United States Court of Appeals
For the First Circuit
No. 07-1384
SECURITIES AND EXCHANGE COMMISSION,
Plaintiff, Appellant,
v.
JAMES TAMBONE; ROBERT HUSSEY,
Defendants, Appellees.
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. Nathaniel M. Gorton, U.S. District Judge]
Before
Selya and Lipez, Circuit Judges,
and Delgado-Colón,* District Judge.
John W. Avery, Senior Litigation Counsel, Securities and
Exchange Commission, with whom Andrew N. Vollmer, Deputy General
Counsel, and Jacob H. Stillman, Solicitor, were on brief, for
appellant.
Elliot H. Scherker, with whom Greenberg Traurig, P.A., A. John
Pappalardo, John A. Sten, David G. Thomas, D. Greg Blankinship, and
Greenberg Traurig, LLP, were on brief, for appellee Tambone.
Christopher M. Joralemon, with whom Warren L. Feldman,
Clifford Chance US LLP, Frank A. Libby, Jr., John J. Commisso, and
Kelly, Libby & Hoopes, P.C., were on brief, for appellee Hussey.
December 3, 2008
*
Of the District of Puerto Rico, sitting by designation.
LIPEZ, Circuit Judge. In this enforcement action brought
by the Securities and Exchange Commission ("SEC" or "the
Commission"), the Commission seeks to hold defendants James R.
Tambone and Robert Hussey, executives of Columbia Funds
Distributor, Inc., the primary underwriter for the Columbia family
of mutual funds, responsible both as primary violators of the
federal securities laws and as aiders and abettors of uncharged
primary violations of Columbia Advisors and/or Columbia
Distributor.1 After carefully reviewing the relevant statutes and
precedents, we conclude that Tambone and Hussey may be held
primarily liable for using false or misleading fund prospectuses to
sell mutual fund shares under Section 17(a)(2) of the Securities
Act of 1933 ("section 17(a)(2)") and Section 10(b) of the Exchange
Act of 1934 ("section 10(b)"), and its implementing regulation,
Rule 10b-5. Additionally, we conclude that the scope of conduct
encompassed by section 17(a)(2)'s prohibition on obtaining money or
property "by means of" any untrue statement of material fact may,
in certain circumstances, be broader than Rule 10b-5(b)'s
prohibition against "making" an untrue statement. Here, however,
1
The provisions at issue in this case are Sections 10(b) and
15(c) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b)
and § 78o(c), respectively, along with Rule 10b-5, 17 C.F.R. §
240.10b-5, promulgated under section 10(b); Section 17(a) of the
Securities Act of 1933, 15 U.S.C. § 77q(a); and Sections 206(1) and
(2) of the Investment Advisers Act of 1940, 15 U.S.C. § 80b-6(1),
(2).
-2-
we conclude that the SEC's second complaint2 alleges with
sufficient particularity violations of both prohibitions by Tambone
and Hussey, as well as aiding and abetting violations. We
therefore reverse the district court's judgment dismissing the
SEC's complaint against Tambone and Hussey.
I.
A. The Roles of the Defendants
The following description of the alleged conduct, drawn
primarily from the SEC's second complaint, is presented in the
light most favorable to the plaintiff. Miss. Pub. Employees' Ret.
Sys. v. Boston Scientific Corp., 523 F.3d 75, 85 (1st Cir. 2008).
During the relevant time period, defendants Tambone and
Hussey were senior executives of Columbia Funds Distributor, Inc.
("Columbia Distributor"), a broker-dealer registered with the SEC
since 1992. Between 1998 and 2003, the company was the principal
underwriter and distributor for a group of approximately 140 mutual
funds ("the Columbia Funds") and, in that capacity, was primarily
responsible for selling those securities and disseminating
informational materials on the funds, including prospectuses, to
investors and potential investors.3 See 15 U.S.C. § 80a-
2
We review the district court's dismissal of the SEC's second
complaint. The SEC's first complaint against defendants was
dismissed without prejudice before the Commission had an
opportunity to amend it with additional related allegations.
3
Although a mutual fund may sell shares directly to broker-
dealers, it typically employs a principal underwriter to distribute
-3-
2(a)(40) (describing the duties of an underwriter to include
purchasing securities from an issuer for resale, or selling
securities for an issuer). Columbia Distributor was also
responsible for answering inquiries from the investing public and
other entities seeking additional information about any of the
Columbia Funds. Columbia Distributor and the issuer of the funds,
Columbia Advisors, a registered investment adviser, were both
wholly-owned subsidiaries of Columbia Management Group, Inc. and
indirect subsidiaries of FleetBoston Financial Corporation.4
As issuer and sponsor, Columbia Advisors was primarily
responsible for creating the content of the prospectuses for the
Columbia Funds. See 15 U.S.C. § 80b-2(a)(11) (defining an
investment adviser as "any person who, for compensation, engages in
the business of advising others, either directly or through
publications or writings, as to the value of securities or as to
the advisability of investing in, purchasing, or selling
and market the fund to broker-dealers and to the investing public.
4
Columbia Distributor previously went by the name Liberty
Funds Distributor, Inc. In November 2001, FleetBoston Financial
Corporation purchased Liberty Financial Group and acquired various
Liberty fund groups and investment advisers, including Liberty
Advisory Services Corp., Colonial Management Associates, Inc.,
Stein Roe and Farnham Inc., Newport Pacific Management, Inc.,
Newport Fund Management, Inc. and Columbia Funds Management
Company. Fleet retained the organization and management of Liberty
Distributor and continued using the Liberty name on the
prospectuses for the Liberty Funds. These entities merged in April
2003 with Fleet Investment Advisors, Inc. into Columbia Advisors.
In April 2004, Bank of America Corporation became the successor to
Fleet.
-4-
securities"). Columbia Fund Services, Inc. ("Columbia Services"),
also a subsidiary of Columbia Management Group, was responsible for
determining whether "market timing" activities were occurring in
the Columbia funds and responding to such activity. Market timing
refers to the practice of buying and selling mutual funds in rapid
succession to exploit short-term inefficiencies in the pricing of
the funds.5 Among the specific Columbia Funds pertinent to this
case were the Acorn Fund Group, the Newport Tiger Fund, the
Columbia Growth Stock Fund, and several others.
Beginning in 1997, Tambone, a registered securities
principal,6 was employed as Co-President of Liberty Distributor,
and later Columbia Distributor, where he was one of the executives
responsible for managing all of Columbia Distributor's activities,
including the fulfillment of its obligations as underwriter of the
5
Market timing is "a mutual fund trading strategy that
'exploit[s] brief discrepancies between the stock prices used to
calculate the shares' value once a day, and the prices at which
those stocks are actually trading in the interim." SEC v. Ficken,
2008 WL 4615797, at *1 (1st Cir. Oct. 20, 2008) (quoting Kircher v.
Putnam Funds Trust, 547 U.S. 633, 637 n.4 (2006)). "The
discrepancy occurs because the value of the fund is calculated only
once each day." SEC v. Druffner, 517 F. Supp. 2d 502, 506 (D.
Mass. 2007).
6
A registered securities principal is one who has been
certified by the Financial Industry Regulatory Authority ("FINRA")
to "manage or supervise [a member entity's] investment banking or
securities business for corporate securities, direct participation
programs, and investment company products/variable contracts." See
FINRA Registration and Examination Requirements,
http://www.finra.org/RegistrationQualifications/BrokerGuidanceRes
ponsibility/Qualifications/p011051 (last visited Dec. 3, 2008).
-5-
Columbia Funds. These duties included the sale and marketing of
the Columbia Funds and the dissemination to investors of the fund
prospectuses and other materials. As Co-President, Tambone was at
times involved in the process of revising the prospectuses,
although the SEC does not allege that he was responsible for
drafting them.
Hussey served as Senior Vice President of the Alliance
Group at Liberty Distributor from 1998 until 2000, where he was
responsible for selling funds to investment advisers and others for
the benefit of their clients. In 2000, he became Liberty
Distributor's Managing Director for National Accounts. In that
capacity, he managed the sale of the funds to broker-dealers and
other entities. Hussey held the same position, with substantially
similar responsibilities, at Columbia Distributor from January 2002
until March 2004. Throughout this period, Hussey reported directly
to Tambone. Both Tambone and Hussey thus played substantial and
direct roles in the sale and distribution of securities, and,
according to the complaint, more than half of the total
compensation that defendants received each year consisted of
commissions from fund sales.
B. The Nature of the Alleged Wrongdoing
Between 1998 and 2003, various Columbia Funds adopted
disclosure statements in their mutual fund prospectuses addressing
market timing practices engaged in by fund investors. The market
-6-
timing practice of rapidly shuffling an investment into and out of
certain targeted funds is known as engaging in "round-trips."
Although potentially beneficial to an individual investor, and not
per se illegal, round-trips and other market timing practices can
adversely affect mutual fund shareholders because the profits
obtained from market timing practices dilute the value of shares in
the fund held by long-term shareholders. Further, round-trips
increase a fund's trading costs (which are borne by all
shareholders), and may cause the mutual fund to realize capital
gains at inopportune times. To prevent such practices, language
was inserted into many of the Columbia Fund prospectuses limiting
the number of round-trips -- specifically, an exchange from one
fund to another and then back again -- a shareholder could engage
in during a given period.7 As market timing practices became more
prevalent, Columbia took additional steps to prevent such behavior.
In May 1999, certain of the prospectuses for the funds belonging to
the Acorn Fund Group began representing that "[t]he Acorn funds do
not permit market timing and have adopted policies to discourage
this practice."
Consistent with the goal of limiting market timing
behavior, Hussey, in 2000, co-led a working group that recommended
that all of the Columbia Funds adopt a consistent position against
7
For example, from 1998 through 2000, the prospectuses for
the funds within the Acorn Fund Group stated that investors would
generally be permitted to make up to four round-trips per year.
-7-
such practices in their prospectuses. The complaint states, based
on information and belief, that in April and May 2000, Hussey and
Tambone each reviewed drafts of the market timing representations
to be included in the prospectuses and offered comments via e-mail
to the in-house counsel for Columbia Advisors. Months later, a
number of the Columbia Funds revised their prospectuses to include
a statement prohibiting market timing (the "Strict Prohibition").8
By the spring of 2001, the remaining Columbia Funds belonging to
Liberty had also adopted the Strict Prohibition language in their
prospectuses. That language remained in these funds' prospectuses
until at least 2003, and was later added to prospectuses for funds
previously owned by Fleet before the acquisition.
The SEC alleges that, concurrent with these amendments,
defendants affirmatively approved or knowingly allowed frequent
trading in particular mutual funds in violation of the Strict
Prohibition disclosures contained in their prospectuses. The
Commission's second complaint details six arrangements that Tambone
8
The Strict Prohibition read:
The fund does not permit short-term or excessive trading
in its shares. Excessive purchases, redemptions or
exchanges of Fund shares disrupt portfolio management and
increase Fund expenses. In order to promote the best
interests of the Fund, the Fund reserves the right to
reject any purchase order or exchange request
particularly from market timers or investors who, in the
advisor's opinion, have a pattern of short-term excessive
trading or whose trading has been or may be disruptive to
the Fund. The funds into which you would like to
exchange may also reject your request.
-8-
approved or knowingly allowed and seven arrangements that Hussey
approved or knowingly allowed, most, but not all of which,
overlapped. We describe the alleged arrangements, none of which
were disclosed to the investors or the independent trustees of the
Columbia Funds.
(1) Hussey and Tambone approved an arrangement allowing
Ilytat, L.P. to engage in frequent and short-term trading in
Newport Tiger Fund, a Columbia mutual fund. According to the
arrangement, Ilytat would place $20 million in the Newport Tiger
Fund, with two-thirds remaining static and one-third being actively
traded. Tambone approved or became aware of the arrangement by
October 2000, when the portfolio manager for the Newport Tiger
Fund, who had initially approved the arrangement, communicated to
both Tambone and Hussey his concern about Ilytat's market timing
practices and the potential harm it could have on the fund and its
investors.9 With Hussey's approval, Ilytat was added to Columbia
9
In response to an email from the Newport Tiger Fund's
portfolio manager in October 2000 discussing Ilytat, in which the
manager states that "their active trading has increased and it has
become unbearable. There will be long term damage to the fund,"
Hussey set forth guidelines for such market timing arrangements,
including:
• Identify and close a long-term asset stream as a
quid-pro-quo to any short-term movements;
• Dictate that any short-term movements must use a
Liberty money market option to ensure gross sales
are not artificially inflated and to ensure that
Liberty generates constant management fee income;
• Bring the potential relationship to the attention
to [sic] the relevant investment management team
-9-
Services' list of "Authorized Accounts for Frequent Trading,"10 and
Hussey, in 2002, reversed a stop placed on Ilytat's trading by
Columbia Services market timing surveillance personnel.
In total, between April 2000 and October 2002, Ilytat
made 350 round-trips in seven international Columbia Funds,
including the Newport Tiger Fund and the Acorn International Fund.
At least 30 of the round-trips in the Newport Tiger Fund were made
during the period from May 2001 through September 2002 when the
fund prospectus contained the Strict Prohibition representation.11
Moreover, despite language in the prospectus for the Acorn
International Fund between September 1998 and September 2000
preventing investors from engaging in more than four round-trips
per year, Ilytat engaged in 27 such round-trips in 1999 and 18 in
2000. Ilytat also engaged in at least 20 round-trips in the fund
between July 2000 and June 2001, when the fund prospectus included
the Strict Prohibition language.
early; and
• Monitor the relationship to ensure the investment
management team's comfort.
Hussey's response, which was copied to Tambone, stated that
the Ilytat arrangement followed these guidelines.
10
The list was designed to protect certain entities from any
internal actions taken to prevent market timing practices.
11
In 2000 and early 2001, before it was amended to include the
Strict Prohibition, the prospectus for the Newport Tiger Fund
stated that "[s]hort term 'market timers' who engage in frequent
purchases and redemptions can disrupt the Fund's investment program
and create additional transaction costs that are borne by all
shareholders."
-10-
(2) From January 2000 through September 2003, Ritchie
Capital Management, Inc. traded frequently in a number of Columbia
Funds, including the Newport Tiger Fund and the Columbia Growth
Stock Fund. In late 2001, Hussey became aware of Ritchie's short-
term trading activities in the two Columbia Funds. In early 2003,
Ritchie Capital Management, Inc. entered into an arrangement with
Columbia Distributor, approved by Tambone and Hussey, designating
certain of Ritchie's investments as "sticky assets,"12 or long-term
assets, and others as available for short-term trading.
(3) In late 2002 or early 2003, Edward Stern entered into
two separate agreements with Columbia Distributor through
intermediaries. One arrangement, secured by Epic Advisors on
behalf of Stern's Canary Investment Management firm, and approved
by Tambone, allowed Stern entities to make three round-trips per
month in each of three Columbia funds. Each fund's prospectus
contained the Strict Prohibition language. The second agreement
involved the placement of $5 million in the Columbia High Yield
Fund, whose prospectus also contained the Strict Prohibition
disclosure. That arrangement, approved by the fund's portfolio
manager, permitted Stern to make one round-trip each month.
12
"Sticky assets" are investment assets that remain in place
within a given fund for an extended period of time. A "sticky
asset" arrangement typically involves keeping these "sticky assets"
in place for a given period of time in return for permission to
actively trade another amount of assets more frequently.
-11-
(4) In 1999, Daniel Calugar was allowed to place up to
$50 million in the Columbia Young Investor Fund and the Columbia
Growth Stock Fund, with permission to make one round-trip per month
with the entire amount. In 2000, knowing that Calugar was trading
at levels exceeding their arrangement, Hussey expressed concern
that Calugar's activities were harming the funds, but took no
action to limit the trading activities. Tambone was apprised by
Hussey of Calugar's activities, but also took no action. Calugar
continued the short-term trading activities until at least August
2001, several months after the funds at issue adopted the Strict
Prohibition language in their prospectuses.
(5) Tambone approved a "sticky asset" arrangement
between Columbia Distributor and broker Sal Giacalone in late 2000.
Per the terms of the arrangement, Giacalone was allowed to make
four round-trips per month of up to $15 million in the Newport
Tiger Fund so long as he also placed $5 million in the long-term
assets of the Acorn Fund. Between November 2000 and April 2001,
Giacalone made a total of 43 round-trips in the Newport Tiger Fund
pursuant to the arrangement.
(6) Hussey approved an arrangement with D.R. Loeser in
late 1998 allowing Loeser to make five round-trips per month of up
to $8 million in the Columbia Growth Stock Fund. In the first five
months of 2000, Loeser made approximately 20 round-trips in the
Growth Stock Fund and another 20 round-trips in the Young Investor
-12-
Fund. Despite knowledge by Tambone and Hussey of Loeser's trading
practices, neither took action to halt the trading activities.
(7) Signalert entered into an arrangement with Columbia
Distributor in 1999, approved by Hussey, in which it agreed to
invest $7.5 million in the Growth Stock Fund and $7.5 million in
the Young Investor Fund in exchange for permission to engage in 10
round-trips annually in each of the funds. Pursuant to the
arrangement, Signalert was also required to place $5 million in
each of six other funds, which could be traded just once each
quarter. During 2000-2001, Signalert made over 50 round-trips in
the Growth Stock Fund and approximately 50 round-trips in the Young
Investor Fund. These included 20 round-trips in the Young Investor
Fund between February and August 2001, after the fund's prospectus
had been amended to include the Strict Prohibition language.
(8) In early 2000, Columbia Distributor agreed to allow
Tandem Financial to make an unlimited number of trades in one or
more of the Columbia Funds. During the period from April 2001
through September 2003, Tandem made 106 round-trips in the Columbia
Tax Exempt Fund, despite the Strict Prohibition disclosure in the
fund prospectus. Hussey and one of Tambone's subordinates became
aware of Tandem's activities in early 2003.
