Defining 'Make' in SEC Rule 10b-5(b): First Circuit Limits Liability to Active Statement Makers

Defining 'Make' in SEC Rule 10b-5(b): First Circuit Limits Liability to Active Statement Makers

Introduction

In the landmark case of SEC v. Tambone and Hussey, decided by the United States Court of Appeals for the First Circuit on March 10, 2010, the court addressed a pivotal issue in securities law: the interpretation of the term "make" within Rule 10b-5(b) of the Securities Exchange Act of 1934. The Securities and Exchange Commission (SEC) sought to hold James Tambone and Robert Hussey, senior executives of Columbia Funds Distributor, Inc., liable for making untrue statements in mutual fund prospectuses concerning market timing practices. This case examined whether mere use or dissemination of statements, without authorship, could constitute a violation of Rule 10b-5(b), thereby expanding the scope of liability for securities professionals.

Summary of the Judgment

The First Circuit affirmed the district court's dismissal of the SEC's Rule 10b-5(b) claims against Tambone and Hussey. The appellate court rejected the SEC's broad interpretation that "making" a statement extends to merely using or disseminating it without being the author. The court emphasized that this interpretation was inconsistent with the rule's wording, the statutory framework, and established Supreme Court precedents. Consequently, the SEC's claims under Rule 10b-5(b) were dismissed, while other claims, such as those under section 17(a)(2) and aiding and abetting provisions, were reinstated for further proceedings.

Analysis

Precedents Cited

The judgment extensively engaged with several key precedents to elucidate the interpretation of "make" in Rule 10b-5(b). Notably:

  • WRIGHT v. ERNST YOUNG LLP (2d Cir. 1998): Established the "bright-line" test for pleading violations under Rule 10b-5(b).
  • Bell Atlantic Corp. v. Twombly (Supreme Court 2007): Introduced the "plausibility" standard for civil complaints, requiring allegations to be more than mere conjecture.
  • Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A. (Supreme Court 1994): Clarified the distinction between primary and secondary (aiding and abetting) liabilities under Rule 10b-5.
  • CHIARELLA v. UNITED STATES (Supreme Court 1980): Held that a duty to disclose information under Rule 10b-5 arises only from a fiduciary or similar relationship of trust and confidence.
  • REASS v. UNITED STATES (4th Cir. 1938): Interpreted "make" to mean actively communicating a statement, not merely composing it.

These precedents collectively underscored the necessity for clear authorship in "making" a statement and reinforced the boundaries between primary and secondary liability.

Legal Reasoning

The court's reasoning centered on the ordinary meaning of "make," aligning it with definitions such as "create," "compose," and "cause to exist." The First Circuit found the SEC's expansive interpretation, which encompassed mere use or dissemination without authorship, to be inconsistent with the rule's text and purpose. The court highlighted the structural differences within Rule 10b-5, noting that subsections (a) and (c) employ broader language like "employ" and "engage," whereas subsection (b) specifically uses "make," indicating a more limited scope.

Furthermore, the court stressed the importance of maintaining the distinction between primary and secondary liability as established in Central Bank. Allowing "make" to include passive actors would blur this critical dichotomy, potentially imposing primary liability on individuals who did not actively engage in creating or communicating false statements.

The court also addressed the SEC's implied representation theory, which posited that securities professionals implicitly assure the accuracy of prospectus statements through their role in disseminating them. The First Circuit rejected this theory, arguing that it would impose an unprecedented and unconditional duty to disclose, contrary to the requirements set forth in precedents like Chiarella.

Impact

This judgment significantly impacts the interpretation of SEC Rule 10b-5(b) by narrowing the circumstances under which securities professionals can be held liable for making false statements. By affirming that "make" does not extend to mere use or dissemination, the court limits the SEC's ability to attribute liability to secondary actors who do not actively create or communicate misleading information.

Consequently, securities professionals will no longer be held primarily liable under Rule 10b-5(b) solely based on their role in distributing prospectuses unless they actively contribute to the creation or communication of false statements. This decision reinforces the need for clear authorship and active participation in fraudulent conduct for primary liability to attach.

Additionally, the ruling preserves the integrity of the primary-secondary liability framework, ensuring that aiding and abetting claims remain distinct from primary violations. This clarity aids both regulators and defendants in understanding the boundaries of liability under securities laws.

