Overview
On June 13, 2011, mutual fund companies and "secondary
actors" in the securities markets scored a major victory when
the US Supreme Court ruled that aggrieved shareholders may seek
relief under the securities laws only from the party with
"ultimate authority" over a false statement.1
In creating this "bright line test" for secondary actors,
the Supreme Court reaffirmed that there is no private right of
action for aiding and abetting securities fraud.2
In a 5-4 decision in Janus Capital Group, Inc. v. First Derivative
Traders, the Court concluded that public mutual fund
company Janus Capital Group, Inc. ("JCG") and its
investment adviser subsidiary, Janus Capital Management
("JCM"), could not be held liable under Section 10(b) of
the Securities Exchange Act of 1934 and Rule 10b-5 for false
statements in prospectuses issued by mutual funds for which JCM
served as investment adviser, but where neither JCM nor JCG had
signed the prospectuses.3 The Court ruled that JCG and
JCM did not "make" a false statement within the meaning
of Rule 10b-5.
Although some commentators have suggested that the Supreme Court is
letting off the hook those persons or entities who helped to draft
or disseminate false statements,4 such parties are
hardly insulated from all liability. First, a shareholder may bring
an action attempting to hold them liable as a "controlling
person" of the maker of a false statement.5 Second,
the US Securities and Exchange Commission ("SEC") may
police the conduct of mutual fund companies and secondary actors by
pursuing aiding and abetting violations of the federal securities
laws.6 Indeed, now that the Supreme Court has read the
securities laws to preclude primary liability for those without
"ultimate authority" over a statement, regulators may
well step up their efforts to monitor the relationships between
issuers and their subsidiaries, as well as the conduct of secondary
actors.
Background of the Case
First Derivative Traders represented a class of shareholders of
JCG, a publicly traded company, who brought suit against JCG and
its wholly owned subsidiary, JCM, on the basis that JCG and JCM
violated the anti-fraud provisions of the securities laws by
participating in the writing and dissemination of allegedly false
and misleading prospectuses issued by the Janus family of mutual
funds.7 Although the mutual funds were managed by JCM
and created by JCG, they were organized as a separate legal entity
known as Janus Investment Fund and owned entirely by mutual fund
investors.8 Janus Investment Fund had no assets, apart
from those owned by the investors.9 JCM provided the
funds with investment advisory services, including "the
management and administrative services" necessary for their
operation.10 All of the officers of the funds were also
officers of JCM, but only one member of the funds' board of
trustees was associated with JCM.11 As the Court noted,
this was more independence than was required under the regulations
governing investment companies.12
First Derivative alleged that statements in the funds'
prospectuses "created the misleading impression" that JCG
and JCM would implement measures to "curb market timing"
in the funds.13 Following revelations that the Attorney
General of the State of New York had filed a complaint against JCG
and JCM alleging that JCG had actually permitted market timing in
several of the funds, investors withdrew significant amounts of
money from them, and JCG's stock price fell nearly 25
percent.14
First Derivative argued that if the "truth" regarding the
market timing practices had been known, the funds would have been
less attractive to investors and JCG would have realized lower
revenues, thereby causing JCG's stock to trade at lower prices.
It claimed that JCM could be held liable for the alleged
misstatements in the fund prospectuses by virtue of its
participation in the drafting and dissemination of the prospectuses
on its website and its close relationship with the funds. It also
tried to hold JCG liable for the acts of JCM as a "controlling
person" under Section 20(a) of the Securities Exchange Act of
1934.15
The district court dismissed First Derivative's complaint for
failure to state a claim against JCG and JCM.16 It
concluded that JCG's dissemination of the prospectuses did not
rise to the level of making a misstatement for securities fraud
purposes and that plaintiffs had failed to demonstrate that the
alleged fraud occurred in connection with the purchase or sale of a
security, since there was no nexus between plaintiffs as JCG
shareholders and JCM.17
But the United States Court of Appeals for the Fourth Circuit reversed, holding that First Derivative sufficiently alleged that "JCM, by participating in the writing and dissemination of the prospectuses, made the misleading statements contained in the documents" and that JCG could be held liable as a control person of JCM.18
Supreme Court Establishes Bright Line Test for Primary Liability
Majority: Only Entity with "Ultimate Authority"
May Be Held Liable
In an opinion by Justice Clarence Thomas, the Supreme Court
reversed the Fourth Circuit's holding. In reaching its
decision, the Court first embarked on an analysis of the meaning of
the word "make" in Rule 10b-5, which makes it unlawful
for any person "[t]o make any untrue statement of material
fact . . . in connection with the purchase or sale of any
security."19 Citing the Oxford English
Dictionary, the majority said the phrase "[t]o make any .
