On March 10, 2010, the First Circuit en banc issued an important decision regarding civil liability under Securities and Exchange Commission Rule 10b-5(b), SEC v. Tambone, __ F.3d __, 2010 WL 796996 (1st Cir. Mar. 10, 2010), concluding that to be liable under Rule 10b-5(b), a person must actually make the statement at issue, not just use or disseminate a statement written by someone else. The court’s decision has important implications for defendants in SEC enforcement actions, as well as private securities actions.


The SEC alleged that the defendants, two executives of a mutual fund distributor, “entered into, approved, and/or knowing permitted arrangements allowing certain preferred customers to engage in market timing” in certain mutual funds, despite knowing that the fund prospectuses prohibited market timing.

Based on these allegations, the SEC charged the defendants with primary violations of § 17(a)(2) of the Securities Act, § 10(b) of the Exchange Act, and Rule 10b-5(b), as well as aiding and abetting. In support of the Rule 10b-5 claim for “mak[ing] any untrue statement” the SEC argued in the district court both that the defendants had participated in the drafting of the prospectuses and that the defendants’ use and dissemination of the prospectuses drafted by others was sufficient to trigger liability.

The district court dismissed all the claims, holding with regard to Rule 10b-5(b), that the SEC’s allegations were insufficient under Fed. R. Civ. P. 9(b) to show that the defendants had “made” the allegedly false statements.

On appeal, the SEC dropped its claim that the defendants participated in drafting the prospectuses, but argued that they were liable under Rule 10b-5(b) because they used the prospectuses in the sale of securities, and because, as securities professionals, they had a duty to investigate the truth and accuracy of the prospectuses they disseminated and had therefore impliedly represented that the statements in the prospectus were true.

In 2008, a divided panel of the First Circuit reversed the dismissal as to all claims, and with regard to the Rule 10b-5(b) claim, “adopted the SEC’s implied representation theory and held that the SEC had thereby alleged that the defendants had made false statements.” SEC v. Tambone, 550 F.3d 106 (1st Cir. 2008). The full court granted en banc review on the Rule 10b-5(b) issues only, SEC v. Tambone, 573 F.3d 54 (1st Cir. 2009), and has now reversed the panel decision, affirming the district court’s dismissal of the Rule 10b-5(b) claim.

First Circuit Analysis

The court began its analysis with the plain language of Rule 10b-5(b), which provides in relevant part, “[i]t shall be unlawful for any person, directly or indirectly, . . . [t]o make any untrue statement of a material fact.” Because the statute does not define the word “make,” the court looked to its ordinary meaning, which includes “compose,” “create,” or “cause to exist.” The court reasoned that the SEC’s interpretation — that “make” can include “use” or “disseminate” — is inconsistent with the word’s plain meaning.

The court, looking at the structure of Rule 10b-5, reasoned that Rule 10b-5(b), the false statement provision, explicitly used the word “make,” while Section 10(b) itself uses the broader words “use or employ.” That the word “make” was explicitly chosen by the drafters of Rule 10b-5 is apparent from a comparison with § 17(a) of the Securities Act (on which Rule 10b-5 was modeled), because § 17(a) instead requires that the defendant “obtain money or property by means of any untrue statement of a material fact.” Thus, while the SEC may charge a violation of § 17(a)(2) where a defendant uses a statement made by another, that same conduct cannot be the basis of a claim under Rule 10b-5(b).

The First Circuit held that the SEC's interpretation of Rule 10b-5(b) was "expansive," "inconsistent 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." It also found that the "SEC's attempt to impute statements to persons who may not have had any role in their creation, composition or preparation falls well short [of being a Rule 10b-5 violation.]" More specifically, the court rejected the SEC’s interpretation as inconsistent with Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164, 173 (1994). Although Central Bank did not decide the meaning of the word “make” in Rule 10b-5(b), the case painted a clear line between primary liability and aiding and abetting. As the First Circuit concluded, “[r]eading ‘make’ to include the use of a false statement by one other than the maker would extend primary liability beyond the scope of conduct prohibited by the text of Rule 10b-5(b).”

The court did not, however, take sides in the circuit split as to whether a defendant’s “substantial participation” in making a false statement is enough for primary liability under Rule 10b-5(b) or whether the plaintiff must prove “both that the defendant actually made a false or misleading statement and that it was attributable to him at the time of public dissemination.” Nonetheless, the court found the SEC’s theory of liability in this case would not satisfy even the “substantial participation” test, and cited with approval the Second Circuit’s holding: “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 [as a primary violator] under section 10(b). Anything short of such conduct is merely aiding and abetting. Shapiro v. Cantor, 123 F.3d 717, 720 (2d Cir. 1997).”

Finally, the First Circuit rejected the SEC’s theory that securities professionals working for underwriters impliedly represent the truth of all statements in the prospectus, because under that theory the defendants “will be liable whenever they fail to disclose material information not included in a prospectus” regardless of whether there is an independent duty to disclose, as required by Chiarella v. United States, 445 U.S. 222 (1980). It made clear that “a party’s nondisclosure of information to another is actionable under Rule 10b-5 only when there is an independent duty to disclose the information arising from ‘a fiduciary or other similar relation of trust or confidence’ between the parties.” Id. at 228. Nor did the court find persuasive the various court of appeals and administrative decisions cited in support of the SEC’s implied representation theory. And the court refused to consider the SEC’s arguments — raised for the first time to the en banc court — that the defendants could be liable under an “entanglement” or “shingle” theory. It found that nothing in these decisions “says that an implied representation of an underwriter can constitute a basis for primary liability under Rule 10b-5(b).”

Practice Tips

As the First Circuit said, the SEC's interpretation of Rule 10b-5(b) advanced in Tambone was “expansive,” and “inconsistent with the ordinary meanings of the phrase ‘to make a statement,’ inconsistent with the structure of the rule and relevant statutes and is in considerable tension with Supreme Court precedent.” As a result of the en banc Court’s decision, the SEC and private plaintiffs making claims against individuals under Rule 10b-5(b) will have to prove that those individuals actually made the statements at issue. Defendants opposing claims under Rule 10b-5(b) should strongly consider a motion to dismiss at the outset where the complaint does not allege facts showing that the defendant actually made the statements at issue. Beyond a motion to dismiss, if the facts allow, discovery should focus on demonstrating that the defendants did not actually make the allegedly false statement.