Saturday, December 6, 2008
On December 3, 2008, the United States Court of Appeals for the First Circuit issued a ruling that allows the SEC to proceed with its fraud action against James Tambone and Robert Hussey, former executives of Columbia Funds Distributor, Inc. ("Columbia Distributor"), the principal underwriter and distributor for a group of approximately 140 mutual funds in the Columbia mutual fund complex ("Columbia Funds"). The SEC alleged that from 1998 through 2003, Tambone and Hussey participated in a fraudulent scheme with Columbia Distributor and Columbia Management Advisors, Inc. ("Columbia Advisors"), the investment adviser to the funds, by secretly entering into or approving arrangements with at least eight preferred customers allowing them to engage in frequent short-term trading in certain Columbia Funds in contravention of the prospectuses that represented that the funds did not permit or were otherwise hostile to market timing or other short-term or excessive trading.
The First Circuit ruling reversed a decision by the District of Massachusetts that had dismissed the case in December 2006 on the ground that Tambone and Hussey could not be held primarily liable for false statements in the prospectuses because they did not make those statements. The First Circuit held that Tambone and Hussey could be held liable. In its decision, the First Circuit emphasized the unique role that underwriters play in the sale and distribution of mutual funds to the investing public and the reliance that the investing public places on them as a result. The First Circuit explained that Tambone and Hussey, as executives of Columbia Distributor, had a legal duty to confirm the accuracy and completeness of the prospectuses and other fund material that they distributed. By distributing the misleading prospectuses, the First Circuit reasoned, Tambone and Hussey made implied statements to potential investors that they had a reasonable basis for believing that the key statements in the prospectuses regarding market timing were accurate and complete.
The SEC first bought action against Tambone and Hussey on February 9, 2005. The District Court dismissed that action without prejudice on January 27, 2006. Thereafter, on May 19, 2006, the SEC filed a new complaint concerning the same conduct. The SEC's complaint alleges that the defendants violated Section 17(a) of the Securities Act of 1933 and Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, and aided and abetted Columbia Distributor's violations of Section 15(c)(1) of the Exchange Act, Columbia Advisors' violations of Sections 206(1) and 206(2) of the Investment Advisers Act of 1940, and the Columbia entities' violations of Section 10(b) and Rule 10b-5 of the Exchange Act. The SEC is seeking an order permanently enjoining Tambone and Hussey from violating the antifraud and other provisions of the federal securities laws, requiring them to disgorge funds received through their violations of the securities laws, and imposing civil monetary penalties. Although the District Court dismissed this complaint on December 29, 2006, the First Circuit, in its decision, remanded the case to the District Court for further proceedings.
In related proceedings, the SEC filed a civil injunctive action against Columbia Management Advisors, Inc. and Columbia Funds Distributor, Inc., in federal court in Massachusetts on February 24, 2004. That action was later dismissed when the two Columbia entities agreed to settle charges through administrative proceedings that resulted in an Order issued by the SEC on February 9, 2005 requiring, among other things, $140 million in disgorgement and penalties to be distributed to investors harmed by market timing activity at Columbia. The SEC is in the process of distributing those funds to investors.