. . statement" in Rule 10b-5 was the "approximate
equivalent of 'to state,'" and that, "[f]or
purposes of Rule 10b-5, the maker of a statement is the person or
entity with ultimate authority over the statement, including its
content and whether and how to communicate
it."20
Analogizing the relationship between JCM and the funds to that of
one between a speechwriter and speaker, the majority observed:
"Even when a speechwriter drafts a speech, the content is
entirely within the control of the person who delivers it. And it
is the speaker who takes credit—or blame—for
what is ultimately said."21 JCM did not
"make" the allegedly false statements even though it had
participated actively in the drafting of the prospectuses because
it did not have ultimate control over their content and
issuance.22 Only Janus Investment Fund—not
JCM—bore the statutory obligation to file the
prospectuses with the SEC and there was no allegation that JCM in
fact filed the prospectuses and falsely attributed them to Janus
Investment Fund. Nor was there anything on the face of the
prospectuses to indicate that any statements came from JCM rather
than Janus Investment Fund, "a legally independent entity with
its own board of trustees[.]"23
The Court also reasoned that adopting a broader interpretation of
the word "make" to include those persons or entities who
contributed "substantial assistance" to the making of a
statement, or to those who had otherwise helped to
"create" a statement,24 would substantially
undermine the Court's previous rejection of private causes of
action for aiding and abetting securities fraud in Central Bank
of Denver, N.A. v. First Interstate Bank of Denver,
N.A.25 "[T]here must be some distinction
between those who are primarily liable (and thus may be pursued in
private suits) and those who are secondarily liable (and thus may
not be pursued in private suits). We draw a clean line between the
two—the maker is the person or entity with ultimate
authority over a statement and others are
not."26
The Court found further support for its reasoning in its decision
in Stoneridge Investment Partners, Inc. v. Scientific
Atlanta,27 in which it rejected a private
securities lawsuit that had been brought under Section 10(b)
against third-party customers and suppliers who allegedly engaged
in undisclosed and misleading transactions that allowed a company
to issue false financial statements.28 The customers and
suppliers' deceptive transactions in Stoneridge and
JCM's participation in the drafting of allegedly false
statements both were undisclosed acts preceding the decision of
independent entities to make public statements.29
Neither could form the basis for a claim under Section 10(b).
