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 the authorship of that statement or, in the alternative, that securities professionals who direct ed 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. Writing for the majority, Circuit Judge Selya stated that the Commission'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." SEC v. Tambone
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, Tambone and Hussey 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. Second, the SEC 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 descibed by the majority, uses "make," a "significantly different (and narrower) verb." In rejecting the SEC view that a person can "make" a statement when using a statement created entirely by others, the appellate court concluded that "word choices have consequences, and this word choice virtually leaps off the page. There is no principled way that we can treat it as meaningless."
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.
In a sharp criticism of the dissent's "metronomic" reliance on the special role and duties of underwriters, the majority asserted that
the duty that the dissent seeks to impose is unprecedented—and far exceeds the scope of Rule 10b-5(b). While that rule could have been drafted to cut a wider swath, it was not. The SEC has other, more appropriate tools that it may use to police the parade of horribilis that the dissent envisions, and it is neither necessary nor wise to attempt to expand the rule by judicial fiat. Most importantly, doing so would, as a matter of law, be wrong.