The complaint alleged that Columbia Advisors, itself or
through portfolio managers for the separate funds, knew or approved
of all of the market timing arrangements, except the arrangement
-13-
with Tandem. In total, during the approximately five-year period
from 1998 to 2003, hundreds of round-trips were executed in the
Columbia Funds in amounts approaching $2.5 billion.
Meanwhile, in his position as Managing Director for
National Accounts, Hussey also helped lead a task force established
to develop procedures for detecting and preventing market timing
activities in the Columbia Funds. Hussey was the designated
contact for inquiries about market timing, including what actions,
if any, should be taken if such activity was detected. In this
capacity, he participated in the creation of a list of "Accounts
Approved for Frequent Trading."13 According to the second
complaint, both Hussey and Tambone, on multiple occasions, blocked
or allowed their subordinates to block efforts to halt the trading
activity of preferred customers.
In addition to overseeing the distribution of
prospectuses, Tambone, on behalf of Columbia Distributor, signed
hundreds of selling agreements for Columbia Funds during this
13
The complaint describes an email forwarded to Hussey by the
market timing surveillance manager describing the differential
treatment given to favored investors:
I review 3 different reports each day that reflect
accounts fitting this criteria [the definition of market
timers]. After these accounts are located, I take action
against some of them. The accounts that are recognized
as timers (that do not have some kind of existing
relationship with us) merit trade cancellations and
placement of account stops. The accounts that are
allowed to trade (due to a sales relationship) are
ignored.
-14-
period. Each selling agreement stated the procedures by which the
customer would purchase shares of the Columbia Funds from Columbia
Distributor and contained express representations and warranties
related to the content of the prospectuses. Tambone referred the
purchaser to the fund prospectuses for information on the fund and
specifically stated in each agreement that "[w]e shall furnish
prospectuses and sales literature upon request."
The SEC learned of the alleged conduct of defendants and
the various Columbia entities during the course of its
investigation of market timing practices of many fund companies.
See Gretchen Morgenson & Landon Thomas, Jr., S.E.C. Finding Fund
Abuses, Official Says, N.Y. Times, Oct. 25, 2003, at C1 ("[A]fter
sending out 88 letters to mutual fund companies and brokerage
firms, [the SEC] found that half . . . had arrangements with one or
more investors allowing them to trade in and out of shares. These
arrangements occurred even though about half of the fund companies
have policies specifically barring market timing, the official
said."). Prior to filing its initial complaint in this case, the
Commission obtained extensive discovery from Columbia, reviewing
hundreds of thousands of pages in documents and taking the sworn
testimony of Mr. Hussey and over 20 other witnesses.14
14
Section 21 (a)(1) of the Securities Exchange Act of 1934
gives the SEC broad authority to "make such investigations as it
deems necessary to determine whether any person has violated, is
violating, or is about to violate any provision of [the Exchange
Act and] the rules or regulations thereunder . . . ." 15 U.S.C. §
-15-
C. Procedural History
The SEC filed a complaint against defendants Tambone and
Hussey in February 2005 alleging securities fraud based on the
above allegations.15 The complaint alleged that defendants
committed primary acts of fraud in violation of section 10(b) of
the Securities Exchange Act, Rule 10b-5, and section 17(a)(2) of
the Securities Act. It also alleged that defendants aided and
abetted primary violations committed by Columbia Advisors and
Columbia Distributor in violation of section 206 of the Advisers
Act, and primary violations committed by Columbia Distributor in
violation of section 15(c)(1) of the Exchange Act. The complaint
sought three remedies: (1) a permanent injunction to restrain
Tambone and Hussey from further violating, either directly or
indirectly, the statutory provisions implicated in this case; (2)
78u(a)(1).
15
In February 2005, the SEC settled an enforcement action
against Columbia Advisors, Columbia Distributor, and three former
Columbia executives related to undisclosed market timing
arrangements in the Columbia Funds. Without admitting or denying
the SEC's findings, Columbia Advisor and Columbia Distributor
agreed to pay $70 million in disgorgement and a civil penalty of
$70 million to the SEC, to be distributed to investors harmed by
the conduct. Press Release, U.S. Securities and Exchange
Commission, Fleet's Columbia Mutual Fund Adviser and Distributor to
Pay $140 Million to Settle SEC Fraud Charges for Undisclosed Market
Timing, 2005-15 (Feb. 9, 2005) (available at
http://www.sec.gov/news/press/2005-15.htm). As a result, the SEC's
claims in this case are targeted at Tambone and Hussey only,
although to establish aiding and abetting liability against these
defendants, the SEC is also required to allege claims against
Columbia Advisors and/or Columbia Distributor for primary
violations of the securities laws.
-16-
disgorgement and pre-judgment interest; and (3) unspecified civil
penalties. See 15 U.S.C. §§ 77t(d), 78u(d)(3), and 80b-9(e).
The defendants moved to dismiss the complaint for failure
to plead fraud with particularity as required by Fed. R. Civ. P.
9(b) and for failure to state a claim upon which relief could be
granted under Rule 12(b)(6). The district court granted the
motions without prejudice on January 27, 2006.
On March 16, 2006, the SEC moved for leave to amend the
original complaint. Before that motion was resolved, the SEC moved
for relief from judgment pursuant to Fed. R. Civ. P. 60(b), having
realized that a motion for leave to amend cannot be considered
after a case has been dismissed. The district court denied both
motions on May 5, 2006.
On May 19, 2006, the SEC filed a second complaint which
sought the same remedies but raised an additional aiding and
abetting offense and offered supplemental factual allegations to
support all of the claimed violations. As characterized by the
district court, the Commission's second complaint contained 110
paragraphs nearly identical to those in the initial complaint, and
twelve additional paragraphs alleging new facts. The additional
paragraphs state generally that both defendants participated in the
review and oversight processes related to market timing issues for
the Columbia Funds, and specifically allege that defendants were
responsible for misrepresentations on market timing in the fund
-17-
prospectuses.16 Despite these additions, the district court again
dismissed the Commission’s claims on December 29, 2006, this time
with prejudice.
Addressing the question of primary liability, the court
applied an attribution test. That is, the court stated that to be
liable under "Section 10(b) of the Exchange Act and Section 17(a)
of the Securities Act, a defendant must have personally made either
an allegedly untrue statement or a material omission." Despite the
SEC's allegations that defendants had participated in working
groups and task forces that led to the revision of the market
timing statements in the false and misleading prospectuses, and
then used those prospectuses to sell the mutual funds, the court
concluded that "[t]he major flaw with the SEC's complaint was then,
and continues to be, a failure to attribute misleading statements
to either Tambone or Hussey." According to the district court,
neither the defendants' roles in disseminating the allegedly
misleading prospectuses nor their participation in the process of
revising the disclosures was sufficient to satisfy the provisions'
attribution requirement.
The court also found other deficiencies in the SEC's
complaint. First, the court ruled that the SEC had failed to
satisfy the pleading particularity requirements imposed by Fed. R.
16
From this point forward in the opinion, we shall refer to
the second complaint as "the complaint."
-18-
Civ. P. 9(b), noting that "[t]he new paragraphs fail [] to identify
the substance of the comments made by either Tambone or Hussey . .
. and . . . fail to allege that any of the language reviewed or
proposed by either defendant was ever actually incorporated into
the fall 2001 prospectus." Second, the court rejected the
Commission's allegation that Tambone and Hussey owed a duty to the
investors to whom they sold the funds. It wrote: "[A]n individual
owes a duty to clarify a misleading statement only if that
statement is attributable to the individual." Without any
statement attributable to them, the defendants could not be held
liable for misleading statements or omissions in the prospectuses,
nor for failing to correct the false prospectuses.
Finally, the court dismissed the SEC's aiding and
abetting allegations, finding that the "SEC had not sufficiently
alleged that the defendants consciously threw in their lot with the
primary violators."
The SEC challenges these conclusions of the district
court on appeal.
II.
We review the district court's grant of a motion to
dismiss de novo. Rodríguez-Ortiz v. Margo Caribe, Inc., 490 F.3d
92, 95 (1st Cir. 2007). Although Fed. R. Civ. P. 8(a)(2) requires
only "a short and plain statement of the claim" sufficient to give
the defendant fair notice of the claim and its factual basis, see
-19-
Conley v. Gibson, 355 U.S. 41, 47 (1957), the "plain statement"
must "possess enough heft to 'sho[w] that the pleader is entitled
to relief.'" Bell Atl. Corp. v. Twombly, 127 S. Ct. 1955, 1966
(2007) (quoting Fed. R. Civ. P. 8(a)(2)). A plaintiff's task
"requires more than labels and conclusions, and a formulaic
recitation of the elements of a cause of action." Id. at 1965; see
also Rodríguez-Ortiz, 490 F.3d at 95.
When reviewing a ruling on a motion to dismiss under Rule
12(b)(6), we accept all well-pleaded facts as true and draw all
reasonable inferences in favor of the plaintiff. ACA Fin. Guar.
Corp. v. Advest, Inc., 512 F.3d 46, 58 (1st Cir. 2008). We are not
limited to the district court's reasoning, but "may affirm an order
of dismissal on any basis made apparent by the record." Ramos-
Pinero v. Puerto Rico, 453 F.3d 48, 51 (1st Cir. 2006).
The SEC must also satisfy the heightened pleading
standard set by Fed. R. Civ. P. 9(b) for allegations of fraud. The
heightened standard applies both where fraud is an essential
element of the claim, as in the Commission's claims under section
10(b), and where the plaintiff alleges fraud even though it is not
a statutory element of the offense, as in the SEC's claims under
section 17(a)(2). Shaw v. Digital Equip. Corp., 82 F.3d 1194, 1223
(1st Cir. 1996) ("It is the allegation of fraud, not the ‘title’ of
the claim that brings the policy concerns [underlying Rule 9(b)] .
. . to the forefront." (quoting Haft v. Eastland Fin. Corp., 755 F.
-20-
Supp. 1123, 1133 (D.R.I. 1991))); see also ACA Fin., 512 F.3d at
68. Rule 9(b) mandates that "[i]n all averments of fraud or
mistake, the circumstances constituting fraud or mistake shall be
stated with particularity."17 Fed. R. Civ. P. 9(b). "Malice,
intent, knowledge, and other condition of mind of a person may be
averred generally." Id. To satisfy the particularity element, we
require that the Commission's complaint include the "time, place,
and content of the alleged misrepresentation with specificity."
Greebel v. FTP Software, Inc., 194 F.3d 185, 193 (1st Cir. 1999).
Further, "[w]here allegations of fraud are explicitly or . . .
implicitly[] based only on information and belief, the complaint
must set forth the source of the information and the reasons for
the belief." Romani v. Shearson, Lehman, Hutton, 929 F.2d 875, 878
(1st Cir. 1991).
To establish scienter, we ordinarily require that a
plaintiff allege sufficient facts to give rise to a "strong
inference that the defendant acted with the required state of
mind." 15 U.S.C. § 78u-4(b)(2); see also ACA Fin., 512 F.3d at 58-
59. We developed this heightened standard in the context of
private securities actions "to minimize the chance 'that a
17
Since the SEC filed its complaint, Rule 9(b) "has been
amended as part of the general restyling of the Civil Rules to make
them more easily understood and to make style and terminology
consistent throughout the rules." We recite the text of the old
version of the rule. The changes were "intended to be stylistic
only." Fed. R. Civ. P. 9 advisory committee's notes (2007
amendment).
-21-
plaintiff with a largely groundless claim will bring a suit and
conduct extensive discovery in the hopes of obtaining an increased
settlement, rather than in the hopes that the process will reveal
relevant evidence,'" Shaw, 82 F.3d at 1223 (quoting Romani, 929
F.2d at 878), and it was largely codified by Congress in the
Private Securities Law Reform Act of 1995 ("PSLRA"). See ACA Fin.,
512 F.3d at 58 n.7 (noting that our prior application of Fed. R.
Civ. P. 9(b) to allegations of scienter in private securities fraud
actions is consistent with the standard imposed by the PSLRA);
Greebel, 194 F.3d at 193 ("The PSLRA's pleading standard is
congruent and consistent with the pre-existing standards of this
circuit.").
Here, however, we are evaluating a securities complaint
filed by the SEC, not a private actor. Therefore, on its face,
the requirements of the PSLRA do not apply. Additionally, the
rationales we set forth for a more demanding standard in private
securities actions do not apply to this SEC enforcement action.
Whereas private parties have a financial incentive to initiate
"strike" suits and drag deep-pocketed defendants into court on
allegations of fraud in hopes of obtaining a lucrative settlement,
the SEC's statutory task is to protect the investing public by
policing the securities markets and preventing fraud. Moreover,
as noted above, the SEC possesses the authority to investigate
conduct prior to filing a complaint, thereby minimizing the
-22-
concerns that may result from a lengthy and intense discovery
process. See 15 U.S.C. § 78u(a)(1); cf. Merrill Lynch, Pierce,
Fenner & Smith, Inc. v. Dabit, 547 U.S. 71, 80-81 (2006) (noting
that the standard for establishing a claim under section 10(b) is
higher in the context of a private suit than in an SEC enforcement
action because courts are rightly concerned with limiting the
"vexatiousness" associated with private Rule 10b-5 suits).
Therefore, the additional scrutiny applied to allegations of
scienter in private securities fraud complaints is unwarranted in
this case. See, e.g., SEC v. Lucent Techs., Inc., 363 F. Supp. 2d
708, 717 (D.N.J. 2005) ("[T]he heightened requirements for
pleading scienter under the PSLRA do not apply to actions brought
by the SEC."); SEC v. ICN Pharm., Inc., 84 F. Supp. 2d 1097, 1099
(C.D. Cal. 2000) ("[T]he 'more rigorous' pleading requirements
under the PSLRA, which go beyond the Rule 9(b) requirements only
apply to private securities fraud actions; they do not apply to a
case . . . brought by the SEC."). Of course, the ordinary
scienter requirements of Rule 9(b) apply. The SEC need only
allege scienter generally. Fed. R. Civ. P. 9(b).
Although we decline to apply the "strong inference"
requirement of the PSLRA, we rely on the method elucidated
recently by the Supreme Court to assess whether scienter has been
adequately alleged. See Tellabs, Inc. v. Makor Issues & Rights,
-23-
Ltd., 127 S.Ct. 2499, 2509 (2007).18 Accordingly, we evaluate "the
complaint in its entirety" to determine "whether all of the facts
alleged, taken collectively" meet the scienter standard. Id.
Further, we conduct a fact-specific inquiry that considers the
circumstances and allegations of the particular case, rather than
relying on a generalized pattern of facts as evidence of motive
and opportunity. Greebel, 194 F.3d at 196 ("The categorization of
patterns of facts as acceptable or unacceptable to prove scienter
or to prove fraud has never been the approach this circuit has
taken to securities fraud."); In re Cabletron Sys., Inc., 311 F.3d
11, 32 (1st Cir. 2002) ("Each securities fraud complaint must be
analyzed on its own facts; there is no one-size-fits-all
template.").
III.
A. Statutory Background
We begin our analysis of the SEC's claims with the text,
history, and purpose of the provisions at issue. See Ernst &
Ernst v. Hochfelder, 425 U.S. 185, 197 (1976) ("[t]he starting
point in every case involving construction of a statute is the
language itself." (quoting Blue Chip Stamps v. Manor Drug Stores,
421 U.S. 723, 756 (1975) (Powell, J., concurring))). The
18
In Tellabs, the Supreme Court was faced with the question
of how to assess whether a private securities complaint alleged
sufficient facts to establish a "strong inference" of scienter
against the defendant, as required by the PSLRA.
-24-
Securities Act of 1933 and the Exchange Act of 1934 were enacted
to "set the economy on the road to recovery" after the 1929 stock
market crash and reports of widespread fraud and abuse in the
securities industry. United States v. Naftalin, 441 U.S. 768, 775
(1979); see also Central Bank of Denver, N.A. v. First Interstate
Bank of Denver, N.A., 511 U.S. 164, 170-71 (1994). Together, the
acts promote this goal by prohibiting fraud through a scheme of
civil and criminal19 liability and "substitut[ing] a philosophy of
full disclosure for the philosophy of caveat emptor." SEC v.
Capital Gains Research Bureau, 375 U.S. 180, 186 (1963). Although
the Securities Act was primarily concerned with the regulation of
new offerings and the Exchange Act with post-distribution trading,
section 17(a) of the Securities Act "was meant as a major
departure" from the scope of the rest of that statute, and was
"intended to cover any fraudulent scheme in an offer or sale of
securities, whether in the course of an initial distribution or in
the course of ordinary market trading." Naftalin, 441 U.S. at
777-78; see also Central Bank, 511 U.S. at 171.
The text of the statutes confirms their common purpose
to prohibit a wide swath of fraudulent behavior that Congress
believed impeded the smooth and honest functioning of the
19
Criminal penalties may be imposed if an individual or entity
is found to have willfully violated section 17(a) of the Securities
Act. 15 U.S.C. § 77x; see Naftalin, 441 U.S. at 778 (criminal
prosecution under section 17(a)).
-25-
securities markets. See Naftalin, 441 U.S. at 775-78; Ernst &
Ernst, 425 U.S. at 194. Section 17(a) was designed to address the
most egregious abuses of securities sellers by authorizing the SEC
to punish violators through injunctive relief or criminal
liability rather than by means of private causes of action. See,
e.g., SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 867 (2d Cir.
