On March 10, the First Circuit, sitting en banc, issued its long-awaited decision in SEC v. Tambone. In its opinion, the Court of Appeals reversed the panel decision and reinstated Rule 12(b)(6) dismissal of the SEC's primary liability fraud claim against two senior executives of Columbia Funds for alleged market timing. In so doing, the First Circuit rejected what it termed the SEC's "expansive interpretation" of what it means to "make" a statement for purposes of Rule 10b-5(b), which makes it unlawful "[t]o make any untrue statement of a material fact …." Accordingly, the decision significantly reduces the potential scope of Section 10(b) liability – whether in SEC enforcement actions or in actions brought by private plaintiffs – for executives who did not author an allegedly false statement but who are nevertheless accused of committing fraud under a broader "implied speaker" theory.
The SEC in Tambone sued two senior executives of a mutual fund underwriter, alleging that the mutual fund prospectuses falsely stated that market timing was forbidden, even though some investors were allowed to engage in the practice. The SEC originally argued primarily that these statements were false and that the defendants were among those who made the statements by "reviewing" and "commenting" on drafts of these statements. The district court held these allegations insufficient as a matter of law and the SEC did not pursue them on appeal. Rather, the SEC asserted that the executives could be deemed to have made these statements by (1) using the prospectuses, and thus the alleged false statements regarding market timing contained therein, in their sales efforts or (2) directing the offering and sale of securities on behalf of an underwriter, thus (according to the SEC) making an implied statement that they believed that the key representations in the prospectus were truthful and complete.
In its March 10 en banc decision, the First Circuit forcefully rejected the SEC's theories, holding that they were "inconsistent with the text of" Rule 10b-5(b) "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." Though the First Circuit did not itself define what it means to make a statement under Rule 10b-5(b), it squarely rejected the SEC's assertion "that one can 'make' a statement when he merely uses a statement created entirely by others." It rejected with equal force the SEC's "implied statement" theory, stating that "that theory effectively imposes upon securities professionals who work for underwriters an unprecedented duty." It elaborated that the import of the SEC's theory would be "to impose primary liability under Rule 10b-5(b) on these securities professionals whenever they fail to disclose material information not included in a prospectus, regardless of who prepared the prospectus. That would be tantamount to imposing a free-standing and unconditional duty to disclose." Any such duty, the Court of Appeals explained, "flies in the teeth of Supreme Court precedent," which makes nondisclosure actionable under Rule 10b-5 only if there is a fiduciary or similar independent relationship of trust or confidence between the parties.
The question of when a non-speaker or non-author of a statement can nevertheless be deemed to have made the statement has taken on critical importance in recent years. Most appellate courts, including the Second Circuit, have adopted a "bright line" test requiring proof that the defendant actually made a false or misleading statement. The Ninth Circuit has adopted a more flexible "substantial participation" test, which would permit liability if the plaintiff can prove that the defendant had substantial participation or intricate involvement in the preparation of fraudulent statements. The First Circuit held that "[t]he SEC's attempt to impute statements to persons who may not have had any role in their creation, composition, or preparation" fails both tests. The decision in Tambone thus significantly limits the theories of liability upon which the SEC and the private plaintiffs' bar can base a claim that an individual committed securities fraud by "making" a false statement, and accordingly makes it more difficult for both the SEC and private plaintiffs to sue non-speaking defendants in many cases.
The First Circuit's comments about the existence of a fiduciary duty also highlight a key bone of contention in the current debate over financial reform legislation: whether broker-dealers should have a fiduciary duty to their clients. The financial reform legislation that passed the House in late 2009 would impose a limited fiduciary duty on broker-dealers. Many Senators have expressed reluctance to go along with this provision, preferring instead that the SEC study the question. If it is not enacted, broker-dealers cannot, under Tambone, be held liable for merely using and disseminating prospectuses created by others. If, however, the fiduciary duty provision is enacted, broker-dealers could, even under Tambone, be held liable for using and disseminating prospectuses created by others if they breach their duty to investigate the nature and circumstances of an offering. The First Circuit's decision in Tambone thus illustrates one reason for the vigorous debate over whether the fiduciary duty provision will be enacted.