SEC Erred in Decision Involving Corporate Statements, Group Tells Court

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By Yin Wilczek

June 16 — The U.S. Chamber of Commerce has asked a federal appeals court to overrule the Securities and Exchange Commission on a case involving corporate statements to investors.

In a June 15 amicus filing to the U.S. Court of Appeals for the First Circuit, the chamber argued that the SEC incorrectly found two former State Street Bank & Trust Co. executives liable under the federal securities laws for misstating the riskiness of State Street's Limited Duration Bond Fund (LDBF).

The SEC erred by concluding that the statements were material without considering the background against which they were made and whether they were made to sophisticated investors, the chamber argued.

The case before the First Circuit has ramifications for organizations that make statements that may influence investor's investment decisions.

The case also bears on the scope of the U.S. Supreme Court's decision in Janus Capital Group Inc. v. First Derivative Traders, 131 S. Ct. 2296, 2011 BL 154641

Primary Liability 

In Janus, the Supreme Court adopted a narrow view of primary liability in a private lawsuit, ruling that only a person who “makes” a false statement can be liable for fraud under 1934 Securities Exchange Act Section 10b-5(b).

In 2010, the SEC's Enforcement Division filed an administrative action against John Flannery, a former fixed income chief investment officer for State Street Global Advisors, and James Hopkins, head of North American product engineering for State Street's fixed income funds.

The division alleged that by 2007, the LDBF was almost entirely invested in subprime residential mortgage-backed securities and derivatives. However, Flannery and Hopkins continued to describe the LDBF as less risky than a typical money market fund and failed to disclose the extent of the fund's concentration in subprime investments, it said.

State Street agreed in 2010 to pay more than $300 million to resolve charges by the SEC and Massachusetts regulators over its alleged role in the controversy.

One year later, SEC Chief Administrative Law Judge Brenda Murray concluded in a novel ruling that Janus applied beyond Rule 10b-5(b) to Rules 10b-5(a) and (c), and 1933 Securities Act Section 17(a). Accordingly, the ALJ held that the division had to prove that the respondents had ultimate authority and control over the alleged misleading documents. Murray found that the respondents weren't responsible for the documents, which, she said, didn't in any event “contain materially false or misleading statements or material omissions.”

ALJ Reversed 

On appeal, a divided SEC reversed in December. The commission held that based on “textual differences” and policy considerations, Janus's ruling was limited to Rule 10b-5(b) and did not apply to the other provisions.

The SEC ultimately found Flannery and Hopkins liable under Section 17(a) for statements made in two letters and a slide that purported to describe the LDBF's “typical” portfolio.

The former executives appealed separately to the First Circuit. They asserted that the commission lacked evidence for its findings and erred on its materiality conclusion, among other arguments. Their appeals were consolidated in March for purposes of briefing and oral argument.

Oral argument has not yet been scheduled.

Big Impact on Companies 

In its June 15 filing, the chamber argued that in determining whether such statements are material for purposes of the federal securities laws, courts should consider:

• whether they were made in face-to-face or open-market settings, and

• the investor's degree of sophistication.


“Under circumstances like these—involving face-to-face transactions and sophisticated investors—courts have properly recognized what the Commission did not: because a ‘reasonable investor' in this type of transaction has more information than someone who transacts on the open market, the government must satisfy a higher threshold of materiality to demonstrate that the alleged misstatement or omission would ‘significantly alter' the ‘total mix' of information,” the chamber said.

Reading too ‘Novel.'

The chamber also argued that the SEC adopted a “novel and expansive” interpretation of Section 17(a)(3), “imposing liability where it had not been contemplated before.”

Even if the provision could support the SEC's reading, it is ambiguous enough to require, under the rule of lenity, that it be interpreted in favor of Flannery and Hopkins, the chamber argued. “Applying the rule of lenity to hybrid statutes of this sort promotes consistent interpretation of the law, fair notice to the public of what the law requires, and clear boundaries between the branches of government.”

The SEC's response is due July 15.

The chamber is represented by Jonathan Cedarbaum, Wilmer Cutler Pickering Hale & Dorr LLP, Washington.

To contact the reporter on this story: Yin Wilczek in Washington at

To contact the editor responsible for this story: Ryan Tuck at

The brief is available at