1968) (Friendly, J., concurring) ("[T]here is unanimity . . . that
§ 17(a)(2) of the 1933 Act -- indeed the whole of § 17 -- was
intended only to afford a basis for injunctive relief and, on a
proper showing, for criminal liability . . . ."); see also David
S. Ruder, Civil Liability under Rule 10b-5: Judicial Revision of
Legislative Intent?, 57 Nw.U. L. Rev. 627, 656 (1963) (referencing
the statute's legislative history). Section 17(a) states:
It shall be unlawful for any person in the offer or sale
of any securities . . . by the use of any means or
instruments of transportation or communication in
interstate commerce or by use of the mails, directly or
indirectly
(1) to employ any device, scheme, or artifice to
defraud, or
(2) to obtain money or property by means of any untrue
statement of a material fact or any omission to state a
material fact necessary in order to make the statements
made, in light of the circumstances under which they were
made, not misleading; or
(3) to engage in any transaction, practice, or course of
business which operates or would operate as a fraud or
deceit upon the purchaser.
15 U.S.C. § 77q(a). Section 10(b) of the 1934 Act performs a
similar catch-all function and also extends coverage beyond
-26-
securities sellers. See Texas Gulf Sulphur, 401 F.2d at 859-60.
Section 10(b) states:
It shall be unlawful for any person, directly or
indirectly . . . .
(b) To use or employ, in connection with the purchase or
sale of any security . . . any manipulative or deceptive
device or contrivance in contravention of such rules and
regulations as the [Securities and Exchange] Commission
may prescribe as necessary or appropriate in the public
interest or for the protection of investors.
15 U.S.C. § 78j(b).
"Section 10(b) of the Exchange Act bars conduct
involving manipulation or deception, manipulation being practices
. . . that are intended to mislead investors by artificially
affecting market activity, and deception being misrepresentation,
or nondisclosure intended to deceive." Ganino v. Citizens Utils.
Co., 228 F.3d 154, 161 (2d Cir. 2000) (quotation marks and
citation omitted). By its literal terms, section 10(b) applies to
conduct in violation of rules and regulations issued by the SEC.
Its prohibitions were given effect almost a decade after its
enactment with the SEC's adoption of Rule 10b-5, among other
rules. The Rule largely mimics the language of section 17(a)
while applying to both the sale and purchase of any security:
It shall be unlawful for any person, directly or
indirectly . . .
(a) To employ any device, scheme, or artifice to
defraud,
(b) To make any untrue statement of a material fact or
to omit to state a material fact necessary in order to
make the statements made, in the light of the
circumstances under which they were made, not
misleading, or
-27-
(c) To engage in any act, practice, or course of
business which operates or would operate as a fraud or
deceit upon any person, in connection with the purchase
or sale of any security.
17 C.F.R. § 240.10b-5. The rule "encompasses only conduct already
prohibited by § 10(b)." Stoneridge Inv. Partners, LLC v.
Scientific-Atlanta, Inc., 128 S. Ct. 761, 768 (2008); see United
States v. O'Hagan, 521 U.S. 642, 651 (1997). Because of its broad
scope and its availability to private plaintiffs, Rule 10b-5 "is
the most commonly used basis for private suits charging fraud in
connection with the purchase or sale of securities." See 3 Thomas
Lee Hazen, Treatise on the Law of Securities Regulation
§ 12.4[1] (5th ed. 2005); see also Ernst & Ernst, 425 U.S. at 196
("During the 30-year period since a private cause of action was
first implied under § 10(b) and Rule 10b-5, a substantial body of
case law and commentary has developed as to its elements.")
(footnote omitted).
Although the text of section 17(a) is nearly identical
to the text of Rule 10b-5, as indeed section 17(a) served as the
guide for Rule 10b-5, there are several key distinctions between
the provisions. See generally 3 Hazen, supra, § 12.22; see also
15 U.S.C. § 77q; 17 C.F.R. § 240.10b-5. First, whereas section
17(a) applies only to brokers and dealers selling or offering to
sell securities, Rule 10b-5 explicitly covers "any person" who
commits a fraudulent act "in connection with the purchase or sale
-28-
of any security."20 See Exchange Act Release No. 3230, 7 Fed. Reg.
3804 (May 21, 1942) (Rule 10b-5 was intended to "close[] a
loophole in the protections against fraud administered by the
Commission by prohibiting individuals or companies from buying
securities if they engage in fraud in their purchase.") (emphasis
added); see also 3 Hazen, supra, § 12.22. Moreover, section 10(b)
and Rule 10b-5 reach only conduct that "coincides" with a
securities transaction –- a sale or purchase, see Merrill Lynch,
547 U.S. at 85 -- and not a fraudulent offer alone.21 In contrast,
because section 17(a) applies to both sales and offers to sell
securities, the SEC need not base its claim of liability on any
completed transaction at all. See Blue Chip Stamps, 421 U.S. at
20
Rule 10b-5 explicitly modified the language of section 17(a)
to create an antifraud prohibition that expanded beyond the sale
context. According to Milton Freeman, one of the rule's co-
drafters, Rule 10b-5 was hastily drafted and approved in response
to a report that the president of a company was buying up his
company's stock based on false statements regarding its financial
outlook. In an attempt to address this specific situation, Freeman
claims to have combined sections 10(b) and 17. Discussion centered
on where the phrase "in connection with the purchase or sale"
should be located. The Commission quickly approved the provision
without any discussion except a statement by Commissioner Sumner
Pike to the effect of, "Well, we are against fraud, aren't we?"
Milton V. Freeman, Conference on Codification of the Federal
Securities Laws: Administrative Procedures, 22 Bus. Law. 891, 922
(1967); see also Blue Chip Stamps, 421 U.S. at 767 (Blackmun, J.,
dissenting).
21
In Blue Chip Stamps, the Supreme Court further confined the
scope of Rule 10b-5 in the context of private causes of action.
421 U.S. at 731-34. Based on policy concerns, the court held that
only actual purchasers or sellers of securities have standing to
bring a private cause of action under Rule 10b-5. Id. at 733-35.
-29-
733-34 (contrasting the text of section 10(b) with that of section
17(a)); Naftalin, 441 U.S. at 773 (explaining that the statutory
terms "offer" and "sale" are "expansive enough to encompass the
entire selling process, including the seller/agent transaction");
see also 3 Hazen, supra, § 12.22.
In addition, as stated above, although private
plaintiffs can maintain a cause of action under Rule 10b-5, only
the SEC may bring a claim to enforce the prohibitions of section
17(a). See Ernst & Ernst, 425 U.S. at 196 ("Although § 10(b) does
not by its terms create an express civil remedy for its violation,
and there is no indication that Congress, or the Commission when
adopting Rule 10b-5, contemplated such a remedy, the existence of
a private cause of action for violations of the statute and the
Rule is now well established.") (footnote omitted); Maldonado v.
Dominguez, 137 F.3d 1, 6-8 (1st Cir. 1998) (joining a majority of
circuits in rejecting a private right of action under section
17(a)).22
22
In Maldonado, we based our decision not to imply a private
right of action in section 17(a) on our assessment of congressional
intent, which we ascertained through the express language of
section 17(a) and its neighboring provisions, as well as the
statute's legislative history. 137 F.3d at 6-8. Noting that
Congress explicitly provided for private causes of action in
sections 11 and 12 of the Securities Act of 1933 but not section
17(a), we concluded that because these provisions "address much of
the same conduct and benefit the same parties as a potential
implied private cause of action, the circumstances [relating to
section 17(a)] militate against that inference." Id. at 7-8.
-30-
Finally, the degree of scienter required to establish a
violation under Rule 10b-5 and section 17(a)(2) differs. To prove
a claim under section 17(a)(2), the subsection pertaining to false
statements or omissions, the SEC need show only that the
defendants acted negligently. Under section 10(b) and Rule 10b-5,
however, the SEC must prove that defendants acted with intent,
knowledge or a high degree of recklessness. See Aaron v. SEC, 446
U.S. 680, 690-97 (1980); Maldonado, 137 F.3d at 7. This
distinction follows closely from the text of the respective
provisions. See Aaron, 446 U.S. at 690-97. Deciding the state of
mind requirements for section 10(b), the Court set forth in Ernst
& Ernst, and confirmed in Aaron, that Congress's inclusion of the
terms "manipulative," "device," and "contrivance" in section 10(b)
indicated that it sought to limit liability to acts that involved
scienter. Ernst & Ernst, 425 U.S. at 197 ("The words
'manipulative or deceptive' used in conjunction with 'device or
contrivance' strongly suggest that § 10(b) was intended to
proscribe knowing or intentional misconduct."); see also Aaron,
446 U.S. at 690-91. By contrast, the Court has noted that section
17(a)(2) "is devoid of any suggestion whatsoever of a scienter
requirement."23 Aaron, 446 U.S. at 696. Nevertheless, the SEC did
23
Likewise, section 17(a)(3), because it "focuses upon the
effect of particular conduct on members of the investing public,
rather than upon the culpability of the person responsible,"
Aaron, 446 U.S at 697, "does not require a 'showing [of] deliberate
dishonesty as a condition precedent to protecting investors.'" Id.
-31-
not rely on this distinction in its section 17(a)(2) claims
against appellees, alleging in the complaint that they acted with
intent, knowledge, or a high degree of recklessness.
The SEC has also invoked two additional statutory
provisions against the defendants. The 1934 Exchange Act includes
an additional antifraud provision targeted specifically at brokers
or dealers operating in the over-the-counter market.24 See 15
U.S.C. § 78o(c)(1)(A). Section 15(c)(1)(A) of the Act states:
No broker or dealer shall make use of the mails or any
means or instrumentality of interstate commerce to
effect any transaction in, or to induce or attempt to
induce the purchase or sale of, any security (other than
[certain exempted securities]) . . . by means of any
manipulative, deceptive, or other fraudulent device or
contrivance.
Id.
Finally, the Investment Advisers Act of 1940 "was
enacted to deal with abuses that Congress had found to exist in
the investment advisers industry." Transamerica Mortgage
Advisors, Inc. v. Lewis, 444 U.S. 11, 12-13 (1979). Intended to
"benefit the clients of investment advisers," id. at 17, Section
206 of the Act "establishes federal fiduciary standards"
(quoting Capital Gains, 375 U.S. at 200).
24
The over-the-counter market consists of stocks which do not
trade on a securities exchange. Louis Loss & Joel Seligman,
Fundamentals of Securities Regulation 753 (5th ed. 2004). Because
such trading is not centralized, it involves direct transactions
between potential buyers and market makers, who deal in a
particular security. See id.
-32-
enforceable by the SEC. Id. at 17, 24 (quotation marks and
citation omitted). The statute reads:
It shall be unlawful for any investment adviser, by use
of the mails or any means or instrumentality of
interstate commerce, directly or indirectly --
(1) to employ any device, scheme, or artifice to defraud
any client or prospective client;
(2) to engage in any transaction, practice, or course of
business which operates as a fraud or deceit upon any
client or prospective client . . . .
15 U.S.C. § 80b-6(1)-(2).
B. The SEC's Claims
In its complaint, the SEC alleges primary and secondary
violations of the securities laws by Tambone and Hussey. Primary
violations refer to violations committed by Tambone and Hussey
themselves; secondary violations, also known as aiding and
abetting violations, refer to actions committed by the defendants
that aided and abetted other actors who committed primary
violations of the securities laws.25
25
The text of a securities statute defines the scope of
primary liability against a defendant. Primary liability may not
attach to conduct that falls short of the explicit statutory
language. Central Bank, 511 U.S. at 177-78. Secondary liability
involves claims brought against individuals and entities for
conduct that substantially contributes to another party's
fraudulent behavior, but does not rise to the level of primary
liability. See 15 U.S.C. § 78t(e) ("[A]ny person that knowingly
provides substantial assistance to another person in violation of
a provision of this chapter, or of any rule or regulation issued
under this chapter, shall be deemed to be in violation of such
provision to the same extent as the person to whom such assistance
is provided."). Although both the SEC and private individuals may
raise claims of primary liability against a defendant, only the SEC
may now bring claims of secondary liability against a defendant.
See id.; see also Central Bank, 511 U.S. at 191.
-33-
The SEC alleges that Tambone and Hussey, officers of
Columbia Distributors, the primary underwriter responsible for
directing efforts to sell the Columbia Funds to investors,
committed primary violations of section 17(a)(2) of the Securities
Act by selling, and offering to sell, the Columbia securities with
false prospectuses. As such, they are alleged to have "obtain[ed]
money or property by means of [an] untrue statement of a material
fact." 15 U.S.C. § 77q(2)(a) (emphasis added).
Additionally, the SEC alleges that Tambone and Hussey
made untrue statements of material fact and hence also committed
primary violations of section 10(b) of the Exchange Act and Rule
10b-5. See 17 C.F.R. § 240.10b-5(b). As officers of the primary
underwriter for the Columbia Funds, appellees had a legal duty to
review and confirm, to a reasonable degree, the accuracy and
completeness of the prospectus statements they were responsible
for distributing. The SEC argues that, by overseeing the
distribution of prospectuses which they knew, or were reckless in
not knowing, contained false and misleading statements, Tambone
and Hussey adopted those statements as their own. The SEC also
alleges that, in light of their duties as primary underwriters --
securities professionals engaged in the offer and sale of
securities -- Tambone and Hussey impliedly made their own
statements to potential investors that they "had a reasonable
basis to believe that the key representations in the prospectuses
-34-
were truthful and complete." The SEC contends that, because the
prospectus statements prohibiting market timing were inaccurate,
this implied statement was false, a fact that defendants knew or
were reckless in not knowing when they used the prospectuses to
sell Columbia Funds.
The same allegations of fraudulent conduct engaged in by
Tambone and Hussey form the basis of the SEC's claims of secondary
liability under section 10(b), Rule 10b-5, section 206, and
section 15(c) of the securities laws. Specifically, the
Commission avers that the defendants substantially assisted
Columbia Advisors and Columbia Distributor in committing acts of
primary liability under the securities laws. By overseeing the
distribution of fund prospectuses which they knew (or were
reckless in not knowing) were false, the defendants assisted these
entities in making false statements to the public in connection
with the sale of Columbia securities.
IV.
A. The Scope of Liability under Section 17(a)(2) of the
Securities Act
Although the SEC's complaint raises general allegations
of fraud under sections 17(a)(1)-(3), the SEC only appeals the
district court's conclusions regarding section 17(a)(2), which
addresses untrue statements. To state a claim under section
17(a)(2), which is intended to prohibit fraud by securities
sellers, the SEC must allege that Tambone and Hussey have (1)
-35-
directly or indirectly (2) obtained money or property (3) by means
of any untrue statement of material fact or any omission to state
a material fact necessary in order to make the statements made, in
light of the circumstances under which they were made, not
misleading, such statement having been made (4) with negligence26
(5) in the offer or sale of any securities. See 15 U.S.C. § 77q;
Aaron, 446 U.S. at 696; see generally 3 Hazen, supra, § 12.22
(discussing the elements).
The parties agree that the SEC has adequately alleged
elements one, four, and five of the statute, but dispute the scope
of conduct covered under elements two and three, and also whether
the complaint adequately alleges these two elements. On the
question of the scope of actionable conduct, the SEC asserts that
section 17(a)(2) extends liability not only to securities sellers
who have directly communicated their personal false or misleading
statements to potential investors in the course of offering or
selling securities to them, but also to sellers who have obtained
money or property "by means of" an untrue statement of material
fact drafted or approved by another individual. Relying on the
statute's passive formulation and its focus on the conduct of
securities sellers, the Commission argues that the scope of
26
As we noted above, the SEC does not rely on this diminished
state of mind requirement when alleging its claims under section
17(a)(2). The SEC alleges that the defendants acted with knowledge
or a high degree of recklessness.
-36-
section 17(a)(2)'s prohibition is broader than that of section
10(b) and Rule 10b-5(b), which prohibit a securities actor from
"mak[ing] any untrue statement."
The defendants contest this reading of section 17(a)(2).
Specifically, they assert that the language "obtain money or
property by means of any untrue statement of a material fact" is
coterminous with the language of Rule 10b-5(b), which prohibits a
securities actor from "mak[ing] a statement." 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. To support this interpretation
of section 17(a)(2), Tambone and Hussey cite several cases that
equate the prohibitions of section 17(a) with those of section
10(b) and Rule 10b-5. See, e.g., SEC v. Monarch Funding Corp.,
192 F.3d 295, 308 (2d Cir. 1999)("Essentially the same elements
[as those required to show a violation of section 10(b) and Rule
10b-5] are required under Section 17(a)(1)-(3) in connection with
the offer or sale of a security . . . ."); SEC v. First Jersey
Sec., Inc., 101 F.3d 1450, 1467 (2d Cir. 1996). Noting that the
language of the provisions is nearly identical, and indeed, that
section 17(a) served as the model for Rule 10b-5, the defendants
assert that it defies logic and language to read section 17(a) as
prohibiting a broader range of conduct than Rule 10b-5. The
defendants also highlight the SEC's own failure to cite any case
-37-
law drawing the distinction that the SEC claims follows from the
text of the provisions. Accordingly, the defendants urge us to
read section 17(a) and section 10(b) as prohibiting the same range
of conduct, and thereby conclude that in order for the SEC to
state a claim of primary liability under section 17(a)(2), it must
allege that the defendants have made a false or misleading
statement.27
Without explicitly analyzing the text of section
17(a)(2), the district court adopted the defendants' position,
concluding that the provisions were identical for purposes of
evaluating the SEC's various claims in this case. Accordingly,
the court grouped section 17(a) together with section 10(b) when
undertaking its analysis. Citing Wright v. Ernst & Young LLP, 152
F.3d 169, 175 (2d Cir. 1998), a decision applying the language of
section 10(b) and Rule 10b-5 in a private securities action, the
district court explained that "[i]n order to be liable for a
primary violation of Section 10(b) of the Exchange Act and Section
17(a) of the Securities Act, a defendant must have personally made
either an allegedly untrue statement or a material omission."28
27
As we discuss below, the defendants then go on to argue that
the SEC has failed to allege that the defendants made any false or
misleading statement in connection with the sale or purchase of
securities. Tambone and Hussey argue that, having failed to state
a claim under section 10(b) and Rule 10b-5(b), the SEC has equally
failed to state a claim under section 17(a)(2).
