Rule 10b(5)-(B)

Recently, the Court of Appeals for the First Circuit, sitting en banc, decided SEC v. Tambone, thereby creating precedent on the question: what does it mean to make a "statement" for the purposes of a securities-fraud enforcement action?

As most of my readers likely know, the Securities Exchange Act of 1934 contains the fateful section 10(b), which declares that it is unlawful to use any "manipulative or deceptive device" in connection with the purchase or sale of any security. The statute also authorizes the SEC to create "rules and regulations" as needed to protect investors against such misstatements. The catch-all rule that the SEC created in reliance on that mandate is 10b-5, which in relevant part, 10b-5(B), prohibits the making of "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...."

But, what exactly does it mean to make a statement? Defendants James Tambone and Robert Hussey worked for Columbia Funds Distributor, an underwriter for mutual funds. It was not part of their job to write the prospectuses for those funds, but they did routinely in the course of employment provide both broker-dealers and investors with copies of the funds prospectuses. Thereby, on the SEC's theory of the case, they "made the statements" that they knew or should have known were in those documents.

Originally, at the district court level, the SEC had contended as a matter of fact that the defendants had been involved in the drafting of these prospectuses. But at some point in the proceedings that contention dropped away and the agency stuck instead with a more legalistic claim -- that the defendants were liable irrespective of whether they had anything to do with the drafting.

Frankly, that confuses me a bit. On a motion to dismiss, the trial court in the normal course of events would have assumed that the contested facts favored the side responding to that motion. Anyway, the First Circuit in decided the matter said: "In accordance with our usual praxis, we deem abandoned all arguments that have not been briefed and developed on appeal."

Praxis? That seems unnecessarily fancy and foreign. "Practice" would be sufficient, would it not?

It is all Greek to me. The upshot though is that the Circuit Court has now ruled that the defendants had not made the "statements" at issue. The majority was concerned, it appears, about a slippery slope:

While the defendants in this case held significant positions, there is no obvious stopping point: virtually anyone involved in the underwriting process might under the SEC's "making a statement" theory be charged and subject to liability in a suit under section 10(b). The SEC may select its defendants sensibly; but private litigants have their own incentives, and the SEC concedes that its definition of "make," if adopted, would apply to private party actions as well.

A wise decision: a thicket best avoided.