The Supreme Court drew the line between primary and secondary liability, resolving a debate which has swirled since its 1994 decision in Central Bank v. First Interstate, 511 U.S. 164. In Janus Capital Group, Inc. v. First Derivative Traders, No. 09-525 (S.Ct. June 13, 2011) Justice Thomas, in an opinion joined by the Chief Justice as well as Justices Scalia, Kennedy and Alito, focuses on what it means to “make” a statement. Using a dictionary, grammar rules and an analogy to speech writing, the Court concludes that “For 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.” Slip op. at 6. Accordingly the decision of the Fourth Circuit in favor of plaintiff was reversed.

Background

The action was brought against Janus Capital Group, Inc. (“JCG”) and Janus Capital Management LLC. (“JCM”). JCG is a publically traded. It sponsors the family of mutual funds known as the Janus Funds. JCM is a wholly owned subsidiary of JCG. It is the investment adviser and administrator to Janus Investment Fund.

Janus Investment Fund issued prospectuses as required by the securities laws. Those documents described the investment strategy and operations of its mutual funds to investors. They were filed with the SEC.

The complaint claims that Petitioner defendants JCG and JCM made false statements in the prospectuses regarding the market timing policies of the Janus Funds. Specifically, plaintiff claims the prospectuses gives the impression that market timing is not permitted. This is false since certain traders were permitted to use the practice, according to plaintiff. The complaint does not state that either defendant actually wrote the statements in the prospectus or that they were publicly attributed to them.

Previously, the Attorney General of New York brought suit against JCG and JCM alleging they had entered into secret arrangements to permit market timing in several of the funds. After the complaint was filed investors withdrew significant amounts of money from the Janus Funds. The withdrawals affected JCG’s value. The price of its stock fell about 25%. This suit followed.

The district court dismissed the complaint. The Fourth Circuit reversed. That court held that by participating in the writing and dissemination of the prospectuses the two defendants made the misleading statements in the documents. The Supreme Court granted certiorari to consider if JCM can be held liable in a private actions under Rule 10b-5 for false statements. The Court concluded it could not and reversed the decision of the Fourth Circuit.

The Court’s opinion

Writing for the Court, Justice Thomas’ opinion begins by noting that the cause of action under Section 10(b) and Rule 10b-5 was implied by the courts, not created by Congress. Thus the Court is “mindful” of the “narrow dimensions” of the right of action.

The Court then focused on what it means to “make a statement.” This is because Rule 10(b)-5 says “’[to] make any . . . statement. . . ‘” Slip op at 6. The person who prepares or publishes a statement is not the maker. “This rule might best be exemplified by the relationship between a speechwriter and a speaker. Even when a speechwriter drafts a speech, the content is entirely within the control of the person who delivers it. And it is the sparker who takes credit – or blame – for what is ultimately said.” Id. At 6-7.

This rule is consistent with Central Bank according to the majority. There the Court concluded that aiding and abetting is not within the scope of Section 10(b). Suits against those who render “substantial assistance” to the making of the statements can be brought by the SEC under its aiding and abetting authority using a provision added to the Exchange Act following Central Bank. If however such persons were primary violators under the Section “then aiders and abettors would be almost nonexistent.” Id. At 7. In distinguishing between contributors and those who make the statement “We draw a clean line between the two” the Court noted. Id. At n. 6.

The “clean rule” is also consistent with the Court’s holding in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148 (2008). There the Court held that defendants who contributed to the claimed fraud were not primary liable because nothing they did made it “’necessary or inevitable for [the company] to record the transactions as it did,’” quoting Stoneridge.

Finally, the Court rejected the government’s claim that “make” should be defined to mean “create.” This interpretation would permit private plaintiffs to bring suit against those who provide false or misleading information that another puts into the statement.

Here neither defendant “made” the statement. Despite the relationships between the entities, each remains as a separate entity. Only Janus Investment Fund had the obligation to file the prospectuses with the SEC. There is no indication that JCM filed them. Likewise, there is nothing on the face of the prospectuses which indicates any statement therein came from JCM rather than Janus Investment Fund. Accordingly, neither defendant can be a primary violator.

Justice Breyer penned a dissent joined by Justices Ginsburg, Sotomayor and Kegan. The dissent argues that there is no support for the position advanced by the majority: “But where can the majority find support for the rule that it enunciates? The English language does not impose upon the word ‘make’ the 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. So do cabinet officials make statements about matters that the Constitution places within the ultimate authority of the President . . . Nothing in the English language prevents one from saying that several different individuals, separately or together, ‘make’ a statement that each has a hand in producing.” Slip op. at 3-4.

Under the rule crafted by the majority if management writes a false prospectus and fools the board and the public nobody would be liable according to Justice Breyer. Nobody would have made the false statement. Indeed, under the rule of the majority it is doubtful that even the SEC could pursue the primary violator who “made” the statement or those who assisted as an aider and abettor, according to Justice Breyer.

Finally, Justice Bryer concludes that the Petitioners here did “make” the statements. This is based on the relationships of the entities.

Analysis

The “clean line” drawn by the majority is simple and straight forward. Those who control the statement are primary violators. Those who do not control the statement are not. Apparently others who contribute to the false statement may be liable but only as aiders and abettors in a suit by the SEC. Those persons can not be held liable in private damage actions under Central Bank.

Janus ends the winning streak of plaintiffs. In two prior decisions this Term the Court ruled in favor of the plaintiffs. In Matrixx Initiatives (here) the Court hewed close to its precedent in concluding what constitutes materiality for a Section 10(b) cause of action. The application of that test by the Court however suggests that it may have been diluted by the decision.

Likewise, in Halliburton the Court handed down a pro-plaintiff decision (here). There it rejected a holding from the Fifth Circuit which would have made class certification significantly more difficult by requiring that plaintiffs establish loss causation as part of the process. Again the Court closely followed its prior precedents in reaching its conclusion.

Neither Matrixx Initiatives nor Halliburton concerned the scope of the cause of action under Section 10(b) and Rule 10b-5 however. As Justice Thomas stated at the outset of his opinion, Congress did not create this cause of action although it has repeatedly acquiesced in it. Rather, it was crafted by the courts. This means it must be narrowly focused, a theme the Court has repeatedly echoed in recent years.

If Janus is anything it is narrow and focused. Under the test crafted by the majority only the person who controls the statement is responsible. In reaching this conclusion the Court specifically rejected the “substantial participation” test crafted by the Ninth Circuit although the decisions of the circuit are not cited. See, e.g., Howard v. Everex Systems, Inc., 228 F. 3d 1057 (9th Cir. 2000); In re Software Toolworks, Inc., 50 F. 3d 615 (9th Cir 1995). It also seems to have rejected the “bright line” test crafted by the Tenth and Second Circuits and followed by others. See, e.g., Shapiro v. Cantor, 123 F. 3d 717 92nd Cir. 1997); Anixter v. Home-State Production Co., 77 F. 3d 1215 (10th Cir. 1996). Again however the precedents on this point are not cited.

In the end however the “clean line” test may be at least as difficult to apply as its predecessors. When the claimed false statement is contained in a document that a company is obligated to file with the SEC Janus says the statement is “made” by the filer. Those who contributed, participated, drafted or even created the statement do not “make” it and thus do not directly violate Exchange Act Section 10(b). In situations where there is no filing obligation however the Janus “clean line” test may not be so straight forward to apply. Just who has “control” under those circumstances may become a facts and circumstances test which is difficult to resolve. In those situations the “clean line” test may become a facts and circumstances test which is not so easy to apply and not so clean.