In Janus Capital Group, Inc. and Janus Capital Management LLC v. First Derivative Traders, decided June 13, 2011, the Supreme Court held that Janus Capital Management LLC (JCM), a subsidiary of Janus Capital Group, Inc. (JCG) and investment advisor for JCG on a group of its mutual funds, cannot be held primarily liable in a private action by JCG shareholders for alleged false statements in a prospectus under Section 10(b) of the Securities Exchange Act of 1934 and SEC’s Rule 10b-5. The Supreme Court reversed the Court of Appeals for the Fourth Circuit, which had ruled that First Derivative Traders had sufficiently plead that JCM “made” material misstatements in the Janus Funds’ prospectus regarding its market-timing policy. The SEC filed an amicus brief in support of First Derivative Traders advocating the position rejected by the Supreme Court.
This action was commenced by JCG shareholders who alleged that JCG and JCM (the “Petitioners”) committed securities fraud by representing in the Janus Funds’ prospectus that the Funds were not intended for market-timing, despite JCM allowing such transactions. When the New York Attorney General made JCM’s secret market-timing arrangements public in 2003, the Funds’ assets decreased and caused JCG’s financial performance to suffer.
At the heart of this case was whether JCM, as investment advisor for JCG, “made” material misstatements and could be primarily liable for securities fraud. Section 10(b) of the Securities Exchange Act makes it unlawful for “any person, directly or indirectly . . . [t]o use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device . . . .” Securities and Exchange Commission Rule 10b-5 deems it a violation of Section 10b for “any person, directly or indirectly . . . [t]o make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading . . . .” (emphasis added). A 1994 Supreme Court case held that there is no aiding-and-abetting liability in private actions under Section 10(b), and that “secondary actors” cannot be held liable in such suits unless “all of the requirements for primary liability … are met.”
JCG and JCM argued that First Derivative Traders failed to plead an actionable claim because an investment advisor cannot be primarily liable as an “issuer” of securities for helping to draft or assisting in preparing and disseminating a prospectus of a different company. That is, they argued that JCM did not “make” any misstatements under Rule 10b-5. Even if JCM could be deemed to have “made” misstatements, liability still did not attach because the statements were not directly and contemporaneously attributed to JCM such that the plaintiffs could have relied on them. The Petitioners classified JCM as a secondary actor whose actions did not rise to the level of primary liability in a private Rule 10b-5 action.
First Derivative Traders argued that JCM made the misrepresentations by writing the mutual fund prospectuses and causing them to be issued for Janus Funds, and relied upon prior SEC interpretations to support the proposition that “make” under 10b-5 includes “creating a statement or causing a statement to exist.” It further argued that there was sufficient reliance on the misstatements because it was publicly disclosed that JCM had day-to-day control of the Funds, and a reasonable investor would have attributed misstatements in the prospectuses to JCM.
Supreme Court Decision
The Supreme Court ruled that, while JCM may have assisted the Funds in preparing the prospectuses, it did not itself “make” the alleged misleading statements within those prospectuses. The Court held that “make” under Rule 10b-5 does not mean “create”, but rather applies to the person or entity with “ultimate authority over the statement, including its content and whether and how to communicate it.” In this case, the entity with the ultimate control to file the prospectuses with the SEC was Janus Investment Fund, not its advisor JCM. The Court stated further that “one who prepares or publishes a statement on behalf of another is not its maker.” The Court rejected First Derivative Traders’ argument that JCM exerted significant influence over their client funds and emphasized that they still remained separate legal entities.
Implications of Decision
The Supreme Court’s determination as to the scope of primary liability under the securities laws does not, as a practical matter, alter the previous scheme of primary liability, but draws a clear line narrowing the scope of that liability. The Court’s decision shields a wide range of service providers in the securities market, including those who advise issuers of securities, and may encourage other industries to follow suit and divide their structure so as to avoid primary liability.
It should be noted that the Court did not address what it means to communicate a “made” statement indirectly under the securities laws because it found that none of the statements in the prospectuses were attributed to JCM. The Court stated in a footnote that “without attribution, there is no indication that Janus Investment Fund was quoting or otherwise repeating a statement originally ‘made’ by JCM.”