28
Because Wright was a private suit, and section 17(a) claims
may be brought only by the SEC, the Second Circuit did not have
occasion to address whether the two provisions prohibited the same
-38-
Finding no false statement attributable to either Tambone or
Hussey, the court rejected the SEC's theory of liability under
both section 17(a)(2) and section 10(b).
When assessing the scope of a statute, we begin, and
often end, with its text and structure. See, e.g., Ernst & Ernst,
425 U.S. at 197 ("'[T]he starting point in every case involving
construction of a statute is the language itself.'" (quoting Blue
Chip Stamps, 421 U.S. at 756 (Powell, J., concurring))); Central
Bank, 511 U.S. at 174 ("Adherence to the text in defining the
conduct covered by § 10(b) is consistent with our decisions
interpreting other provisions of the securities Acts."); see also
Aaron, 446 U.S. at 695-97 (parsing the language of section
17(a)(1)-(3) to determine whether scienter is required to
establish a violation of each provision). In this context, we are
guided by the Supreme Court's oft-recited instruction that courts
must construe the language of the securities laws "'not
technically and restrictively, but flexibly to effectuate [their]
remedial purposes.'" Affiliated Ute Citizens of Utah v. United
States, 406 U.S. 128, 151 (1972) (quoting Capital Gains, 375 U.S.
at 195). Additionally, in comparing the text of section 17(a)
with that of section 10(b) and Rule 10b-5, the Supreme Court
itself has found meaningful distinctions in small variations in
range of fraudulent conduct. Instead, the court focused its
analysis on primary liability under section 10(b). For this
reason, we discuss Wright at length in Part V, infra.
-39-
language. See Aaron, 446 U.S. at 695-97 (finding that the
provisions, despite their common purpose and similar texts,
require different levels of scienter for liability). We must
display the same adherence to the importance of text.
We do not read the case law cited by the defendants as
foreclosing the Commission's argument that section 17(a)(2) is
broader than section 10(b) and Rule 10b-5(b). Although we have
previously analyzed section 17(a) claims identically to those made
under section 10(b) and Rule 10b-5 where the parties agreed that
the analysis was the same, see SEC v. Rocklage, 470 F.3d 1, 4 n.1
(1st Cir. 2006), that treatment does not preclude our recognition
here that the scope of actionable conduct under the two statutes
may be different. Indeed, this is necessarily so because, as we
have noted, the text of the statutes mandate different showings
with respect to scienter. See Aaron, 446 U.S. at 695-97. Nor are
the SEC's arguments foreclosed by Supreme Court precedent or
decisions of this circuit. Cf. Naftalin, 441 U.S. at 778
("[U]ndoubtedly[,] . . . the [Securities Act and the Exchange Act]
prohibit some of the same conduct. . . . But '[the] fact that
there may well be some overlap is neither unusual nor
unfortunate.'" (quoting SEC v. Nat'l Sec., Inc., 393 U.S. 453, 468
(1969))).
After carefully examining the respective texts at issue,
we find the Commission's argument regarding the scope of conduct
prohibited by section 17(a)(2) persuasive. Because section
-40-
17(a)(2) was drafted to apply to broker-dealers, its prohibitory
language focuses specifically on conduct engaged in by a seller.
The statute 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.
In contrast to the "by means of any untrue statement"
language of section 17(a)(2), Rule 10b-5(b) renders it unlawful
"[t]o make any untrue statement of a material fact . . . in
connection with the purchase or sale of any security." As the
drafters intended, Rule 10b-5 expands liability to cover all
segments of the securities industry, including drafters, auditors,
accountants, and distributors. See Central Bank, 511 U.S. at 191.
As we stress below, any one of these actors who makes an untrue
statement in connection with the purchase or sale of a security
may be found primarily liable. See id. However, Rule 10b-5's
expansion of coverage beyond the seller of securities is
accompanied by a more restrictive statement of the conduct that
will suffice to establish liability. The "to obtain money or
property by means of any untrue statement" language of section
17(a)(2) is replaced by the requirement in Rule 10b-5(b) that the
-41-
actor "make" an "untrue statement of a material fact . . . in
connection with the purchase or sale of any security."
This reading of section 17(a)(2) (that it does not
require the defendant to make the false statement at issue), is
supported by Congress's inclusion of the phrase "directly or
indirectly" in the statutory text of section 17(a). The statute
makes it "unlawful for any person . . . directly or indirectly .
. . to obtain money or property by means of any untrue statement
of a material fact." That a seller may be liable for indirectly
obtaining money by means of an untrue statement reinforces the
conclusion that the untrue statement at issue need not have been
made by the securities seller.29 Cf. Ballay v. Legg Mason Wood
Walker, Inc., 925 F.2d 682, 691 (3d Cir. 1991) ("These words --
'directly or indirectly' -- convey a legislative intent to
encompass all conduct meeting the other elements of a section
17(a) claim."). Therefore, based on our reading of the text of
section 17(a)(2), we conclude that this provision covers conduct
that may not be prohibited by section 10(b) and Rule 10b-5.
Specifically, primary liability may attach under section 17(a)(2)
29
The defendants contend that the phrase "directly or
indirectly" modifies the "by the use of any means" clause of
section 17(a) and not the conduct described in section 17(a)(2).
This reading is not, however, the most natural reading of the
provision. Given the text and structure of the provision,
including the placement of a comma separating the "by the use of
any means" clause from the "directly or indirectly" clause, we read
the "directly or indirectly" language to modify the "to obtain
money or property" clause at the start of sub-section (2) of the
statute.
-42-
even when the defendant has not himself made a false statement in
connection with the offer or sale of a security.30
B. Applying Section 17(a)(2) to the Conduct of Defendants
Before we assess whether the SEC stated sufficient
allegations to support claims of liability under section 17(a)(2)
against Tambone and Hussey, we must describe generally the role of
an underwriter in the mutual fund process. Our understanding of
this role is central to our analysis both of this issue and
liability under section 10(b). Principal underwriters, also
commonly referred to as distributors, play an essential role in
the securities industry, and specifically the mutual fund market.
Section 2(a)(40) of the Investment Act defines an "underwriter" as
someone who has "purchased from an issuer with a view to, or sells
for an issuer in connection with, the distribution of any
security, or participates or has a direct or indirect
30
The dissent agrees that we must "give effect" to the
"striking divergence" between the language of section 17(a)(2) and
Rule 10b-5. However, it also accuses us of "glossing over" this
distinction in our discussion of defendants' liability under
section 10(b) and Rule 10b-5, infra. The dissent fails to
understand that, although the statutory provisions are not
coextensive, they may comfortably overlap. As the Supreme Court
has recognized, this "'fact is neither unusual nor unfortunate.'"
Naftalin, 441 U.S. at 778 (quoting Nat'l Sec., Inc., 393 U.S. at
468). Instead, "[t]he two [statutory provisions] can exist and be
useful, side by side." Edwards v. United States, 312 U.S. 473, 484
(1941) (discussing the interaction between the mail fraud statute
and the Securities Act of 1933). In other words, although it is
possible to violate section 17(a)(2) without "making" a statement
as required by Rule 10b-5, if defendants have "made" false
statements within the meaning of 10b-5, that conduct will always
satisfy the "by means of" element of 17(a)(2) liability.
-43-
participation in any such undertaking, or participates or has a
participation in the direct or indirect underwriting of any such
undertaking." 15 U.S.C. § 80a-2(a)(40). Likewise, a "principal
underwriter" of a mutual fund is
[a]ny underwriter who as principal purchases from such
company, or pursuant to contract has the right . . .
from time to time to purchase from such company, any
such security for distribution, or who as agent for such
company sells or has the right to sell any such security
to a dealer or to the public or both.
Id. § 80a-2(a)(29).
Often affiliated with the mutual fund's investment
adviser, in this case Columbia Advisors, the underwriter is thus
primarily responsible for the sale and distribution of specified
funds. The underwriter enters into agreements with brokers,
dealers, and other intermediaries for the sale of the fund's
shares or, alternatively, sells funds directly to the investing
public. See United States v. Nat'l Assoc. of Sec. Dealers, Inc.,
422 U.S. 694, 698-99 (1975). Regardless of how the funds are
distributed to the public, the underwriter is responsible for
ensuring that the investors or potential investors receive
prospectus statements. See 15 U.S.C. § 77e(b)(2) (requiring that
a prospectus be provided prior to the public sale of shares); 17
C.F.R. § 240.15c2-8(h) (requiring a distributor to provide a
broker-dealer participating in the distribution or trading of a
security with sufficient quantities of the prospectus to ensure
-44-
they reach the investors pursuant to section 5(b) of the
Securities Act).
Further, the underwriter is typically responsible for a
number of other tasks, including (1) creating and distributing
advertising materials and other disclosure documents for the
traded securities; (2) ensuring compliance with state and federal
offering requirements; (3) identifying potential investors and
responding to inquiries; (4) executing purchase and redemption
transactions; and (5) providing other services not provided by the
fund administrator. Laurin Blumenthal Kleiman & Carla G. Teodoro,
The ABCs of Mutual Funds 2007: Forming, Organizing and Operating
a Mutual Fund: Legal and Practical Considerations, 1612 PLI/Corp
9, 31-32 (2007). The underwriter is required to register with the
SEC under the Exchange Act of 1934, with the states in which it
sells securities under the applicable state blue sky laws, and
with the National Association of Securities Dealers ("NASD"). Id.
Not surprisingly, the allegations in the complaint are
consistent with this general description of the underwriter's role
in the mutual fund process. As executives of Columbia
Distributor, the principal underwriter for the Columbia Funds,
Tambone and Hussey were primarily responsible for distributing the
fund prospectuses to potential investors and other broker-dealers.
As the SEC states in its brief, "whether selling shares of the
Columbia funds directly to investors, or indirectly through other
-45-
broker-dealers, Columbia Distributor was required to offer and
sell those shares through the use of the fund prospectuses." The
SEC alleges that to make these sales, defendants used prospectuses
containing statements regarding market timing which they knew, or
were reckless in not knowing, were false, and even specifically
referred potential investors to those misleading prospectuses to
answer any questions the investors might have. Further, both
defendants' compensation depended significantly on their sale of
Columbia funds. Thus, assuming the allegations are correct, as we
must, the defendants' conduct falls squarely within the
prohibitions established by section 17(a)(2) of the Securities
Act. Tambone and Hussey, in offering and selling securities,
obtain[ed] money by means of an[] untrue statement of [] material
fact." The section 17(a)(2) claims should not have been dismissed
by the district court.31
V.
A. The Scope of Liability under Rule 10b-5(b): Making a Statement
Having concluded that the SEC has stated a claim of
primary liability against the defendants under section 17(a)(2),
we turn to the SEC's allegations regarding section 10(b) and Rule
10b-5. Although the SEC's complaint includes general allegations
31
The SEC, having raised allegations of fraud against the
defendants, must also satisfy the pleading particularity
requirements of Fed. R. Civ. P. 9(b). We address this issue in
Part VI. below.
-46-
of fraud in violation of sub-sections (a) and (c) of Rule 10b-5,
provisions that address the use of fraudulent practices, schemes,
devices, or courses of business, the SEC has not pursued on appeal
the district court's dismissal of these claims. Therefore, we
limit our discussion to Rule 10b-5(b), which prohibits the making
of false statements or omissions in connection with the purchase
or sale of any security.
To establish a claim of primary liability under Rule
10b-5(b), a private plaintiff must show (1) a material
misrepresentation or omission made by the defendant; (2) a
connection between the misrepresentation or omission and the
purchase or sale of a security; (3) scienter, specifically that
the defendant acted with intent, knowledge, or a high degree of
recklessness; (4) reliance by the plaintiff upon the
misrepresentation or omission; (5) economic loss; and (6) loss
causation. See Stoneridge, 128 S. Ct. at 768; ACA Fin., 512 F.3d
at 58. Because this is an SEC enforcement action rather than a
private claim, the Commission need not allege any of the elements
required to establish a direct link between a defendant's
misrepresentation and an investor's injury -- including reliance
by the investor on an explicit misstatement, economic loss, and
loss causation. See GFL Advantage Fund, Ltd. v. Colkitt, 272 F.3d
189, 206 n.6 (3d Cir. 2001); SEC v. Rana Research, Inc., 8 F.3d
1358, 1363-64 (9th Cir. 1993); Schellenbach v. SEC, 989 F.2d 907,
-47-
913 (7th Cir. 1993); SEC v. Blavin, 760 F.2d 706, 711 (6th Cir.
1985); see also Stoneridge, 128 S. Ct. at 769 ("Reliance by the
plaintiff . . . is an essential element of the § 10(b) private
cause of action.") (emphasis added). As with the SEC's claim
under section 17(a)(2), the parties contest the legal standard
applicable to the first element of the claim -- that the defendant
made a materially false or misleading statement32 -- as well as
whether elements one and three have been sufficiently alleged in
the complaint. We first address the question of what it means to
"make" a statement for the purposes of Rule 10b-5(b).
The SEC urges us to conclude that the district court
erred in finding that defendants, by using false and misleading
prospectus statements to sell securities, did not "make" a
statement that could render them primarily liable. The Commission
argues that, as senior executives of the primary underwriter for
the Columbia Funds, Tambone and Hussey had a duty to confirm the
accuracy and completeness of the prospectuses they were
responsible for distributing to broker-dealers and potential
investors. In light of this duty, the SEC contends that the
32
Appellants do not claim that the statements or omissions at
issue were immaterial, insisting instead that they did not make
them. To satisfy the materiality element, the misrepresentations
must be "misleading to a material degree," In re Cabletron, 311
F.3d at 27, signifying that a reasonable investor would believe
that they "significantly altered the total mix of information made
available," Basic, Inc. v. Levinson, 485 U.S. 224, 232 (1988)
(internal quotation omitted).
-48-
defendants "made" statements in two ways. First, by using
misleading prospectuses despite a duty to review and confirm the
accuracy of their contents, the defendants adopted the false
statements made by others in the fund prospectuses as their own.
The SEC also asserts that by using the prospectuses in this way,
defendants made an implied statement of their own to potential
investors that they had a reasonable basis to believe that the key
statements in the prospectuses regarding market timing were
accurate and complete. Because certain statements in the
prospectuses regarding market timing were allegedly false,
defendants' implied statement was also false. In these two ways,
the SEC asserts that defendants' conduct rose to the level of
primary liability under section 10(b) and Rule 10b-5(b). On this
point, the Commission notes:
[I]t would be anomalous to shield the person responsible
for selling securities from primary liability for using
or offering materials that they know, or are reckless in
not knowing, are false and misleading simply because the
false statements are not ascribed to them. . . . Their
role is to act as the intermediary between the issuer of
the securities and the investors, to disseminate the
prospectus and to encourage investors to purchase the
securities on the basis of the prospectus. They are a
necessary link in the chain of distribution.
As we explain below, 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-
-49-
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.
1. Text of Section 10(b)
As with all matters of statutory interpretation, we
begin our analysis with the text of the relevant provisions --
here, Rule 10b-5(b) and section 10(b) of the Exchange Act.
Although Rule 10b-5 itself offers little guidance on how to define
"make," we must also look to the text of section 10(b), its
authorizing statute. Ernst & Ernst, 425 U.S. at 197 ("In
addressing [the question of the proper scienter requirement under
section 10(b) and Rule 10b-5], we turn first to the language of
s 10(b), for '(t)he starting point in every case involving
construction of a statute is the language itself.'" (quoting Blue
Chip Stamps, 421 U.S. at 756 (Powell, J., concurring))); Pinter v.
Dahl, 486 U.S. 622, 653 (1988) ("The ascertainment of
congressional intent with respect to the scope of liability
created by a particular section of the Securities Act must rest
-50-
primarily on the language of that section."). The statutory
language is particularly relevant in this case because "[t]he
scope of Rule 10b-5 is coextensive with the coverage of § 10(b),"
a view which has led the Supreme Court to "use § 10(b) to refer
both to the statutory provision and the Rule." Zandford, 535 U.S.
813, 816 n.1 (2002); see also Stoneridge, 128 S. Ct. at 768 ("Rule
10b-5 encompasses only conduct already prohibited by § 10(b).").
In other words, the term "make a statement" in Rule 10b-5 must be
read in conjunction with the text of section 10(b), which deems it
"unlawful for any person . . . [t]o use or employ, in connection
with the purchase or sale of any security . . . , any manipulative
or deceptive device or contrivance in contravention of such rules
and regulations as the Commission may prescribe." 15 U.S.C. §
78j(b) (emphasis added).33
The SEC's allegations against appellants are stated in
precisely those statutory terms. The SEC avers that defendants
used and employed prospectuses containing statements prohibiting
market timing practices -- statements that they knew or were
reckless in not knowing were false -- in order to sell Columbia
Funds. In using the prospectuses in this way, they made implied
statements of their own regarding the accuracy and completeness of
33
The Second Circuit has stated that section 10(b) prohibits
"conduct involving manipulation or deception," and defined
deception as "misrepresentation, or nondisclosure intended to
deceive." Ganino, 228 F.3d at 161.
