Supreme Court Issues Decision in Securities Fraud Case

On June 13, 2011, the United States Supreme Court rendered a decision in the Janus Capital Group, Inc. v. First Derivative Traders, No. 09-525.  In a 5-4 decision, the Court held that a mutual fund’s investment adviser cannot be held liable for securities fraud under Rule 10b-5 over false statements in a mutual fund’s prospectuses.  In sum, the Court found that Rule 10b-5 provides a private right of action only against the person or company with “ultimate control” over the statements in the prospectuses (i.e. the mutual fund itself), not the mutual fund investment adviser who was “significantly involved” in the preparation of the prospectuses.

Rule 10b-5 of the Securities Exchange Act of 1934 (the “Act”) provides that it is unlawful for “any person, directly or indirectly,…[t]o make any untrue statement of material fact” (emphasis added) in connection with the sale or purchase of securities.  The Court in Janus Capital therefore had to determine who may be held liable in a private right of action for having “made” untrue statements of material fact in the mutual fund prospectuses.

Janus Capital Group (“Janus Capital”), a public company, created a group of mutual funds called The Janus Investment Fund (“Janus Investment”).  Janus Investment hired Janus Capital Management LLC (“Janus Management”), a wholly-owned subsidiary of Janus Capital, to act as its investment adviser and administrator.  Janus Investment is a separate legal entity from Janus Capital and Janus Management and owned by mutual fund investors.  Janus Management provides investment advice and administration to Janus Investment. 

Pursuant to securities laws, Janus Investment issued prospectuses to its investors describing investment strategies and operations of its mutual funds.  First Derivative Traders, a company owning stock in Janus Capital, sued Janus Capital and Janus Management for securities fraud, alleging that Janus Investment’s prospectuses falsely provided that Janus Management would implement policies to restrain trading strategies based on market timing and delays and that those statements led to a fall in Janus Capital’s stock value.  First Derivative Traders claimed that Janus Capital should be held liable for Janus Management’s acts as a “controlling person” under Section 20(a) of the Act.

The Court provided that Janus Management did not “make” untrue statements of material fact, which is required to pursue a 10b-5 action, stating that the Court must interpret Rule 10b-5 with “narrow dimensions.”  Accordingly, the Court held that 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” and that “one who prepares or published a statement on behalf of another is not its maker.”  The Court likened the relationship between investment adviser and mutual fund to a speechwriter and the speaker, stating “[e]ven when a speechwriter drafts a speech, the content is entirely within the control of the person who delivers it.”  In this case, it is Janus Investment, not Janus Management or Janus Capital, that is statutorily obligated to file the prospectuses with the SEC   Thus, Janus Management, because it did not have ultimate control over the statement, did not “make” the statement for purposes of 10b-5. 

The Court came to this conclusion despite recognizing that there exists a very close relationship between mutual funds and their investment advisers and that investment advisers exert significant influence over mutual funds.  Notwithstanding the foregoing, the Court found that “corporate formalities were observed,” Janus Investment had an independent board of trustees different from the board of trustees of Janus Management, and that Janus Capital and Janus Management “remain separate legal entities.”  Finally, the Court stated that redistributing liability in securities cases based on the close relationship between investment advisors and the mutual funds they advise is not the responsibility of the courts, but rather Congress.

Justice Thomas wrote for the majority, in which Chief Justice Roberts and Justices Kennedy, Scalia and Alito joined.  Justice Breyer wrote for the dissent, in which Justices Sotomayor, Ginsburg and Kagan joined.