S.E.C. v. Tambone

• Decision Date: 03 December 2008
• Docket Number: No. 07-1384.,07-1384.
• Citation: 550 F.3d 106
• Parties: SECURITIES and EXCHANGE COMMISSION, Plaintiff, Appellant, v. James TAMBONE; Robert Hussey, Defendants, Appellees.
• Court: U.S. Court of Appeals — First Circuit

550 F.3d 106

SECURITIES and EXCHANGE COMMISSION, Plaintiff, Appellant, v. James TAMBONE; Robert Hussey, Defendants, Appellees.

No. 07-1384.

United States Court of Appeals, First Circuit.

Heard September 12, 2007.

Decided December 3, 2008.

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 U.S. LLP, Frank A. Libby, Jr., John J. Commisso, and Kelly, Libby & Hoopes, P.C., were on brief, for appellee Hussey.

Before SELYA and LIPEZ, Circuit Judges, and DELGADO-COLN,^* District Judge.

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, 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(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 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 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 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 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 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 Services' list of "Authorized Accounts for...