United States: New Decision Creates Split In Southern District Of New York Over Janus Decision

Originally published in V&E Securities Litigation and Enforcement Update E-communication, February 24, 2012

A new decision from the Southern District of New York (S.D.N.Y.) has created a split in that district concerning the application of the U.S. Supreme Court's decision in Janus Capital Group, Inc. v. First Derivative Traders 131 S. Ct. 2296 (2011), in SEC enforcement actions. In SEC v. Pentagon Capital Management PLC, Judge Robert W. Sweet of the S.D.N.Y. focused on the distinctions between private and public actions — and the language of their respective statutory provisions — to explain why Janus should not be extended to SEC enforcement actions under Section 17(a) of the Securities Act.

As explained in our June 13, 2011, Securities Litigation and Enforcement Update E-communication, the Janus decision limited private securities fraud actions against secondary actors, such as bankers, lawyers, auditors, and accountants, who merely review or assist with a company's drafting or distribution of false or misleading statements. Janus held that "[f]or Rule 10b-5 purposes, 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," while "[o]ne who prepares or publishes a statement on behalf of another is not its maker."¹ But while Janus clearly sought to define the limits of private 10b-5 actions, defendants have raised Janus as a defense to liability in public actions brought by the SEC under Section 17(a) of the Securities Act of 1933.

The first S.D.N.Y. case to consider the application of Janus in an SEC enforcement action found that Janus applied equally to a Section 17(a)(2) claim. SEC v. Kelly, No. 08-CV-4612, 2011 WL 4431161 (Sept. 22, 2011). In doing so, Judge Colleen McMahon noted that "numerous courts have held that the elements of a claim under Section 17(a) are 'essentially the same' as those for claims under Rule 10b–5."² Rejecting the SEC's claim that Janus is inapplicable to Section 17(a)(2) claims because 17(a)(2)'s language differs from that of Rule 10b-5, Judge McMahon concluded that "both provisions have the same functional meaning with it comes to creating primary liability" because "the SEC must prove that the defendant made materially false statements or omissions" under either provision.³

Only recently, however, S.D.N.Y. Judge Sweet reached the opposite conclusion. SEC v. Pentagon Capital Management PLC, No. 08 Civ. 3324, 2012 WL 479576 (Feb. 14, 2012). In Pentagon Capital Management, Judge Sweet found that Janus should not apply to claims under Section 17(a). Relying on SEC v. Daifotis, No. C 11–00137, 2011 WL 3295139, (N.D. Cal. Aug. 1, 2011), Judge Sweet found that the absence of the word "make" in Section 17(a), which appears in Rule 10b-5, is an important distinction that favors limiting Janus's application to Rule 10b-5 cases only. This was the same argument the SEC raised, and Judge McMahon rejected, in Kelly. Judge Sweet also observed, in the context of claims under Rules 10b-5(a) and (c), that the Janus Court stressed the distinction between public and private actions in its decisions, and "not[ed] that its holding was limited to 'accord [ ] with the narrow scope that we must give the implied private right of action' under Rule 10b–5 to private plaintiffs in contrast to the Commission."⁴ In contrast with suits brought by private parties under Rule 10b-5, Judge Sweet emphasized, "[t]here is no indication that the Court or Congress intended for actions brought by the SEC to be so limited."⁵ Although not included in Judge Sweet's discussion of Section 17(a), this reasoning would appear to apply equally to claims under that provision. Notably, Judge Sweet cited a California federal district court case to support his conclusion, while failing to mention or distinguish Judge McMahon's Kelly decision.

This recent split within the Southern District of New York adds further uncertainty regarding the interpretation and application of the Janus decision. Until the Second Circuit resolves the issue — or at least until additional S.D.N.Y. courts weigh in on the question — secondary actors assisting in the drafting or distribution of public statements may remain subject to broad SEC enforcement claims of primary fraud liability.

Footnotes

1. 131 S. Ct. at 2302.

2 No. 08-CV-4612, 2011 WL 4431161, at *5.

3 Id.

4 No. 08 Civ. 3324, 2012 WL 479576, at *41 (quoting Janus, 131 S.Ct. at 2303).

5 Id.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.