-51-
those prospectuses. These implied statements were false. As
such, they were a "manipulative or deceptive device or contrivance
in contravention" of the Commission's rules.34 Cf. 17 C.F.R. §
240.15c1-2 (defining "manipulative, deceptive, or other fraudulent
device or contrivance" in section 15(c)(1) of the Exchange Act to
include "any untrue statement of a material fact."). The implied
statements that Tambone and Hussey made about the truth and
accuracy of the prospectuses derive from their statutory duties
and their central role in the securities market.
2. The Duties of an Underwriter
In assessing whether a defendant has committed a primary
violation of the securities laws, courts have examined the
defendant's role in the securities market in addition to the
specific conduct alleged in the complaint. These decisions
34
The dissent accuses us of engaging in "sleight of hand" by
"us[ing] the broad language of the statute ['use or employ'] to
define the obviously narrower language of the rule ['to make']."
However, as we discuss above, the Supreme Court has stated that
"[t]he scope of Rule 10b-5 is coextensive with the coverage of
10(b)," and also that:
Rule 10(b)-5 was adopted pursuant to authority granted
the Commission under s 10(b). The rulemaking power
granted to an administrative agency charged with the
administration of a federal statute is not the power to
make law. Rather, it is the power to adopt regulations
to carry into effect the will of Congress as expressed by
the statute.
Ernst & Ernst, 425 U.S. at 212-14 (internal quotation marks and
citations omitted). Rule 10b-5(b) implements with some specificity
this broad prohibition of section 10(b). It does not narrow the
prohibition.
-52-
indicate that a defendant's general responsibilities and statutory
duties with respect to the sale and distribution of securities
inform the legal significance of specific conduct under Rule
10b-5(b). See, e.g., In re Scholastic Corp. Sec. Litig., 252 F.3d
at 77 (analyzing a corporate executive's liability for "making"
misleading statements in light of his duties and
responsibilities); SEC v. KPMG LLP, 412 F. Supp. 2d 349, 376-77
(S.D.N.Y. 2006) (holding that three engagement partners of an
auditing firm who possessed the "ultimate authority to determine
whether an audit opinion should be issued" could be primarily
liable under the securities laws for misstatements contained in
the audit opinion letters, although a fourth defendant, who only
acted as a concurring review partner, could not be held primarily
liable, as his responsibilities were "not the equivalent of the
audit engagement partner's responsibilities"). Indeed, in Wright,
one of the "sensible precedents" the dissent accuses us of
"relegat[ing] . . . to the scrap heap," and which it praises for
its interpretation of Central Bank, see infra, the court
acknowledged that "silence where there is a duty to disclose can
constitute a false or misleading statement within the meaning of
§ 10(b) and Rule 10b-5." 152 F.3d at 177 (emphasis added). Just
as a defendant's particular role in the securities market may
convert his silence into a statement for the purposes of section
10(b), so too may a defendant, by virtue of his role in the market
-53-
and his statutory duties, make an implied statement without
actually uttering the words in question.
As already noted, underwriters play an essential role in
the sale and distribution of mutual funds to the investing public,
which occurs either directly or through other broker-dealers. The
text and statutory history of the Securities Act of 1933, and
specifically the statute's treatment of underwriters in sections
1135 and 12,36 highlight the unique position they occupy in the
securities industry. As the Southern District of New York has
observed in the context of evaluating several securities claims:
[I]n enacting section 11, "Congress recognized that
underwriters occupied a unique position that enabled
them to discover and compel disclosure of essential
facts about the offering. Congress believed that
subjecting underwriters to the liability provisions
would provide the necessary incentive to ensure their
careful investigation of the offering."
In re Worldcom, Inc. Sec. Litig., 346 F. Supp. 2d 628, 662
(S.D.N.Y. 2004) (quoting The Regulation of Securities Offerings,
Securities Act Release No. 7606A, 63 Fed. Reg. 67174, 67230 (Dec.
4, 1998), 1998 WL 833389). Although underwriters are not insurers
35
Section 11 of the Securities Act "prohibits false statements
or omissions of material fact in registration statements" and
"identifies the various categories of defendants subject to
liability for a violation," including underwriters. Central Bank,
511 U.S. at 179; see also 15 U.S.C. § 77k(a)(5).
36
Section 12 "prohibits the sale of unregistered, nonexempt
securities as well as the sale of securities by means of a material
misstatement or omission; and it limits liability to those who
offer or sell the security." Central Bank, 511 U.S. at 179; see
also 15 U.S.C. § 77l(a).
-54-
for offerings, In re Worldcom, 346 F. Supp. 2d at 662, Congress
has mandated that they "exercise diligence of a type commensurate
with the confidence, both as to integrity and competence, that is
placed in [them]." H.R. Conf. Rep. No. 73-152, 1933 WL 984, at
*26 (1933). The duty of an underwriter to conduct a reasonable
investigation has been explained by the SEC as follows:
"By associating himself with a proposed offering [an
underwriter] impliedly represents that he has made such
an investigation in accordance with professional
standards. Investors properly rely on this added
protection which has a direct bearing on their appraisal
of the reliability of the representations in the
prospectus. The underwriter who does not make a
reasonable investigation is derelict in his
responsibilities to deal fairly with the investigating
public."
In re Worldcom, 346 F. Supp. 2d at 662-63 (insertions in original)
(quoting In re the Richmond Corp., Exchange Act Release No. 4585,
41 SEC Docket 398 [1961-1964 Transfer Binder] Fed. L. Sec. Rep.
(CCB) ¶ 76,904, 1963 WL 63647, at *7 (Feb. 27,1963); see also
Municipal Securities Disclosure, Exchange Act Release No. 26,100,
41 SEC Docket 1131, 1988 WL 999989, at *20 (Sept. 22, 1988)
(observing that the underwriter "occupies a vital position in an
offering" and that, by its participation in a sale of securities,
the underwriter makes a recommendation that "implies that the
underwriter has a reasonable basis for belief in the truthfulness
and completeness of the key representations made in any disclosure
-55-
documents used in the offerings")37; Sanders v. John Nuveen & Co.,
524 F.2d 1064, 1070 (7th Cir. 1975) ("[T]he relationship between
the underwriter and its customers implicitly involves a favorable
recommendation of the issued security. Because the public relies
on the integrity, independence and expertise of the underwriter,
the underwriter's participation significantly enhances the
marketability of the security." (footnote omitted)).
The case law addressing the duties of underwriters
buttresses the SEC's analysis and extends it beyond the
traditional context of sections 11 and 12 of the Securities Act.
Although sections 11 and 12 specifically concern an underwriter's
obligation to ensure the accuracy of registration statements and
prospectuses, underwriters are among the securities actors to whom
section 10(b) has been applied. See, e.g., SEC v. Dain Rauscher,
Inc., 254 F.3d 852, 858 (9th Cir. 2001) (finding genuine issue of
material fact as to whether underwriter violated Rule 10b-5 by not
complying with its "duty to make an investigation that would
provide him with a reasonable basis for a belief that the key
representations in the statements provided to the investors were
truthful and complete."); Flecker v. Hollywood Entm't Corp., 1997
WL 269488, at *9 (D. Or. Feb. 12, 1997) (finding triable issue of
37
The SEC specifically observes in this Release that the
underwriters' "obligation to have a reasonable basis for belief in
the accuracy of statements directly made concerning the offering is
underscored when a broker-dealer underwrites securities." Id. at
21.
-56-
section 10(b) primary liability against underwriter for allegedly
false statements that inflated stock prices); In re MTC Elec.
Techs. S'holder Litig., 993 F. Supp. 160, 162 (E.D.N.Y. 1997)
("MTC II")(applying the standard of primary liability to
underwriters in the context of private allegations of Rule 10b-5
violations); Phillips v. Kidder, Peabody & Co., 933 F. Supp. 303,
315-16 (S.D.N.Y. 1996) (same); In re U.S.A. Classic Sec. Litig.,
No. 93 Civ. 6667 (JSM), 1995 WL 363841, at *5 (S.D.N.Y. June 19,
1995) (finding that an underwriter's participation in the issuance
of a prospectus was sufficient to state a claim of primary
liability under Rule 10b-5); In re Software Toolworks, Inc. Sec.
Litig., 50 F.3d 615, 629 (9th Cir. 1994) (finding disputed issues
of material fact as to whether underwriters' participation in
drafting an allegedly misleading letter to the SEC violated
section 10(b)); Sanders, 524 F.2d at 1069 (applying Rule 10b-5 to
an underwriter alleged to have violated its duty to reasonably
investigate the securities it marketed and their issuer); In re
Enron Corp. Sec., Derivative & ERISA Litig., 235 F. Supp. 2d 549,
612 (S.D. Tex. 2002) (finding, based on case law highlighting an
underwriter's duty to investigate an issuer and the securities it
offers to investors, that an underwriter of a public offering
could be held liable under section 10(b) and section 11 of the
Securities Act "for any material misstatements or omissions in the
registration statement made with scienter").
-57-
These precedents reflect the unique position of
underwriters as securities insiders whose role is "that of a trail
guide -- not a mere hiking companion," and who are relied upon by
investors for their "reputation, integrity, independence, and
expertise." Dolphin and Bradbury, Inc. v. SEC, 512 F.3d 634, 640-
41 (D.C. Cir. 2008). Underwriters have access to information of
substantive interest and consequence to investors, and a
concomitant duty to investigate and confirm the accuracy of the
prospectuses and other fund materials that they distribute. See
id.; see also Sanders, 524 F.2d at 1071 ("Although the underwriter
cannot be a guarantor of the soundness of any issue, he may not
give it his implied stamp of approval without having a reasonable
basis for concluding that the issue is sound."); Walker v. SEC,
383 F.2d 344, 345 (2d Cir. 1967) ("The Commission is justified in
holding a securities salesman chargeable with knowledge of the
contents of sales literature.").
In light of this duty to review and confirm the accuracy
of the material in the documentation that it distributes, an
underwriter impliedly makes a statement of its own to potential
investors that it has a reasonable basis to believe that the
information contained in the prospectus it uses to offer or sell
securities is truthful and complete. The SEC alleges that Tambone
and Hussey made such implied statements to investors about timing
practices in the Columbia Funds when they knew, or were reckless
-58-
in not knowing, that the representations in the prospectuses about
timing practices were false. This falsity made their implied
statements false. As such, these implied statements were a
violation of Rule 10b-5(b).
B. The Counterarguments of The Defendants and The Dissent
Tambone and Hussey assert that the text of Rule 10b-5(b)
and cases analyzing the scope of primary liability under the Rule
and section 10(b) require that the Commission allege that they
actually made a misrepresentation which is publicly attributable
to them, not that they have impliedly done so. They contend that
to hold otherwise would be to disregard the Supreme Court's
holding in Central Bank and effectively eliminate the boundaries
between primary and secondary liability. The dissent takes this
position as well.
1. Central Bank and its Implications
The issue in Central Bank was whether the indenture
trustee for bonds issued by the public Building Authority to
finance improvements at a planned development in Colorado Springs
could be held liable in a private cause of action under Rule 10b-5
for aiding and abetting a primary violation of the law. Although
Central Bank had become aware that the collateral for the bonds
-59-
had likely become insufficient to support them, it delayed
undertaking an independent review of the original appraisal.
Before an independent review could be done, the Building Authority
defaulted on a portion of the bonds. The plaintiff raised claims
of primary liability against four violators: the Building
Authority, which issued the defaulted bonds in question, two
underwriters for the bonds, and a director of the development
company in charge of providing an appraisal of the bonds. The
Building Authority defaulted early in the litigation and the
claims against the underwriters were settled. See First
Interstate Bank of Denver, N.A. v. Pring, 969 F.2d 891, 893 n.1
(10th Cir. 1992).
The Supreme Court, relying on the text of section 10(b)
and Rule 10b-5, concluded that the aiding and abetting claims
against Central Bank must be dismissed because private plaintiffs
may only bring claims of primary liability, not aiding and
abetting liability, against defendants. Nevertheless, the Court
noted that "[i]n any complex securities fraud . . . there are
likely to be multiple violators; in this case, for example,
respondents named four defendants as primary violators."38 511
38
Tambone and Hussey urge us to reject the Commission's claims
of primary liability because of the SEC's own admission that
Columbia Advisors, not defendants, "remained primarily responsible
for all representations made" in the fund prospectuses. However,
this quotation from Central Bank illustrates the Supreme Court's
recognition that a securities fraud will likely involve multiple
violators, thereby suggesting that individuals with different
-60-
U.S. at 191. Finally, the Court concluded that it is not the
identity of a securities actor but his conduct that determines
whether he may be liable as a primary violator:
The absence of § 10(b) aiding and abetting liability
does not mean that secondary actors in the securities
markets are always free from liability under the
securities Acts. Any person or entity, including a
lawyer, accountant, or bank, who employs a manipulative
device or makes a material misstatement (or omission) on
which a purchaser or seller of securities relies may be
liable as a primary violator under 10b-5, assuming all
of the requirements for primary liability under Rule
10b-5 are met.
Id.39
responsibilities could be primarily liable for the same
misstatement. 511 U.S. at 191. Therefore, the primary liability
of Columbia Advisors does not preclude the primary liability of
Tambone and Hussey for their own use of the false and misleading
statements contained in those prospectuses. Additionally, in a
recent private suit, the Supreme Court confirmed this principle by
indicating that defendants Charter Communications, Scientific-
Atlanta, Inc., and Motorola, Inc., had all engaged in the
fraudulent conduct at issue. See Stoneridge, 128 S. Ct. at 769-70.
Although the Supreme Court's statement in Central Bank referred to
Rule 10b-5(b), addressing material statements and omissions, and
its comment in Stoneridge applied to 10b-5(a) or (c), addressing
devices, schemes, artifices, acts, practices, or courses of
business, the scope of primary liability in each subsection is
governed by the language of section 10(b) of the Exchange Act.
Therefore, the Supreme Court's recent confirmation that multiple
individuals may be primarily liable under Rule 10b-5(a) or (c) is
applicable to its interpretation of Rule 10b-5(b).
39
See also In re Ikon Office Solutions, Inc., 277 F.3d 658,
666-67 (3d Cir. 2002) (noting that "liability under section 10(b)
may extend to secondary actors in the securities markets," and that
this is consistent with "the primary purpose of the Securities
Exchange Act of 1934," namely, "to protect against manipulated
stock prices by imposing strict and extensive disclosure
requirements, irrespective of the type of actor that disseminates
information to the investing public"); Houston v. Seward & Kissel,
LLP, No. 07cv6305(HB), 2008 WL 818745, at *7 n.22 (S.D.N.Y. 2008)
-61-
Defendants argue that the Commission's allegations are
insufficient to establish primary liability under Central Bank.
Similarly, the dissent, while acknowledging that Central Bank does
not foreclose the possibility that "persons in the defendants'
positions" may be found primarily liable, accuses us of
"dismantl[ing] Central Bank's interpretive prescription in its
entirety" and "fl[ying] in the teeth of the Supreme Court's
circumspect vision of primary liability." The dissent agrees with
defendants that our holding is at odds with Central Bank's careful
distinction between primary and secondary liability.
There is no conflict between Central Bank and our
interpretation of Rule 10b-5. The Court in Central Bank addressed
only the question of "whether private civil liability under
section 10(b) extends as well to those who do not engage in the
manipulative or deceptive practice, but who aid and abet the
violation." Stoneridge, 1128 S. Ct. at 775 (Stevens, J.,
dissenting)(quoting Central Bank, 511 U.S. at 167).40 As such, the
Court did not interpret the phrase "to make" in Rule 10b-5 as it
(noting that even after Central Bank, the implied right of action
"continues to cover secondary actors who commit primary
violations").
40
See also Central Bank, 511 U.S. at 176 (“The problem, of
course, is that aiding and abetting liability extends beyond
persons who engage even indirectly, in a proscribed activity;
aiding and abetting liability reaches persons who do not engage in
the proscribed activities at all, but who give a degree of aid to
those who do.”).
-62-
applies to primary liability -- which is the question that we
address above. See, e.g., SEC v. Wolfson, 539 F.3d 1249, 1258
(10th Cir. 2008) ("Recognizing the dichotomy between primary
liability and aiding and abetting liability created by Central
Bank, the Commission alleges that [defendants] are primary
violators of § 10(b). Thus, the question we confront today is
whether the acts [committed by defendants] are sufficient to show
that they 'made' the [alleged] material misstatements and
omissions . . . such that they can be held primarily liable."); In
re ZZZZ Best Sec. Litig., 864 F. Supp. 960, 969 n.11 (C.D. Cal.
1994) (noting that because "[p]laintiff's counsel in that case
expressly conceded that the Central Bank of Denver had not itself
committed a manipulative or deceptive act[,]" the Court "did not
have the opportunity to address the issue of whether [it] could
have been found primarily liable under Section 10(b)/Rule 10b-5
had such an allegation been added to the complaint and had the
issue of manipulation or deceit not been conceded."); Robert S.
DeLeon, The Fault Lines Between Primary Liability and Aiding and
Abetting Claims Under Rule 10b-5, 22 J. Corp. L. 723, 729 (1997)
("Although the Central Bank court used the phrase 'make a material
misstatement or omission,' the focus of its analysis . . . dealt
with the need for a 'material misstatement or omission' or a
'manipulative act' and not on the words 'making' or 'commission.'"
(footnote omitted)).
-63-
Additionally, Central Bank analyzes the scope of section
10(b) and Rule 10b-5 in a suit brought by a private plaintiff.
Although, as the dissent rightly observes, the Court focused on
the text of the respective provisions, it also emphasized the
element of reliance (which was not satisfied in that case), as
well as a set of policy considerations that arise exclusively in
the context of private securities litigation. In this respect,
Central Bank was primarily a manifestation of the Court's desire
to limit the scope of the judicially-implied private cause of
action under Rule 10b-5.41 This is the context that must inform
our understanding of Central Bank's "interpretive prescription."