Dissent: Majority Defined "Make" Too Narrowly
In dissent, Justice Stephen Breyer took issue with the
majority's interpretation of the word "make" in Rule
10b-5: "[t]he English language does not impose upon the word
'make' boundaries of the kind the majority finds
determinative. Every day, hosts of corporate officials make
statements with content that more senior officials or the board of
directors have 'ultimate authority' to
control."30 In his view, the specific relationships
alleged among JCM, the funds, and the statements in the funds'
prospectuses warranted a conclusion that JCM "made" those
statements.31 "The relationship between JCM and
[the funds]," he wrote, "could hardly have been
closer."32 In addition to the fact that each of the
funds' 17 officers also was a vice president for JCM, JCM
furnished advice and recommendations concerning the funds'
investments and was responsible for the day-to-day management of
the funds' business affairs.33
Justice Breyer was particularly concerned by allegations that JCM
kept the funds' trustees "in the dark" about the
"true" market timing facts, which suggested to him the
possibility that JCM had used an innocent intermediary for its
misstatements in violation of Section 20(b) of the Securities
Exchange Act.34 In such circumstances, Section 20(a)
would not apply to JCM, since it requires proof of control of
another person who is liable for a securities
violation.35 Given the probable unavailability of
Section 20(a) and a "dearth of authority construing Section
20(b)," Justice Breyer suggested that, at a minimum, the Court
should have remanded the case to allow First Derivative the
opportunity to amend its complaint to add a claim under Section
20(b).36
Key Takeaways for Market Participants
The Court's decision is the latest in a series of cases in
which it has taken a narrow view of the scope of the implied
private right of action under Section 10(b).37 Indeed,
citing its earlier language in Stoneridge cautioning
against expansion of that scope, the majority emphasized that,
while the implied private right of action "remains the
law," "[c]oncerns with the judicial creation of a private
cause of action caution against its expansion," especially
when "Congress did not authorize it when it first enacted the
statute and did not expand upon it when it revisited the
law."38 Not even the concerns about the "close
relationship between investment advisers and mutual funds"
expressed by the dissent warranted judicial expansion of the
implied private right of action absent congressional
approval.39 Janus emphasizes again that
"any reapportionment of liability in the securities
industry" will require legislative action.40
The Court's decision also provides important clarification for
all participants in the securities markets:
1. Primary liability is strictly limited to the entity that
"makes" a statement. The majority drew a
"clean line" between primary violators—who may
be held liable in private causes of action—and secondary
actors, who may not. Only those with "ultimate authority"
over a statement's content and dissemination will face
liability under Section 10(b) and Rule 10b-5. Absent that
"ultimate authority," participation or assistance in the
creation of a statement—no matter how
substantial—will not be enough. Nor will republication of
a statement.
2. The decision may alter the dynamic between investment
advisers and mutual funds' boards of directors. The
Court's decision that investment advisers may not be held
liable under Section 10(b) for statements they draft but do not
sign may prompt boards of directors of mutual funds to request that
investment advisers themselves sign the prospectuses and thereby
subject themselves to private liability under Section 10(b) in the
event of any material misrepresentations or omissions.
3. Regulators still retain the ability to pursue
aiders-and-abettors. Even though shareholders may not sue
"once-removed" actors for statements made by others,
government and industry regulators nonetheless retain the ability
to bring causes of action for aiding and abetting violations of the
securities laws.41 Indeed, now that the Supreme Court
has read the securities laws to limit shareholders' ability to
sue secondary actors for fraudulent statements, the SEC may
increasingly seek to fill the void.
4. Issuers still face liability in private causes of action
for violations of Section 20(a). In the private litigation
context, actors still may be held liable for securities fraud
committed by persons or entities that they control, provided those
persons or entities had ultimate authority over a false statement
and the other requirements of Sections 10(b) and 20(a) are
met.
5. Plaintiffs may now attempt to use Section 20(b) of the
Exchange Act to hold issuers accountable for the statements of
their "innocent intermediaries." In a footnote,
the majority declined to consider whether Congress created private
liability for entities that act through innocent intermediaries in
Section 20(b), which makes it "unlawful for any person,
directly or indirectly, to do any act or thing which it would be
unlawful for such person to do under the provisions of this title
or any rule or regulation thereunder through or by means of any
other person."42 Accordingly, the majority left
open the possibility that private litigants could use Section 20(b)
as a mechanism by which to hold issuers liable in such
circumstances, and Justice Breyer indicated that this could be an
alternative path for aggrieved shareholders.
Footnotes
1 Janus Capital Group, Inc. v. First Derivative
Traders, 564 U.S. ---, slip op. at 10-12 (2011).
2 Id., slip op. at 7.
3 Id., slip op. at 10-12.
4 Editorial, So No One's Responsible?, N.Y. Times,
June 15, 2011, at A26.
