Today the Supreme Court decided Janus Capital Group v. First Derivative Traders. A 5-4 majority of the Court ruled in an opinion by Justice Thomas that a company can’t be held primarily liable in a private securities fraud action for false statements that are primarily attributed to a different entity even though the company took part in drafting and distributing those statements.
The conservative majority of the Supreme Court held that Janus Capital Group (JCG) could not be held liable in a lawsuit brought by individual or group investors for violations of federal securities laws. The Court ruled that Janus Capital Group (JCG) and its wholly owned subsidiary Janus Capital Management (JCM) could not be held to have “made” untrue statements in a Janus Investment Fund (JIF or “Fund”) prospectus because JCG had created the Fund as a legally separate entity, even though all of the JIF officers that drafted the prospectus were employees of a JCG subsidiary.
The JIF is a trust of mutual funds operated under the Janus name. First Derivative Traders, as well a class of other private investors, owned stock in JCG. JCM was hired to act as an advisor to the Fund. In practice, however, all of JIF’s officers were also JCM officers, and they carried out the day-to-day business of the Fund. JCM even hosted the Fund’s prospectuses on its website.
In 2002, JIF issued its annual prospectus, which stated that the Fund did not engage in and would resist any attempts at the use of a trading technique known as “market timing.” However, in 2003 the New York Attorney General’s office filed a case against JCG and JCM, alleging a secret agreement to use market timing in the Fund. JCG and JCM later settled for $100 million in fines and reimbursements to Fund investors. JCG’s stock dropped in price as a result, and First Derivative brought this suit against JCG and JCM to recover their losses.
For decades, courts have held that Securities and Exchange Commission (SEC) Rule 10b-5, published pursuant to Section 10 of the Securities Exchange Act of 1934, allows harmed investors to sue anyone who “makes any untrue statement of a material fact” in connection with the purchase or sale of securities. The Fourth Circuit Court of Appeals held that JCM’s participation in the writing and dissemination of the misleading prospectus was sufficient to say that they had “made” the statements as a matter of law, thereby allowing the case to go forward.
The defendants appealed to the Supreme Court, which under Chief Justice Roberts has developed a reputation for protecting corporate interests from the civil justice system. Justice Thomas’s opinion for the 5-vote majority explicitly gave “narrow dimensions” to the important right of action that Rule 10b-5 provides investors. Looking to dictionary definitions of “make,” Thomas wrote that the Rule should be read as “to state” rather than, as the Government urged in its amicus brief, “to create.” Since the Fund’s board was not controlled by JCM employees, only its officers who prepared and published the prospectus, the Court allowed the corporate form to trump practical responsibility.
“One who prepares or publishes a statement on behalf of another is not its maker,” Thomas wrote on behalf of the Court. Such a case would merely be one of “substantial assistance,” a violation of securities law which only the SEC itself may pursue in court. Somewhat ironically for the ultra-conservative justice, the investing public will now be more dependent on government regulators.
Justice Breyer, for the four dissenting Justices, pointed out that “every day, hosts of corporate officials make statements with content that more senior officials or the board of directors have the ultimate authority to control.” The majority’s cramped reading, if extended, could open up a whole new world of securities fraud. Further, Breyer noted, the SEC’s authority to pursue those “substantial assistance” or “aiding and abetting” cases only extends to instances where the Court’s ultimate “maker” of untrue statements (i.e., the corporate board) knew of the fraud; that is, if the officers deceived their board as well as the public, it seems no one could be held liable.
In siding with Janus, the Court has limited the power of private investors and the courts to hold Wall Street insiders accountable for securities fraud. Now, the deeper the deception runs, the more likely will be that investment managers can paper-over their wrongdoing.