We therefore reject the dissent's assertion that Central Bank's
conservative approach to its interpretation of Rule 10b-5 in a
case brought by a private plaintiff should be stretched beyond its
logic to invalidate our interpretation, in an enforcement action,
of an element on which the Supreme Court was silent.
2. The Line Between Primary and Secondary Liability
Because aiding and abetting claims were no longer
available in private actions after Central Bank, there was more
pressure on courts to clearly delineate the outer boundaries of
primary liability -- a question the Supreme Court did not address
41
Cf. O'Hagan, 521 U.S. at 664 (noting that Central Bank
"concerned only private civil litigation under §10(b) and Rule 10b-
5, not criminal liability[,]" and therefore that its "reference to
purchasers or sellers of securities must be read in light of a
longstanding limitation on private § 10(b) suits.").
-64-
in Central Bank. Our sister circuits have crafted two divergent
standards to analyze the question: the "bright-line" test,
associated most closely with the Second Circuit, and the broader
"substantial participation" test, articulated by the Ninth
Circuit. We briefly outline these approaches and explain why they
are not relevant here, contrary to the arguments of the defendants
and the dissent.
Under the most prominent version of the bright-line
test, primary liability requires a showing of two elements: first,
that an individual has "actually [made] a false or misleading
statement," and second, that the statement (or omission) has been
"attributed to that specific actor at the time of public
dissemination." Wright, 152 F.3d at 175. Thus, with its
incorporation of these two elements, the standard purports to draw
a "bright-line" between primary and secondary liability. See
Shapiro v. Cantor, 123 F.3d 717, 720 (2d Cir. 1997) ("[I]f Central
Bank is to have any real meaning, a defendant must actually make
a false or misleading statement in order to be held liable under
Section 10(b). Anything short of such conduct is merely aiding
and abetting, and . . . not enough to trigger liability under
Section 10(b)." (quoting In re MTC Elec. Techs. S'holders Litig.,
898 F. Supp. 974, 987 (E.D.N.Y. 1995) ("MTC I"))).42
42
Several other circuits have also adopted the bright-line
test, or close variations of it. See, e.g., Ziemba v. Cascade
Int'l, Inc., 256 F.3d 1194, 1205 (11th Cir. 2001) ("Following the
-65-
The first element of the bright-line test -- that the
defendant "actually make" the statement at issue -- mimics the
text of Rule 10b-5, thereby offering little additional guidance on
the precise boundaries of the term "make." The second part of the
test -- the public attribution requirement -- follows directly
from the element of reliance that is required in a private Rule
10b-5 action. To assert a successful claim under Rule 10b-5, a
plaintiff must establish that she has relied on a false and
material statement made by the defendant. See supra. This
requirement is designed to ensure that the "'requisite causal
connection between a defendant's misrepresentation and a
plaintiff's injury' exists as a predicate for liability."
Stoneridge, 128 S. Ct. at 769 (quoting Basic, 485 U.S. at 243).
The attribution requirement is a natural corollary of this
Second Circuit, we conclude that . . . the alleged misstatement or
omission upon which a plaintiff relied must have been publicly
attributable to the defendant at the time that the plaintiff's
investment decision was made."); see also Regents of Univ. of Cal.
v. Credit Suisse First Boston (USA), 482 F.3d 372, 386-90 (5th Cir.
2007) (analyzing Central Bank in the context of Rule 10b-5(a)and
(c)); In re Charter Commc'ns, Inc. Sec. Litig., 443 F.3d 987, 992
(8th Cir. 2006) ("[A]ny defendant who does not make or
affirmatively cause to be made a fraudulent statement or omission,
or who does not directly engage in manipulative securities trading
practices, is at most guilty of aiding and abetting and cannot be
held liable under § 10(b) or any subpart of Rule 10b-5."). The
Tenth Circuit, in Anixter v. Home-Stake Prod. Co., 77 F.3d 1215,
1226 (10th Cir. 1996), held that "in order for accountants [to be
primarily liable], they must themselves make a false or misleading
statement (or omission) that they know or should know will reach
potential investors." It has since clarified that, although this
is a "bright line" test, public attribution is not required.
Wolfson, 539 F.3d at 1260.
-66-
principle, because "[a]n individual who relies on a statement that
he believes was made by one person cannot then assert a claim
against another." SEC v. Collins & Aikman Corp., 524 F. Supp. 2d
477, 490 (S.D.N.Y. 2007).
The facts of Wright illustrate how the bright-line test
has been applied. In Wright, the court held that the auditing
firm Ernst & Young could not be liable for a misstatement approved
by the firm and contained in its client's press release because
the release noted that the information was unaudited and,
therefore, Ernst & Young's "assurances were never communicated to
the public either directly or indirectly." 152 F.3d at 176. The
plaintiff had alleged that Ernst & Young knew that its advice
would be passed on to investors and that it was understood in the
securities market that the press release contained an implicit
statement from the auditors that the financial information in the
release was accurate. The court rejected plaintiff's arguments as
insufficient to support primary liability under Central Bank
"because no false or misleading statement was attributed to Ernst
& Young at the time of public dissemination." Id. at 178.
In contrast, to allege a primary violation under the
substantial participation test, a plaintiff need only show that a
secondary actor has "substantially participated" or played "a
significant role" in the making of a fraudulent statement and not
that he has "made" or created the statement himself. See Howard
-67-
v. Everex Sys., Inc., 228 F.3d 1057, 1061 n.5 (9th Cir. 2000)
("[W]e have held that substantial participation or intricate
involvement in the preparation of fraudulent statements is grounds
for primary liability even though that participation might not
lead to the actor's actual making of the statements."); In re
Software Toolworks, 50 F.3d at 628 n.3 (allowing potential
liability for accountants who "played a significant role" in the
drafting and reviewing of misstatements); In re ZZZZ Best Sec.
Litig., 864 F. Supp. at 970 (concluding that an accounting firm
could be held liable under § 10(b) for its undisclosed
participation in the review and preparation of documents released
to the public by the company and attributable only to that
company). Because of its broad interpretation of the scope of
primary liability, the substantial participation test has been
criticized as inconsistent with Central Bank's prohibition of
private aiding and abetting liability. See, e.g., Anixter, 77
F.3d at 1226 n.10 ("To the extent these cases allow liability to
attach without requiring a representation to be made by defendant,
and reformulate the 'substantial assistance' element of aiding and
abetting liability into primary liability, they do not comport
with Central Bank of Denver."). As a result, no other circuit has
adopted this test to assess primary liability.
Regardless of their relative merits, neither the bright-
line nor substantial participation test is relevant to this case.
-68-
The substantial participation test evaluates whether one actor can
be deemed to have made a statement made or created by another
because of the actor's substantial participation in the making or
creation of that statement. In this case, as we have explained,
Tambone and Hussey are accountable for their own implied
statements, making the "substantial participation" inquiry
unnecessary. See In re LDK Solar Sec. Litig., ___ F.3d ___, No.
C07-05182WHA, 2008 WL 4369987, at *8 (N.D. Cal. Sept. 24, 2008)
(declining to address defendants' claim that they had not
"substantially participated" in making the fraudulent statements
at issue because the court had already determined that they should
be "deemed actually to have made those statements.").
Similarly, the bright line test, which is urged upon us
by appellees and the dissent, does not address what it means to
"make" a statement, as we have described, and it imposes an
attribution requirement which, contrary to the position of the
district court, is inapplicable to SEC enforcement actions. In
the first place, the plain text of the statute does not require
attribution. Indeed, it would be ironic to read the requirements
of a private cause of action (which include attribution) into the
statutory text when section 10(b) and Rule 10b-5 initially applied
only to SEC enforcement actions. See, e.g., Stoneridge, 128 S.
Ct. at 768 ("Though the text of the Securities Exchange Act does
not provide for a private cause of action for § 10(b) violations,
-69-
the Court has found a right of action implied in the words of the
statute and its implementing regulation."); see also Merrill
Lynch, 547 U.S. at 80-83 (noting that the Supreme Court has placed
certain limitations on private causes of action under section
10(b) as a result of policy considerations).
Moreover, although public attribution, like direct
reliance, is necessary in a private action, public attribution
should not be required in a Commission action where there is no
need to establish such a causal connection. See, e.g., Wolfson,
539 F.3d at 1259-60 (observing that the attribution requirement
"stems directly from the need for private litigants to prove
reliance on alleged fraud to succeed on a private cause of
action," and, "given [this] unambiguous connection between
reliance and attribution," declining to "impose an attribution
element in an SEC enforcement action"); Collins & Aikman Corp.,
524 F. Supp. 2d at 490 ("If the attribution requirement is
motivated by the need to show reliance, which I find to be the
more cogent analysis, then it does not apply to actions brought by
the SEC."); KPMG, 412 F. Supp. 2d at 375 (in an enforcement
action, finding "no reason to impose a requirement that a
misstatement [be] publicly attributed to a defendant for liability
to attach").
Finally, we reject defendants' assertion that we should
require attribution as a matter of policy in order to ensure that
-70-
primary liability and secondary liability are sufficiently
delineated from one another.43 The Supreme Court in Central Bank
established the crucial dichotomy between those who, regardless of
their role in a securities transaction, make misleading
representations themselves, and those who merely assist the
culpable actor without personally using or employing any
"manipulative or deceptive device" as prohibited by section 10(b).
Thus, to distinguish between primary and secondary liability, we
must focus on the specific conduct of defendants in light of their
role in the securities market, rather than on whether investors
specifically relied on their statements. That is precisely what
we have done here in deciding that defendants' implied statements
that they had a reasonable basis to believe that the market timing
disclosures in the prospectuses were truthful and complete fall
within the purview of the "make a statement" requirement of Rule
10b-5(b). However, to survive a motion to dismiss, the complaint
must still allege facts supporting this theory of liability with
the requisite particularity. We turn now to the pleading issue.
VI.
A. Primary Liability
1. Section 17(a)(2)
43
But see Lucent, 363 F. Supp. 2d at 724 ("Not only is [the
bright-line public attribution] test consistent with the statutory
language of Section 10(b), but it more clearly delineates which
types of behavior will give rise to primary liability versus
secondary liability.").
-71-
As we have described, to state a claim under section
17(a)(2), the SEC must allege that Tambone and Hussey have (1)
directly or indirectly (2) obtained money or property (3) by means
of any untrue statement of material fact or any omission to state
a material fact necessary in order to make the statements made, in
light of the circumstances under which they were made, not
misleading (4) with negligence (5) in the offer or sale of any
securities. See supra Part IV.A. The SEC goes beyond section
17(a)(2)'s relaxed scienter requirement, instead alleging that the
defendants acted either knowingly or highly recklessly.
The defendants assert that the SEC failed to state its
claims of securities fraud with sufficient particularity. They
argue that the complaint was deficient in omitting the specific
details of statements in the fund prospectuses that could be
deemed misleading as a result of the alleged market timing
arrangements. Further, they argue that the majority of the
defendants' conduct alleged in the complaint, including their
distribution activities and participation in preferred investor
arrangements, occurred prior to the adoption of the Strict
Prohibition language in the various prospectuses, and therefore
cannot provide the basis for a primary violation under the
securities laws.
a. General Allegations
-72-
We are persuaded that the SEC's complaint satisfies the
pleading standards of Rule 9(b). The SEC alleges that Tambone, as
Co-President of Columbia Distributor, and Hussey, as Managing
Director of National Accounts for Columbia Distributor, were
responsible for overseeing the distribution of fund prospectuses
in connection with their sale of Columbia Funds. As executives of
the primary underwriter, the defendants had a duty to reasonably
investigate the fund prospectuses and other disclosure documents
released to the investing public to confirm their accuracy and
truthfulness.44
Tambone's obligation is confirmed by the hundreds of
selling agreements allegedly entered into by Columbia Distributor
and signed by Tambone, with terms governing the distribution of
Columbia Funds by other broker-dealers. Each agreement noted
Columbia Distributor's role as the principal distributor of the
relevant funds and referred the purchaser to the prospectuses for
information on the funds. Each selling agreement expressly
represented and warranted that (a) "the [p]rospectus . . . we
issue . . . will comply with all applicable state and Federal
laws, rules and regulations [and] (b) each [p]rospectus and all
44
According to the complaint, over half of the total
compensation Tambone and Hussey received each year consisted of
commissions for fund sales made pursuant to their duties. The
defendants do not dispute that they were compensated in part based
on their sale of the Columbia Funds. Rather, they contest the
degree to which their compensation was linked to the alleged
fraudulent conduct in connection with market timing activities.
-73-
sales literature we issue will not by statement or omission be
misleading . . . ."
The Commission also adequately alleges that the fund
prospectuses, which the defendants were responsible for
distributing, contained several disclosures concerning short-term
or excessive trading practices that could be deemed material
misrepresentations. The disclosures, which stated that the
individual Columbia Funds were hostile to and did not permit
short-term or excessive trading of their shares, could constitute
misrepresentations because at the time the disclosures were made,
the defendants had approved or had knowledge of arrangements with
several preferred entities to allow these prohibited practices.45
Further, the SEC alleges that defendants knew, or were highly
reckless in not knowing, that these statements in the prospectuses
were false.
The complaint also avers the defendants' scienter
generally, as required by Fed. R. Civ. P. 9(b), alleging that the
defendants oversaw the distribution of the various fund
prospectuses during 2002 and 2003, when they contained the Strict
Prohibition language. Concurrently, both Hussey and Tambone were
45
The prospectus disclosures were also material to the
Columbia Funds investors. Given the scope of the alleged trading
practices at issue, "there is a substantial likelihood that a
reasonable investor would consider [the statements] important in
making an investment decision." SEC v. PIMCO Advisors Fund Mgmt.
LLC, 341 F. Supp. 2d 454, 464 (S.D.N.Y. 2004); see Basic, 485 U.S.
at 231-32.
-74-
aware that preferred customers frequently engaged in short-term or
excessive trading practices contrary to the prospectus
disclosures. Although the market timing arrangements were
typically entered into before the Strict Prohibition language was
added to the fund prospectuses, the defendants' distribution of
the prospectuses, which was the fraudulent conduct at issue,
occurred both before and after the amendments to the prospectuses
and at a time when the defendants knew the market timing
arrangements were in place. By continuing to distribute these
prospectuses without revisions, in the face of such knowledge and
a duty to confirm the accuracy of the prospectus statements, the
defendants could be found to have acted knowingly or highly
recklessly. See, e.g., In re Scholastic, 252 F.3d at 76 ("Where
the complaint alleges that defendants knew facts or had access to
non-public information contradicting their public statements,
recklessness is adequately pled for defendants who knew or should
have known they were misrepresenting material facts . . . .").
b. Particular Instances
The SEC states these general claims with sufficient
particularity. Its most substantial allegations arise from the
arrangement between Ilytat, L.P. and Columbia Distributor. The
complaint alleges that Hussey, with Tambone's knowledge, approved
an arrangement beginning in 2000 that allowed Ilytat to engage in
frequent, short-term trading practices in return for Ilytat's
-75-
infusion of $20 million of "sticky assets" into the Newport Tiger
Fund. As a result of this arrangement, Ilytat allegedly executed
a number of round-trips into and out of the Newport Tiger Fund,
the Acorn International Fund, and the Acorn International Select
Fund. Specifically, the complaint alleges that Ilytat executed
over 30 round-trips during the period from May 2001 through
September 2002 in the Newport Tiger Fund, 27 round-trips from
September 2000 to December 2001 in the Acorn International Fund,
and at least 20 round-trips during the period from July 2000 to
June 2001 in the Acorn International Select Fund, all at times
when the respective prospectuses contained the Strict Prohibition
language expressing the fund's hostility to such practices.
According to the complaint, the defendants had knowledge
of Ilytat's arrangement and harmful conduct. By March 2001,
Ilytat had been placed, with Hussey's approval, on a list of
"Authorized Accounts for Frequent Trading," which contained the
preferred customers whose trading practices would not be limited,
regardless of their frequency. The same month, Hussey is alleged
to have allowed Ilytat to continue its trading practices with
respect to the Acorn International Fund specifically, by directing
the Columbia Services manager responsible for market timing
surveillance to prevent others from taking steps to halt such
practices. In 2002, Hussey prevented Columbia Services' market
timing surveillance personnel from halting Ilytat's trading
-76-
practices, thereby allowing the conduct to continue for almost
three additional months.
Tambone allegedly was similarly aware of the market
timing practices engaged in by Ilytat, at least with respect to
the Newport Tiger Fund. In October 2000 and March 2001, Tambone
and Hussey received e-mails from the Newport Tiger Fund portfolio
manager informing them of the potential damage that Ilytat's
trading practices could inflict on the fund. In response to an e-
mail in October 2000, Hussey set forth the guidelines for entering
market timing arrangements, which included a requirement that the
fund obtain a long-term asset stream "as a quid-pro-quo" for any
short-term movements. Tambone was copied on this response.
According to the complaint, Tambone was also informed on other
occasions by the Tiger Fund portfolio manager and his superior
regarding concerns about the negative impact of the frequent
trading practices on his fund. Although all of the dated
communications discussed in the complaint occurred prior to May
2001, when the Newport Trading Fund added the Strict Prohibition
representation, Tambone had been placed on notice that the market
timing practices were occurring.
The complaint alleges similar conduct by Tambone and
Hussey with respect to Daniel Calugar and the funds in which he
invested. In 1999, Hussey approved an arrangement allowing
Calugar to make one round-trip per month with his entire
-77-
investment in the Columbia Young Investor Fund and the Columbia
Growth Stock Fund. In May 1999, at the beginning of 2000, and
again in early 2001, Hussey received information that Calugar was,
in fact, engaging in frequent round-trips in these funds and
others. Tambone also received an email from Hussey in 2000
apprising him of Calugar's practices. The complaint alleges that
Calugar continued to trade through at least August 2001, months
after the Strict Prohibition language was adopted in these funds'
prospectuses.
