In Janus Capital Group v. First Derivative Traders, No. 09–525 (decided June 13, 2011), a divided U.S. Supreme Court ruled that an investment adviser to a mutual fund cannot be held directly liable under Rule 10b-5 for misstatements in the fund's prospectus. The decision is welcome news for investment advisers, as the ruling effectively limits private shareholder actions against a fund complex and its subsidiaries in the prospectus disclosure process. However, the case should also serve as a reminder to the boards of directors of investment companies that they are responsible for oversight of disclosure in a fund's prospectus and should take care to ensure the disclosure is accurate.
The case involved Janus Capital Group, Inc. and its subsidiary, Janus Capital Management LLC ((JCM), collectively, Janus), in its capacity as adviser and administrator to the Janus Investment Fund, and stemmed from a private shareholder action under Rule 10b-5 of the Securities Exchange Act (Exchange Act) related to certain market-timing prospectus disclosure of the Janus Investment Fund. The suit asserted that Janus, due to the inherent control it retained in the prospectus drafting process due to its position as the investment adviser to the Janus Investment Fund, was ultimately liable for allegedly misrepresenting certain disclosure in the Janus Investment Fund's prospectus.
The Court held that even though Janus may have been “significantly involved in preparing the prospectuses, Janus did not itself ‘make' the statements at issue,” and could not be held liable for the statements, because the prospectus was subject to the ultimate control of the board of trustees of the Janus Investment Fund. This ruling by the court follows a 2008 Supreme Court decision that sought to curb the implied private right of a shareholder to bring suit against a company's banks and business partners for providing false information. Referencing this decision, the Court majority stated that the shareholders in the Janus case were seeking to “create the broad liability” that the Court previously “rejected” in 2008, which the majority again rejected in this case.
The decision provides that for “purposes of Rule 10b-5, the maker of a statement is the person or entity with ultimate authority of the statement, including its content and whether and how to communicate it.” In the case of the Janus Investment Fund's prospectus, the entity with the ultimately authority was the fund's board of trustees. So, the Court majority's decision essentially relegates mutual fund prospectus liability to the officers and trustees of the fund, while limiting the liability of other participants in the drafting of the prospectus, such as investment advisers and other service providers.
In addition, the Court majority's decision is written broadly and will likely act to severely diminish the future merits of similar private lawsuits under Rule 10b-5 regardless of the industry in which they arise.