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The 1st U.S. Circuit Court of Appeals recently issued an en banc opinion that rejected the U.S. Securities and Exchange Commission’s reliance on prospectus language in bringing a Rule 10(b)(5) case against broker-dealer executives. The decision overturned an earlier panel ruling upholding the SEC’s use of the rule, which bars untrue statements in connection with the purchase or sale of a security. The March 9 opinion in SEC v. Tambone, authored by Circuit Judge Bruce Selya on an issue of first impression, rejected “the SEC’s expansive interpretation” of the rule. Rule 10b-5(b) of the Securities Exchange Act of 1934 bars “any untrue statement of a material fact” in connection with the purchase or sale of a security. The SEC’s case alleged that broker-dealer executives violated the rule by allowing “market timing” — frequent purchases and sales of a single mutual fund — despite prohibitive language in company prospectuses. Selya wrote that the SEC erroneously concluded that an individual can “‘make’ a statement … by merely using or disseminating a statement without regard to the authorship of that statement.” The SEC has deemed that disclosures in a prospectus, for example, are implied statements made by securities professionals who sell securities on behalf of an underwriter, Selya wrote. “We reject the SEC’s expansive interpretation,” Selya wrote. “It is inconsistent with the text of the rule and with the ordinary meanings of the phrase “to make a statement,” inconsistent with the structure of the rule and relevant statutes, and in considerable tension with Supreme Court precedent.” The dissenting opinion, authored by Judge Kermit Lipez and joined by Judge Juan Torruella, stated that the language of Section 10(b) and Rule 10b-5(b), the underwriter’s role and duties in the securities market, and decades of case law “inescapably permit the SEC to proceed against [James] Tambone and [Robert] Hussey for making false statements within the purview of Rule 10b-5(b). “My colleagues overstate the significance of [ Central Bank of Denver, N.A. v. First Interstate Bank of Denver N.A., 511 U.S. 164 (1994)] for the interpretive issue before us, fail to account for the underwriter’s unique statutory duty to provide investors with accurate information, and misguidedly allow concerns about excessive private litigation to influence their judgment on the scope of public enforcement by the Securities and Exchange Commission,” Lipez wrote. The SEC sued Tambone and Hussey, who were executives of broker-dealer Columbia Funds Distributor Inc., in the District of Massachusetts in February 2005. The SEC claimed the men violated securities laws by approving or allowing preferred customers to engage in market timing, despite the language in the company’s prospectuses “expressing hostility toward,” the practice. The SEC sued the men for violating Rule 10b-5(b); section 17(a)(2), which makes it illegal “to obtain money or property by means of any untrue statement of a material fact”; and section 10(b) of the Securities Act, which gives the SEC authority to bar any “manipulative or deceptive device or contrivance.” The SEC also alleged that the defendants aided and abetted several securities law violations made by Columbia Advisors and mutual fund underwriter and marketer Columbia Distributor. The district court dismissed the SEC’s amended complaint in December 2006. A divided 1st Circuit panel reversed that ruling in a December 2008 opinion authored by Lipez. The full court withdrew the panel ruling for an en banc hearing on the Rule 10b-5(b) issues. Since the en banc court only considered the 10b-5(b) claims, it remanded the case back to the district court for further proceedings on the section 17(a)(2) and aiding and abetting claims. Cliff Sloan, a Washington litigation partner at New York-based Skadden, Arps, Slate, Meagher & Flom who argued the case for defendant Hussey, said the defendants appreciate the 1st Circuit’s en banc opinion. “We think its analysis of [the rule] is correct and well reasoned,” Sloan said. The decision “is an important, and correct, clarification of Rule 10b-5(b),” said Paula DeGiacomo, a Boston litigation shareholder at Greenberg Traurig, who argued the case at the 1st Circuit. Greenberg Traurig represented defendant Tambone in the case. SEC spokesman John Heine said the agency “is reviewing the decision.” Rich Bernstein, a Washington partner at Willkie Farr & Gallagher who submitted an amicus brief supporting the defendants on behalf of the U.S. Chamber of Commerce, called the ruling “a major victory for investment banks and the mutual fund industry.” “It places a significant roadblock in front of class action plaintiffs that would attempt to drag underwriters into Rule 10b-5(b) litigation,” Bernstein said. The Securities Industry and Financial Markets Association, the Center for Audit Quality, the New England Legal Foundation and Associated Industries of Massachusetts, also submitted single or joint amicus briefs supporting Tambone’s position. The National Association of Shareholder and Consumer Attorneys submitted an amicus brief supporting the SEC.

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