The complaint levels additional allegations against
Hussey individually. According to the complaint, Hussey approved
an arrangement that permitted Signalert to invest in the Columbia
Young Investor Fund and the Columbia Growth Fund and to make a
number of round-trips in each fund annually. Hussey was
subsequently informed in 2000 that Signalert was engaging in these
practices and doing so in excess of the agreed-upon levels. After
February 2001, when the prospectuses for these two funds were
amended to include the Strict Prohibition language, Signalert
allegedly made 20 round-trips in the Young Investor Fund and over
20 in the Growth Stock Fund.
c. Summary
The SEC alleges that Tambone and Hussey, as executives
of the primary underwriter of the Columbia Funds, were responsible
for overseeing the distribution of fund prospectuses to potential
-78-
investors. In that capacity, the defendants allowed the
prospectuses, which contained statements that they knew, or should
have known, were false, to be disseminated and used to sell the
funds, earning money as a commission for those sales. Simply
stated, they "obtain[ed] money . . . by means of an[] untrue
statement of a material fact." This conduct amounts to a primary
violation under section 17(a)(2). Therefore, we find that the SEC
has stated claims of primary securities fraud against Tambone and
Hussey pursuant to Securities Act Section 17(a)(2) with sufficient
particularity to meet the requirements of Fed. R. Civ. P.
12(b)(6), in conjunction with Rule 9(b). Defendants' motions to
dismiss the section 17(a)(2) claims should have been denied.
2. Section 10(b) and Rule 10b-5
To state a claim of primary liability under Rule 10b-
5(b), the SEC's complaint must allege that the defendants (1) made
a materially false or misleading statement (2) in connection with
the sale or purchase of securities, and (3) acted with intent,
knowledge or a high degree of recklessness. See supra Part V.A.
The same allegations that the Commission made against
appellants in the context of its section 17(a)(2) claims also
apply to its claims under section 10(b) and Rule 10b-5(b). As the
SEC asserts, by using the prospectus statements to sell Columbia
Funds, defendants "made their own implied, but false,
representations to investors as to the truthfulness and
-79-
completeness of the statements made in the prospectuses." These
implied statements were a product of their duty "to make an
investigation that would provide [them] a reasonable basis for a
belief that the key representations in the statements provided to
the investors were truthful and complete." If the key
representations about the timing practices were false or
misleading, as the SEC alleges, this implied statement about the
truthfulness and completeness of the statements made in the
prospectus was also false. The SEC has sufficiently alleged that
defendants, either knowingly or highly recklessly, made multiple
false statements. Defendants' motions to dismiss the primary
liability claims under section 10(b) and Rule 10b-5(b) should have
been denied.
B. Aiding and Abetting Liability
We turn to the Commission's three claims of aiding and
abetting liability against Tambone and Hussey: that they aided and
abetted Columbia Advisors' violations of Sections 206(1) and
206(2) of the Advisers Act, Section 10(b) of the Exchange Act and
Rule 10b-5, and Section 15(c)(1) of the Exchange Act.
To establish a claim of aiding and abetting liability
under the securities laws, the Commission must prove: (1) a
primary violation was committed; (2) the defendant was generally
aware that his role or conduct was part of an overall activity
that was improper; and (3) the defendant knowingly and
-80-
substantially assisted in the primary violation. Cleary v.
Perfectune, Inc., 700 F.2d 774, 777 (1st Cir. 1983). If the
defendant has a duty to disclose the primary violations,
recklessness will suffice to establish scienter. Id.; see also
Graham v. SEC, 222 F.3d 994, 1004 (D.C. Cir. 2000) (indicating
that recklessness was sufficient to establish a claim of aiding
and abetting liability under section 10(b) and Rule 10b-5); SEC v.
Peretz, 317 F. Supp. 2d 58, 63 (D. Mass. 2004) (noting that the
pre-Central Bank case law regarding aiding and abetting liability
survived the enactment of Section 104 of the PSLRA). A
defendant's silence or inaction may satisfy the "knowing and
substantial assistance" standard if such silence or inaction was
consciously intended to further the principal violation. Cleary,
700 F.2d at 778.
1. Section 10(b) of the Exchange Act and Rule 10b-5
Our conclusions regarding secondary liability follow
directly from our analysis of the primary liability claims. The
SEC has sufficiently alleged an uncharged primary violation46 of
section 10(b) and Rule 10b-5 by Columbia Advisors, which is
primarily responsible for writing all statements made in the fund
46
As noted above, the SEC reached a settlement with Columbia
Advisors and Columbia Distributor, among others, regarding the
allegations in this complaint and therefore has not brought
separate actions against these entities.
-81-
prospectuses.47 It alleges generally that Columbia Advisors knew
and approved of all but one of the market timing arrangements
entered into, and specifically states that Columbia Advisors,
either itself or through various portfolio managers in charge of
the funds at issue, approved the initial agreement with Ilytat,
the arrangement with Ritchie related to the Growth Stock Fund and
the Short Term Bond Fund, as well as the arrangements with
Calugar, Giacalone, D.R. Loeser, and Signalert. With knowledge of
these arrangements and the subsequent market timing practices
occurring as a result of them, Columbia Advisors continued to make
statements in the prospectuses prohibiting such activities in
these funds. These allegations support the claim that Columbia
Advisors made the misleading prospectus statements and knew they
were being communicated to investors.
The second element of aider and abettor liability is
satisfied by allegations that the defendants knew, or were at
least reckless in not knowing, that the fund prospectuses they
were distributing contained false or misleading statements. As we
have emphasized, defendants' positions as officers of Columbia
Distributors imposed upon them a duty to review the accuracy of
47
The SEC alleges that defendants aided and abetted the
primary violations of both Columbia Advisors and Columbia
Distributor. Because we conclude that the allegations could
support a finding that Columbia Advisors committed a primary
violation of section 10(b) and Rule 10b-5, we need not address the
claims of primary liability asserted against Columbia Distributor
under this provision.
-82-
the prospectus disclosures. That duty was particularly relevant
here because Tambone and Hussey had knowledge of the market timing
arrangements and practices. Therefore, Tambone and Hussey knew or
should have known that the prospectuses contained false and
misleading statements regarding market timing practices. Further,
a review of the relevant prospectuses would have revealed that
Columbia Advisors, by drafting the false statements in the
prospectuses, was also engaging in primary violations of Rule 10b-
5.
Finally, we conclude that the SEC has satisfied the
third element of aiding and abetting liability. The defendants'
failure to correct the misleading disclosures in the prospectuses,
given their duties as underwriters, as well as their use of those
prospectuses to sell the funds to investors, substantially
assisted Columbia Advisors in its own primary violations. See
PIMCO, 341 F. Supp. 2d at 467-68. By distributing the
prospectuses written by Columbia Advisors, the defendants
communicated the false statements to the investing public, thereby
causing Columbia Advisors' primary violation of Rule 10b-5. See
Metge v. Baehler, 762 F.2d 621, 624 (8th Cir. 1985) (requiring a
showing that "the secondary party [has] proximately caused the
violation" and citing, with approval, another court's holding that
plaintiff must show "substantial causal connection between the
culpable conduct of the alleged aider and abetter and the harm."
-83-
(quoting Mendelsohn v. Capital Underwriters, Inc., 490 F. Supp.
1069, 1084 (N.D. Cal. 1979))).
In reaching this conclusion, we necessarily reject the
district court's finding that the defendants did not affirmatively
contribute to Columbia Advisors' primary violations. The district
court based its conclusion on its determination that the
"defendants were not under a duty to disclose the market timing
arrangements to investors." However, as explained above, we have
rejected that determination. As a result of their position as
executives of Columbia Distributor, the defendants had a duty to
review and investigate the fund prospectus statements and other
materials to determine their accuracy and truthfulness, a duty
independent of the fund issuer's responsibility to draft and
produce such materials, see Cleary, 700 F.2d at 777 (stating that
a duty to disclose may arise "where the law imposes special
obligations, as for accountants and brokers"); Chris-Craft Indus.,
Inc. v. Piper Aircraft Corp., 480 F.2d 341, 370 (2d Cir. 1973)
(finding an underwriter liable as an aider and abettor under
section 14(e), which prohibits false or misleading statements in
connection with a tender offer, for acting recklessly in
determining whether a registration statement contained a
materially false statement). In light of this duty, defendants'
conduct in overseeing the distribution of the false prospectuses
-84-
to potential investors amounted to affirmative acts in substantial
assistance of the primary violations.48
2. Section 206 of the Investment Advisers Act
The SEC also alleges that Tambone and Hussey aided and
abetted violations by Columbia Advisors of sections 206(1) and (2)
of the Investment Advisers Act. Section 206 of the Advisers Act
makes it unlawful for any investment adviser, among other things,
"(1) to employ any device, scheme, or artifice to defraud any
client or prospective client; [and] (2) to engage in any
transaction, practice, or course of business which operates as a
fraud or deceit upon any client or prospective client." 15 U.S.C.
§ 80b-6; see SEC v. Fife, 311 F.3d 1, 11 (1st Cir. 2002).
According to the Act, an "investment adviser" is "any person who,
for compensation, engages in the business of advising others,
either directly or through publications or writings, as to the
value of securities or as to the advisability of investing in,
purchasing, or selling securities." 15 U.S.C. § 80b-2(a)(11).
Section 206 imposes a fiduciary duty on investment advisers to act
at all times in the best interest of the fund and its investors,
and includes an obligation to provide "full and fair disclosure of
all material facts" to investors and independent trustees of the
48
Having reached this conclusion, we need not address, as the
district court did, whether the defendants' inaction was
accompanied by a "conscious intent[] to further the principal
violation." Cleary, 700 F.2d at 778.
-85-
fund. Capital Gains, 375 U.S. at 191, 194, 200-01 (addressing the
requirements of an investment adviser pursuant to section 206 of
the Advisers Act). An adviser has "an affirmative obligation to
employ reasonable care to avoid misleading [his or her] clients."
Id. at 194 (quotation marks and footnote omitted). Courts have
interpreted sections 206(1) and 206(2) to include essentially the
same elements as a section 17(a) claim, except that section 206(1)
requires proof of fraudulent intent on the part of the primary
actor, whereas the SEC need only allege negligence to state claims
under sections 206(2) and 17(a)(2) and (3). See, e.g., PIMCO, 341
F. Supp. 2d at 470.
We conclude that the SEC has alleged with sufficient
particularity a primary violation of sections 206(1) and (2) of
the Advisers Act. Columbia Advisors, an investment adviser to all
of the Columbia Funds, including those that maintained the
misleading prospectuses, allegedly failed to satisfy its fiduciary
obligations by placing its own interests above those of the funds
and their investors. Specifically, the complaint alleges that
Columbia Advisors knowingly allowed preferred investors to engage
in short-term and excessive trading in the Columbia Funds, and
that such trading harmed the interests of long-term shareholders.
Despite knowledge of these arrangements, Columbia Advisors
knowingly or intentionally failed to disclose the practices, and
the conflicts of interest they created. These fraudulent
-86-
disclosures or omissions allegedly constituted a "device, scheme,
or artifice to defraud" under section 206(1) and a "practice, or
course of business which operates as a fraud or deceit upon any
client or prospective client" under section 206(2). See PIMCO,
341 F. Supp. 2d at 470.
The second and third elements of secondary liability
were also adequately pled in the complaint. Tambone's and
Hussey's conduct and state of mind, discussed above, establish
with equal force the requisite elements for the SEC's claims under
section 206. The defendants allegedly knew, or were reckless in
not knowing, first, that Columbia Advisors' representations in the
prospectuses regarding market timing were false, and second, that
Columbia Advisors was disinclined to stem the harmful market
timing practices. In furtherance of the Advisors' deceptive
activities, defendants disseminated the misleading prospectuses
and allowed the market timing practices to continue. The section
206 claims against defendants should not have been dismissed.
3. Section 15(c) of the Exchange Act
Finally, the SEC alleges that defendants aided and
abetted a primary violation of Section 15(c)(1) of the Exchange
Act, 15 U.S.C. § 78o(c)(1), by Columbia Distributor. Section
15(c)(1) prohibits a broker-dealer from inducing or attempting to
induce the sale of any security by means of a "manipulative,
deceptive, or other fraudulent device or contrivance." 15 U.S.C.
-87-
§ 78o(c)(1). The relevant SEC regulation, Rule 15c1-2, 17 C.F.R.
§ 240.15c1-2, defines "manipulative, deceptive, or other
fraudulent device or contrivance" to include
any untrue statement of a material fact and any omission
to state a material fact necessary in order to make the
statements made, in the light of the circumstances under
which they are made, not misleading, which statement or
omission is made with knowledge or reasonable grounds to
believe that it is untrue or misleading.
The elements required to prove a violation under section
15(c)(1) are equivalent to those required under Securities Act
section 17(a), including that the defendant acted negligently.
See Aaron, 446 U.S. at 707-08 (Blackmun, J., concurring in part
and dissenting in part); SEC v. George, 426 F.3d 786, 792 (6th
Cir. 2005).
Based on the allegations in the complaint, we conclude
that the SEC has adequately stated a primary violation by Columbia
Distributor of section 15(c)(1), and related aiding and abetting
violations by Tambone and Hussey.49 Columbia Distributor, a
broker-dealer under the Exchange Act, induced or attempted to
induce the sale of various Columbia Funds by means of a misleading
statement in the fund prospectuses. Further, it did so with the
requisite level of scienter, ascertained through the mental state
49
We assess whether the SEC has adequately stated a primary
violation under section 15(c)(1) by Columbia Distributor rather
than Columbia Advisors because the statute applies only to broker-
dealers. The SEC has alleged that Columbia Distributor was a
broker-dealer from early 1998 through August 2003.
-88-
of its management, namely Tambone. See PIMCO, 341 F. Supp. 2d at
470; 3 Hazen, supra, § 12.8[4] ("[K]nowledge of a corporate
officer or agent acting within the scope of authority is
attributable to the corporation" (citing In re Atlantic Fin.
Mgmt., 784 F.2d 29, 31-34 (1st Cir. 1986) (applying principles of
apparent authority in the securities context))).
We need not rehash the allegations constituting the
other elements of liability. Tambone's and Hussey's conduct
elaborated above satisfies the remaining elements and compels our
conclusion that the SEC satisfied its burden under Fed. R. Civ. P.
12(b)(6) with respect to its aiding and abetting claims under
section 15(c)(1).
VII.
Reciting this court's prerogative to affirm a district
court's decision on any independently sufficient ground present in
the record, Hussey individually raises two additional rationales
for affirming the court's decision below to dismiss the SEC's
various claims. First, he asserts that the Due Process Clause of
the Constitution bars the SEC's claim because he and other
securities actors in his position were given insufficient notice
regarding the prohibited nature of his alleged activities.
Second, he argues that most of the SEC's claims are time-barred
because the SEC failed to comply with the five-year statute of
limitations period. Specifically, he asserts that many of the
-89-
alleged misstatements in question involved prospectuses issued as
long ago as 1998. Further, he claims that because the SEC had
knowledge that market timing practices were occurring, but failed
to act, it is not entitled to receive the benefit of equitable
tolling for its claims.
Neither of Hussey's claims have merit. The Commission
seeks with its action to enforce provisions of the securities laws
that have been in existence for over half a century. Since their
inception, it has been unlawful to offer or sell a securities
using a false or misleading statement. The Due Process Clause of
the Constitution requires nothing more by way of notice. See,
e.g., Hill v. Colorado, 530 U.S. 703, 732-33 (2000) (holding that
statute was not impermissibly vague under the Due Process Clause
because it provided a person of reasonable intelligence fair
notice of what is prohibited).
Regarding Hussey's second claim, the applicable five-
year statute of limitations period Hussey invokes applies only to
penalties sought by the SEC, not its request for injunctive relief
or the disgorgement of ill-gotten gains. See, e.g., SEC v.
Diversified Corporate Consulting Group, 378 F.3d 1219, 1224 (11th
Cir. 2004) ("When the SEC sues to enforce the securities laws, it
is vindicating public rights and furthering public interests, and
therefore is acting in the United States's sovereign capacity.
This is so even though the SEC seeks disgorgement as a remedy of
-90-
the violation . . . .") (per curiam); SEC v. Rind, 991 F.2d 1486,
1490-91 (9th Cir. 1993) (reaching the same conclusion); see also
28 U.S.C. § 2462. Therefore, those remedies are not barred.
On the issue of penalties, to gain the benefit of
equitable tolling, the SEC must establish (1) that there were
insufficient facts available to put it on inquiry notice of the
possibility of fraud, and (2) that it exercised due diligence in
attempting to uncover the factual basis underlying this alleged
fraudulent conduct at the point when those facts were available.
Maggio v. Gerard Freezer & Ice Co., 824 F.2d 123, 127-28 (1st Cir.
1987). Here, because of the self-concealing50 nature of the
defendants' conduct, as well as their failure to report any of the
alleged preferred investor arrangements to the independent
trustees of the Columbia Funds, the SEC did not become aware of
the activity until September 2003 when the Columbia entities
responded to an inquiry from the Commission. See Cook v. Avien,
Inc., 573 F.2d 685, 695 (1st Cir. 1978) (noting that the statute
of limitations is tolled until the "plaintiff in the exercise of
reasonable diligence discovered or should have discovered the
fraud," even if there are no "affirmative acts on the part of
defendants" to conceal their conduct from the other party); SEC v.
50
The acts were self-concealing because a reasonable investor
would not have been aware that market timing activities were
allegedly occurring in several of the Columbia funds, in light of
the text of the fund prospectuses that represented otherwise.
