On December 3, 2008, the First Circuit reversed the District of Massachusetts’ dismissal of an SEC enforcement action against two former executives of Columbia Funds.  The SEC’s case alleged fraud related to mutual fund market timing arrangements.

The SEC issued a Litigation Release today discussing the case, and noting that the ruling now permits it to proceed with its fraud action against the two executives, James Tambone and Robert Hussey.

The SEC states that it alleges that Tambone and Hussey participated in a fraudulent scheme with Columbia Distributor and Columbia Management 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.

According to today’s Litigation Release, the First Circuit ruling reversed the finding of the lower court 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 and

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.