Complex Concepts Simplified

Rule 10b-5(b)

Rule 10b-5(b) is a key provision under the Securities Exchange Act of 1934 that prohibits making any untrue statement of a material fact or omitting to state a material fact necessary to make the statements made not misleading, in connection with the purchase or sale of any security. This rule is instrumental in preventing securities fraud.

Primary vs. Secondary Liability

Primary Liability: Refers to individuals or entities who directly make false statements or engage in deceptive practices. These parties are directly responsible for the fraudulent conduct.

Secondary Liability: Also known as aiding and abetting liability. This applies to those who assist or facilitate the primary violators but do not directly engage in the fraudulent conduct themselves.

Implied Representation Theory

This theory suggests that securities professionals, by virtue of their role, implicitly assure the accuracy and completeness of the information they disseminate, even if they did not author the content. The First Circuit rejected this theory, maintaining that only active making of statements constitutes a violation.

Pleading Standards

Twombly/Iqbal Standard: Requires that a complaint contain enough factual allegations to make the claim plausible, not just conceivable. This prevents suits based on vague or unfounded claims.

Federal Rule of Civil Procedure 9(b): Requires that certain types of claims, including fraud, be pled with particularity, specifying the who, what, when, where, and how of the alleged misconduct.

Conclusion

The First Circuit's decision in SEC v. Tambone and Hussey serves as a critical clarification in securities law, particularly concerning the scope of liability under Rule 10b-5(b). By affirming that the term "make" does not encompass mere use or dissemination of statements, the court has restricted the SEC's ability to hold securities professionals liable unless they actively participate in making false statements.

This ruling upholds the importance of clear authorship and active involvement in fraudulent activities, ensuring that liability is appropriately assigned. Additionally, it reinforces the established primary-secondary liability framework, providing clearer guidance for both regulators and defendants in securities litigation. As a result, this judgment promotes fairness and precision in the enforcement of securities laws, safeguarding professionals from unfounded secondary liability while maintaining robust mechanisms to combat genuine securities fraud.

Case Details

Year: 2010
Court: United States Court of Appeals, First Circuit.

Judge(s)

Bruce Marshall SelyaMichael BoudinSandra Lea LynchKermit Victor LipezJuan R. Torruella

Attorney(S)

John W. Avery, Senior Litigation Counsel, with whom David M. Becker, General Counsel, Mark D. Cahn, Deputy General Counsel, and Jacob H. Stillman, Solicitor, were on supplemental brief, for appellant. Arthur R. Miller, William B. Scoville, Jr., Peter G.A. Safirstein, Milberg LLP, New York City, Kevin P. Roddy, Wilentz, Goldman Spitzer, P.A., Woodbridge, NJ, Salvatore J. Graziano, Ann M. Lipton, and Bernstein Litowitz Berger Grossmann LLP, New York City, on supplemental brief for National Association of Shareholder and Consumer Attorneys (NASCAT), amicus curiae. Paula J. DeGiacomo, with whom Elliot H. Scherker, Greenberg Traurig LLP, A. John Pappalardo, John A. Sten, and Greenberg Traurig, P.A., Boston, MA, were on supplemental brief, for appellee Tambone. Clifford M. Sloan, with whom Christopher M. Joralemon, Gibson, Dunn Crutcher LLP, New York City, Warren L. Feldman, Skadden, Arps, Slate, Meagher Flom LLP, New York City, Frank A. Libby, Jr., John J. Commisso, and Libby-Hoopes, P.C., Boston, MA, were on supplemental brief, for appellee Hussey. Douglas R. Cox, Michael J. Scanlon, Jason J. Mendro, Gibson, Dunn Crutcher LLP, Washington, DC, on supplemental brief for Center for Audit Quality, amicus curiae. Carter G. Phillips, Jonathan F. Cohn, Daniel A. McLaughlin, Eric D. McArthur, Sidley Austin LLP, Washington, DC, Ira D. Hammerman, Kevin M. Carroll, on supplemental brief for Securities Industry and Financial Markets Association, amicus curiae. Richard D. Bernstein, Barry P. Barbash, Frank M. Scaduto, Willkie Fair Gallagher LLP, Robin S. Conrad, and Amar D. Sarwal, Washington, DC, on supplemental brief for United States Chamber of Commerce, amicus curiae. John Pagliaro, Staff Attorney, and Martin J. Newhouse, Boston, MA, on supplemental brief for New England Legal Foundation and Associated Industries of Massachusetts, amici curiae.

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