-91-
Power, 525 F. Supp. 2d 415, 425-26 (S.D.N.Y. 2007). Although
Hussey rightly points out that market timing activities were
widespread throughout the industry prior to 2003, and therefore
the SEC was on notice of such conduct, the basis of the
Commission's claims is not the market timing activities per se,
but rather the fraud committed upon investors by misleading them
about the presence of such activities in the Columbia Funds. As
stated in its complaint, the SEC received no information prior to
September 2003 that alerted it to any potential fraud or that
triggered a duty to inquire whether the defendants or the Columbia
entities were engaged in such activity. See Young v. Lepone, 305
F.3d 1, 8 (1st Cir. 2002) (discussing "storm warnings" that would
have triggered plaintiff's duty to act). Thus, we conclude that
the allegations here support a claim that the five-year statute of
limitations period was tolled until September 2003 when the SEC
rightly inquired and learned of the defendants' activities.
VIII.
We summarize our conclusions:
1. Section 17(a)(2) covers conduct that may not be
prohibited by section 10(b) and Rule 10b-5(b). Specifically,
primary liability may attach under section 17(a)(2) if the
defendant has "in the offer or sale of any securities . . .
obtain[ed] money . . . by means of any untrue statement of a
-92-
material fact," even if he has not himself made the untrue
statement within the meaning of Rule 10b-5(b).
2. Tambone and Hussey, executives of a mutual fund's
primary underwriter, were primarily responsible for distributing
fund prospectuses to potential investors and other broker-dealers.
To make their sales, they used prospectuses which they knew, or
were reckless in not knowing, contained representations about
market timing practices which were allegedly false. In doing so,
they "obtain[ed] money or property by means of an[] untrue
statement of [] material fact," in violation of section 17(a)(2).
3. Tambone and Hussey, executives of a mutual fund's
primary underwriter, had a legal duty to confirm the accuracy and
completeness of the fund prospectuses that they used in the sale
of the mutual fund's securities. As a result of this duty,
Tambone and Hussey made implied statements to potential investors
that they had a reasonable basis to believe that the statements in
the prospectuses regarding market timing practices were accurate
and complete. Because certain statements in the prospectuses
regarding market timing were allegedly false, defendants' implied
statements were also false. These implied statements fall within
the purview of section 10(b) and Rule 10b-5(b).
4. The district court erred by requiring the SEC to
allege actionable statements publicly attributed to Tambone and
-93-
Hussey as a distinct element of its claims of primary liability
under section 17(a), section 10(b), and Rule 10b-5.
5. The SEC's claims that Tambone and Hussey committed
primary violations of Section 17(a)(2) of the Securities Act,
Section 10(b) of the Exchange Act, and Rule 10b-5(b), were pled
with sufficient particularity to satisfy the requirements of Fed.
R. Civ. P. 9(b).
6. The SEC also stated claims of secondary liability in
its complaint against defendants Tambone and Hussey under Sections
10(b) and 15(c) of the Exchange Act, Rule 10b-5, and Sections
206(1) and 206(2) of the Advisers Act, and stated such claims with
sufficient particularity to satisfy the requirements of Fed. R.
Civ. P. 9(b).
The judgment of the district court is reversed; the case is
remanded to the district court for further proceedings consistent
with this opinion.
So ordered.
- Concurring and Dissenting Opinion Follows -
-94-
SELYA, Circuit Judge (concurring in part and dissenting
in part). In recent months, the securities industry has been
wracked by a treacherous combination of market forces, overly
optimistic risk-taking, and lapses in judgment. The majority
proposes to add to this perfect storm by judicial enlargement of
the scope of primary liability for violations of the antifraud
provisions of the securities laws. I have come to conclude that
this path-breaking step, though taken in the guise of an
interpretation of Rule 10b-5, involves nothing less than a
rewriting of that rule. In the bargain, it stretches the concept
of primary liability beyond what I believe the Supreme Court would
countenance and allows the SEC to cast a wider net than any court
has ever thought possible.
I view this radical departure as an unwarranted
usurpation of legislative and administrative authority. Thus, I
respectfully dissent from Part V of the majority opinion. At the
same time, I agree with the majority's holding that the SEC has
stated a cognizable claim under section 17(a)(2) of the Securities
Act of 1933. I am nonetheless concerned that the language in
which the majority couches this holding is overly broad. Thus,
I concur in the judgment as to that issue without joining Part IV
of the majority opinion.
My exegesis begins with the text of the relevant statute
and rule. See Cent. Bank of Denver v. First Interstate Bank of
-95-
Denver, 511 U.S. 164, 173 (1994). Section 10(b) of the Exchange
Act of 1934 renders it unlawful for a person "directly or
indirectly . . . [t]o use or employ, in connection with the
purchase or sale of any security . . . any manipulative or
deceptive device or contrivance in contravention of such rules and
regulations as the [SEC] may prescribe." 15 U.S.C. § 78j(b). The
"in contravention of such rules" language invites clarification
of the statute through rulemaking. The SEC has obliged.
The rule providing clarification in this instance is
Rule 10b-5(b). That provision prohibits "any person" from
"directly or indirectly . . . mak[ing] any untrue statement of a
material fact or . . . omit[ting] to state a material fact." 17
C.F.R. § 240.10b-5(b). My disagreement revolves around the proper
interpretation of the first element of a Rule 10b-5(b) violation:
a material misstatement made by the defendant.
In my view, the verb choice is critical to an
understanding of the rule. Yet the majority casually conflates
this carefully chosen verb ("make") with a very different verb
("use") in order to impose primary liability on defendants who
have not "made" any misstatements but, rather, are alleged to have
used prospectuses that contain misstatements crafted by others.
See ante at 51. The word "make" is not infinitely elastic — and
I do not think that it either can or should be interpreted so
expansively. To make a bad situation worse, the majority's
-96-
confusion of these two distinct verbs flies in the teeth of the
Supreme Court's circumspect vision of primary liability with
respect to the antifraud provisions of the securities laws. Let
me briefly sketch the background and then explain the basis for
these two conclusions.
In this civil enforcement action, the SEC accuses the
defendants of sins of commission, not sins of omission; that is,
of making untrue statements of material fact. For present
purposes, then, the pivotal word in the rule is "make." Rule 10b-
5 does not define that word, and the Supreme Court has not
directly addressed its meaning in this setting.51 Thus, it seems
logical to consult the dictionary in order to glean the essence
of the word. See, e.g., Perrin v. United States, 444 U.S. 37, 42
(1979).
To "make" means to "act" or "cause to exist, occur, or
appear," or "create [or] cause." Webster's Third New
International Dictionary 1363 (1993). The SEC charges these
defendants, in substance, with passing along to brokers, dealers,
and customers prospectuses containing false statements of material
51
The majority correctly acknowledges that Rule 10b-5 cannot
be read to sweep more broadly than the statute to which it is
appurtenant. Ante at 51. It then turns this axiom inside out and
uses the broad language of the statute to define the obviously
narrower language of the rule. Ante at 51-52. I do not find
either this sleight of hand or the majority's circular attempt to
explain it, ante at 51 n.34, persuasive.
-97-
fact created by others.52 To stretch the word "make" to cover that
conduct, so that an underwriter's status as such renders him per
se liable for others' statements, requires a freewheeling
interpretation that disregards both plain meaning and orthodox
definitions. There is no principled justification for such an
interpretation; in the last analysis, it amounts to a thinly-
disguised attempt to rewrite the rule. That is a step forbidden
to us as judges. See Robinson v. Shell Oil Co., 519 U.S. 337, 340
(1997); United States v. Charles George Trucking Co., 823 F.2d
685, 688 (1st Cir. 1987).
There is a further problem. The majority's freewheeling
approach blurs the line that the Supreme Court has taken pains to
draw between primary and secondary liability with respect to the
antifraud provisions of the securities laws. As Rule 10b-5(b)
itself suggests, that line should be kept sharp and clear: a
person who does not actually make or affirmatively cause to be
made a materially false statement may be held liable as a
secondary violator (for aiding and abetting), but he cannot be
held liable as a primary violator. See In re: Charter Commc'ns,
Inc., Sec. Litig., 443 F.3d 987, 992 (8th Cir. 2006), aff'd sub
52
Although the SEC's complaint contains some vague allusions
that Tambone and Hussey may somehow have participated in drafting
the prospectuses, the SEC has focused its primary liability
arguments under section 10(b) and Rule 10b-5(b) on the defendants'
use of the prospectuses. In accordance with our usual praxis, I
deem abandoned arguments that have not been developed on appeal.
United States v. Zannino, 895 F.2d 1, 17 (1st Cir. 1990).
-98-
nom. Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc.,
128 S. Ct. 761 (2008).
Central Bank is of central importance in arriving at
this conclusion. The majority labors to downplay the significance
of Central Bank by remarking the obvious: that the Court did not
address the specific issue with which we are faced. See ante at
61-63. But even though Central Bank's holding does not explicitly
control here, its teachings cannot be so blithely dismissed.
While the decision there left open the precise boundaries of
primary liability, it remains the beacon by which courts must
steer in navigating the interpretive channels that run through the
antifraud provisions of the securities laws.
In Central Bank, the Supreme Court laid out its approach
to interpreting section 10(b) in private securities actions. 511
U.S. at 167-90. The Court emphasized that a correct
interpretation must center on the language of the statute itself.
Id. at 175. It admonished that expansive readings of such
statutes, based on judicially manufactured policy rationales,
should be avoided. Id. at 188-89 (stating that "[p]olicy
considerations cannot override our interpretation of the text and
structure of the Act").
That prescription comprises the gold standard for courts
embroiled in securities fraud litigation. Fairly read, the
Court's opinion counsels against superimposing judicial policy
-99-
preferences on unsympathetic language in a statute or rule. The
majority opinion disregards that wise counsel.
Central Bank is informative in another respect as well.
The Court specifically held that a private plaintiff cannot
maintain an action for aiding and abetting under section 10(b) or
Rule 10b-5. Id. at 191. As a result, the line between primary
violators and secondary violators has become highly significant
for those who deal in securities. That line has ready application
here.
There is no need for me to reinvent this particular
wheel, for the Second Circuit has gotten it exactly right: "if
Central Bank is to have any real meaning, a defendant must
actually make a false or misleading statement in order to be held
liable under Section 10(b). Anything short of such conduct is
merely aiding and abetting, and no matter how substantial that aid
may be, it is not enough to trigger liability under Section
10(b)." Wright v. Ernst & Young LLP, 152 F.3d 169, 175 (2d Cir.
1998) (quoting Shapiro v. Cantor, 123 F.3d 717, 720 (2d Cir.
1997)); accord Anixter v. Home-Stake Prod. Co., 77 F.3d 1215,
1226-27 (10th Cir. 1996) ("Reading the language of § 10(b) and
10b-5 through the lens of Central Bank of Denver, we conclude that
in order for [defendants] to 'use or employ' a 'deception'
actionable under the antifraud law, they must themselves make a
false or misleading statement . . . ."). The majority opinion in
-100-
this case effectively relegates these sensible precedents to the
scrap heap — and it does so without any meaningful support in the
case law.53
I find further support for a plain-meaning
interpretation of Rule 10b-5(b) in a comparison of its text with
that of section 17(a) of the Securities Act of 1933. It is common
ground that Rule 10b-5 was devised after and in light of section
17(a). See United States v. Persky, 520 F.2d 283, 287 (2d Cir.
1975). For the most part, the rule's provisions mirror the
counterpart provisions contained in section 17(a). Compare 17
C.F.R. § 240.10b-5(a) ("to employ any device"), and id. § 240.10b-
5(c) ("to engage in any act"), with 15 U.S.C. § 77q(a)(1) ("to
employ any device"), and id. § 77q(a)(3) ("to engage in any
transaction"). There is a notable difference in language,
however, between Rule 10b-5(b) and its counterpart provision,
section 17(a)(2). The former uses the word "make," 17 C.F.R. §
240.10b-5(b), while the latter uses the phrase "by means of," 15
U.S.C. § 77q(a)(2). It would be foolhardy to gloss over this
striking divergence or to view it as mere linguistic happenstance.
It represents a purposeful choice of language and, as such, it
53
To be sure, earlier cases, cited somewhat disingenuously by
the SEC, take a less categorical view. See, e.g., Chris-Craft
Indus., Inc. v. Piper Aircraft Corp., 480 F.2d 341, 370 (2d Cir.
1973). But these cases preceded the Supreme Court's seminal
decision in Central Bank and, thus, have no continuing vitality.
-101-
must be given effect.54 See United States v. Ahlers, 305 F.3d 54,
59-60 (1st Cir. 2002) (discussing court's obligation to "presume
that . . . differential draftsmanship was deliberate"); cf. Nalley
v. Nalley, 53 F.3d 649, 652 (4th Cir. 1995) ("When the wording of
an amended statute differs in substance from the wording of the
statute prior to amendment, we can only conclude that Congress
intended the amended statute to have a different meaning.").
Doing so bars a court from reading "make" so open-endedly as to
distort its meaning and, in the same fell swoop, obscure the
obvious distinction between "make" and "by means of." The
majority's rendition ignores this distinction.
In an apparent effort to blunt the force of this
reasoning, the majority places weight on the fact that this is an
SEC enforcement action rather than a private securities fraud
suit. See ante at 47. I agree with the majority's conclusion
that the absence of any need to show reliance in an SEC
enforcement action means that the SEC is not required to
54
Indeed, the majority notes both the relationship and the
linguistic differences between section 17(a)(2) and Rule 10b-5(b)
in discussing section 17(a)(2) liability. See ante at 41-42.
There, the majority concedes that the scope of Rule 10b-5(b) is
"more restrictive" than that of section 17(a)(2). Id. at 41. I
fail to understand how the majority can rely on this distinction in
adjudicating the dismissal of the section 17(a)(2) claim, but
gloss over it in adjudicating the dismissal of the Rule 10b-5(b)
claim. The majority's cursory attempt to explain this
inconsistency, ante at 42 n.30, simply does not hold water. Once
the word "make" is construed to mean "implied making" through
"use," any principled distinction between "make" and "by means of"
is irretrievably lost.
-102-
demonstrate public attribution. See SEC v. Wolfson, 539 F.3d
1249, 1260 (10th Cir. 2008) (declining to impose a public
attribution requirement in an SEC enforcement action "given the
unambiguous connection between reliance and attribution, and the
fact that the SEC need not prove reliance"). But for present
purposes, this is thin gruel: the absence of any need to prove
reliance does not allow a court to dismantle Central Bank's
interpretive prescription in its entirety.55 SEC enforcement
actions have no reliance requirement because they are meant to
protect the public generally. See Schellenbach v. SEC, 989 F.2d
907, 913 (7th Cir. 1993). That fact does not give the SEC carte
blanche to punish under a primary liability framework those whose
conduct is not proscribed by the language of the relevant statute
or rule. Nor does the absence of a reliance requirement give a
court a reason to expand the scope of primary liability for
violators of the antifraud provisions of the securities laws.
The majority concludes that "making" can be "implied."
Ante at 58. This is exactly the sort of judicial adventurism
55
In this respect, it is instructive to note that after
Central Bank courts began to strike down aiding and abetting claims
under Rule 10b-5 because "[i]t was difficult to understand how the
SEC could bring an aiding and abetting claim under Rule 10b-5 if a
private litigant [could] not." Louis Loss & Joel Seligman,
Fundamentals of Securities Regulation 1329 (2004). Congress later
enacted a different provision to allow the SEC to bring aiding and
abetting actions. See id. at 1329 n.37 (citing Sec. Ex. Act §
20(f)). Congress easily could have done the same in the Rule 10b-5
context, but it has not done so.
-103-
against which the Central Bank Court warned. While I fully agree
that underwriter-executives owe a duty to their clients and to
those who purchase securities, a breach of that duty, without
more, does not expose those executives to whatever liability the
SEC decides to impose. The SEC's attempt in this case to employ
Rule 10b-5(b) to punish such a breach impermissibly equates a
passive omission — failing to correct a false statement made by
another — with the affirmative misconduct that the language of the
rule targets.56
If more were needed — and I doubt that it is — the
precedents are telling. Although this case is one of first
impression, the courts of appeals in the aftermath of Central Bank
generally have chosen one of two tests, limned by the majority,
see ante Part V.B.2, as an aid in drawing the line between primary
and secondary liability. Compare, e.g., Wright, 152 F.3d at 173-
76 (elucidating attribution test), with, e.g., Howard v. Everex
Sys., Inc., 228 F.3d 1057, 1061 n.5 (9th Cir. 2000) (elucidating
substantial participation test). I agree with the majority that
this case does not present a suitable occasion to choose between
these competing tests. My concern, however, is that the
56
I do not mean to suggest that persons in the defendants'
positions could never be found primarily liable for a section 10(b)
and Rule 10b-5 violation. As the Central Bank Court recognized,
511 U.S. at 191, such a scenario is conceivable. But the
allegations in this case, even if true, do not align with the
requirements for primary liability.
-104-
majority's "implied making" theory of liability captures a much
broader range of conduct than either of the existing tests.
There is no need for me to wax longiloquent. This is
one of those occasions when the language and structure of a rule
and the teachings of the Supreme Court coalesce to signal a
particular result. Instead of heeding this signal, the majority
prefers to rewrite Rule 10b-5 to achieve a different result. That
rewriting is beyond the court's legitimate authority. Moreover,
the majority's result, I fear, has the potential to cause a great
deal of mischief. At the very least, the majority opinion will
garble the law and cause confusion in an industry much in need of
clarity.
Because the SEC's complaint fails to state a claim under
Rule 10b-5(b) upon which relief can be granted against these
defendants, I would affirm the district court's dismissal of that
count. To the extent that the majority holds to the contrary, I
respectfully dissent.
-105-