5 Section 15 of the Securities Act of 1933, codified at 15 U.S.C.
§ 77o; Section 20(a) of the Securities Exchange Act of 1934,
codified at 15 U.S.C. § 78t.
6 Section 20(e) of the Securities Exchange Act of 1934, codified
at 15 U.S.C. § 78t(e).
7 Janus, 564 U.S. ---, slip op. at 1, 3.
8 Id., slip op. at 1-2.
9 Id., slip op. at 2.
10 Id.
11 Id.
12 Id. (noting that up to 60 percent of the board of a
mutual fund may be composed of "interested persons" and
citing 54 Stat. 806, as amended, 15 U.S.C. § 77b(a)(1),
77(b)(2), 80a-8(b), 80a-2(a)(31), 80a-29(a)-(b)).
13 Id., slip op. at 4.
14 Id. Because the funds compensated JCM based on the
total value of the funds and JCM's management fees constituted
a significant percentage of JCG's income, the loss of value in
the funds arguably affected JCG's value as well.
15 Id., slip op. at 9-12. Although First Derivative
argued in the lower courts that JCG violated Rule 10b-5 by itself
making the statements that were contained in the prospectuses, on
writ of certiorari to the Supreme Court, First Derivative sought to
hold JCG liable only as a control person of JCM. Because Section
20(a) applies only to those who control other parties or entities
who may be held liable for securities violations, whether First
Derivative stated a claim against JCG therefore depended on whether
it had stated a claim against JCM. If JCM could not be held liable
under Section 10(b), JCG could not be liable as a control person
under Section 20(a). Id., slip op. at 5 n.5.
16 In re Mutual Funds Inv. Litig., 487 F. Supp. 2d 618,
620 (D. Md. 2007).
17 Id.
18 In re Mutual Funds Inv. Litig., 565 F.3d 111, 121 (4th
Cir. 2009) (emphasis in original).
19 17 C.F.R. § 240.10b-5.
20 Janus, 564 U.S. ---, slip op. at 6.
21 Id., slip op. at 6-7.
22 Id., slip op. at 5.
23 Id., slip op. at 11.
24 In an amicus brief filed on behalf of First Derivative, the
Government argued that "make" should be defined as
"create." Id., slip op. at 8.
25 511 U.S. 164, 180 (1994).
26 Janus, 564 U.S. ---, slip op. at 7 and n.6.
27 552 U.S. 148 (2008).
28 Id. at 166-67.
29 Janus, 564 U.S. ---, slip op. at 9.
30 Id., slip op. at 3 (Breyer, J., dissenting).
31 Id., slip op. at 2 (Breyer, J., dissenting).
32 Id., slip op. at 13-14 (Breyer, J. dissenting).
33 Id., slip op. at 13 (Breyer, J. dissenting).
34 Id., slip op. at 9-11, 13 (Breyer, J.,
dissenting).
35 Id., slip op. at 9 (Breyer, J., dissenting) (citing
Morrison v. Nat'l Australian Bank, Ltd., 561 U.S. ---,
---, n.2 (2010) ("Liability under § 20(a) is obviously
derivative of liability under some other provision of the Exchange
Act."))
36 Id., slip op. at 10-11 (Breyer, J., dissenting)
(citing 5B A. Jacobs, Disclosure and Remedies Under the Securities
Law § 11-8, p. 11-72 (2011)).
37 See, e.g., Stoneridge, 552 U.S. at 165; Dura
Pharms., Inc. v. Broudo, 544 U.S. 336 (2005) (securities fraud
plaintiffs must allege and prove that they suffered economic loss
as a result of defendants' misrepresentations); Central
Bank, 511 U.S. at 180.
38 Janus, 564 U.S. ---, slip op. at 6 (citing
Stoneridge, 522 U.S. at 165-67).
39 Id., slip op. at 10.
40 Id.
41 15 U.S.C. § 78t(e).
42 Janus, 564 U.S. ---, slip op. at 10 n.10.
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