The Commission is again asking the Supreme Court to adopt an expansive reading of Exchange Act Section 10(b). The argument is in its amicus curiae brief filed in Janus Capital Group., Inc. v. First Derivative Traders, No. 09-525 (S.Ct.) in support of Respondent. The case presents a critical issue of primary and secondary liability in private securities fraud actions Section 10(b)(here).

This will be the third time the High Court has considered the question. Previously, in Central Bank of Denver, N.A. v. First Interstate Ban of Denver, N.A., 551 U.S. 164 (1994) the Court held that Section 10(b) does not include a claim for aiding and abetting. Subsequently, in Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148 (2008) the Court rejected a claim that scheme liability is covered by the antifraud provision.

Janis again focuses on the reach of Section 10(b). The action was brought against Janus Capital Group, Inc. and Janus Capital Management LLC. The former is the publicly traded asset-management firm that sponsors a family of mutual funds known as the Janus Funds. The latter is a wholly owned subsidiary of Janus Capital and is the investment adviser to the Janus Funds. The complaint claims that the defendants made false statements regarding the market timing policies of the Janus Funds. Specifically, plaintiff claims the prospectus 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 prospects or that they were publicly attributed to them. The district court dismissed the complaint. The Fourth Circuit reversed.

In the Supreme Court the SEC argues for a reading of the Section 10(b) which would support plaintiff’s claim that the investment adviser is primarily liable. Stressing the language of the statute, the Commission begins its analysis focusing on the word “make,” contending that its traditional interpretation of this statutory term encompasses the conduct here. That interpretation the Commission argues is predicated on the ordinary meaning of the term and is entitled to deference. It includes those who create or write a statement. Since it is clear that an issuer can speak “indirectly” to the markets and be liable under Section 10(b), it “follows that someone else can make a statement indirectly by creating it and having it appear in a prospectus formally issued in the name of another entity.” Under this interpretation of the word, the investment adviser here “made” the false statements about market timing here.

The Commission goes on to distinguish between those who aid and abet a violation and those who may be secondary actors but commit a primary violation. The former are not within the ambit of Section 10(b) while, as Stoneridge made clear, the latter are covered. Thus even if Respondent here is viewed as a secondary actor the allegations in the complaint constitute a primary violation. Therefore they are sufficient. In this regard the Court need not decide when an outside accountant or lawyer may be subject to liability under the Section the SEC argued.

The Commission concludes it arguments by disputing Petitioner’s claim that the complaint fails to satisfy the causation requirements of a Section 10(b) cause of action. Under Basic v. Levinson, 485 U.S. 224 (1988) the fraud-on-the-market presumption is sufficient according to the SEC. Neither that case nor Stoneridge contain an attribution requirement which some circuit courts follow and which requires that the statement be attributed to the speaker to be held liable. Here, in view of the nature of the relationships in a mutual fund complex it is clear that Respondent can be held liable under Section 10(b) according to the Commission.

The SEC’s argument here is consistent with its historic expansive reading of Section 10(b). The agency’s position is, however, reminiscent of its argument regarding scheme liability. Under that theory the Commission claimed that those who participate in a scheme to defraud under certain circumstances may be held primarily liable. A variation of the Commission’s theory was adopted by the Ninth Circuit in Simpson v. AOL Time Warner, Inc., 452 F. 3d 1040 (9h Cir. 2006).

The Stoneridge Court did not adopt the Commission’s scheme liability theory. There the High Court focused on the element of reliance and the remoteness of the conduct of the third party vendors who were alleged to have participated in a “scheme” with Charter Communications to falsify its financial statements.

Underlying the Court’s analysis in Stoneridge are two key points. First, the cause of action for damages under Section 10(b) was created by the courts and not congress. The Supreme Court has repeatedly cited this fact in limiting private claims under the Section. Second, the Court prefers a bright line test. Like its theory of scheme liability, the Commission’s arguments in Janus do not appear to fully address these points. And, the Commission is advancing it theory of liability at a time when Congress just refused to extend aiding and abetting to private damage actions in favor of a study on the question by the SEC (here). On the other hand, perhaps the third time is the charm.  

Argument is scheduled for December 7, 2010 at 10:00 a.m.