The First Circuit Court of Appeals reversed a district court ruling dismissing a Securities and Exchange Commission action against certain senior executives of the primary underwriter for a family of mutual funds stemming from allegedly false statements included in the prospectuses for the mutual funds regarding their prohibition of “market timing” transactions. The SEC alleged that the defendants were secondarily liable for violations of Section 10(b) of the Securities and Exchange Act of 1934 and Rule 10b-5 thereunder for “implied statements” made in the prospectuses that were not true when made. The SEC also alleged primary liability for violations of Section 17(a)(2) of the Securities Act of 1933 for obtaining money in the offer or sale of securities by the means of an untrue statement of a material fact.
The defendants, as senior executives of the primary underwriter, were responsible for disseminating informational materials for the mutual funds, including their prospectuses. During the relevant time period, the fund prospectuses were amended to limit and, in some instances, ban “market-timing”—i.e., an investor’s rapid succession round-trip transactions made to take advantage of short-term inefficiencies in the fund’s prices. Notwithstanding these amendments, the SEC alleged that the executives affirmatively approved special arrangements with particular investors to permit “market-timing” transactions that conflicted with the provisions of the applicable prospectuses.
The First Circuit held that the SEC’s allegations sufficiently alleged an uncharged primary violation against the defendants’ underwriter-employer, ruling that the language in the prospectus banning market-timing was misleading in light of the conflicting arrangements made with particular investors. With respect to the individual defendants’ secondary liability under Section 10(b) and Rule 10b-5, the First Circuit held that the SEC had sufficiently alleged their knowledge of the fraud and that defendants had substantially assisted the fraud, ruling that defendants’ “positions as officers... imposed upon them a duty to review the accuracy of the prospectus disclosures” which they failed to satisfy as a result of their “failure to correct the misleading disclosures.” In addressing the primary liability claim under Section 17(a)(2), the First Circuit held that under Section 17(a)(2), in contrast to Section 10(b) and Rule 10b-5, a claim could be stated so long as a materially misleading statement allegedly was made in connection with the offer or sale of securities, regardless of whether the statement was alleged to have been made by the defendants charged with the violation. (SEC v. Tambone, 2008 WL 5076554 (1st Cir. Dec. 3, 2008))