities laws, highlighting that the drafters specifically and deliberately used the narrower verb “make” in Rule 10b-5 in comparison to other provisions of the federal securities laws (e.g., Section 17(a)(2) and Rule 10b-5(a)).

Finally, in reaching its decision, the court analyzed Supreme Court precedent in Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164 (1994).² “Under modern Supreme Court precedent dealing with Rule 10b-5, much turns on the distinction between primary and secondary violators. . . . If Central Bank’s carefully drawn circumscription of the private right of action is not to be hollowed—and we do not think that it should be—courts must be vigilant to ensure that secondary violations are not shoehorned into the category reserved for primary violations.” Tambone at 20–21. 

 ¹   It is important to note that in the en banc rehearing the judges unanimously agreed that the district court erred in dismissing the SEC’s Section 17(a) and aiding 
      and abetting claims and remanded those claims to the district court for further proceedings.

²  In Central Bank, the Supreme Court rejected Section 10(b) liability for those who assist the fraudulent conduct of others.