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Wednesday, September 28, 2011

Worst Decisions, #3: Janus Capital v. First Derivative

AFJ is counting down the 10 worst decisions of the Corporate Court's 2010-11 term. Yesterday at #4, we talked about American Free Enterprise v. Bennett, which makes it easier for wealthy special interests to buy elections.

Worst Decisions of the 2010-11 Corporate Court Term: #3: Janus Capital Group v. First Derivative Traders

In a 5-4 decision, the Corporate Court created a major new loophole that allows holding companies in the $12 trillion mutual-fund industry to escape liability for securities fraud.  The corporations may now create subsidiaries that can then make false and misleading statements on behalf of the parent company and that have no assets other than investors’ money.

Janus Capital Group is a huge financial investment corporation that has created numerous subsidiaries, including Janus Investment Fund, which deliberately misled investors in its mutual fund prospectus by telling the public that it did not allow hedge funds to engage in “market time” transactions. Behind the scenes, hedge funds were routinely engaging in just those sorts of timing transactions with Janus. When the truth came out, the Janus stock dropped precipitously, costing deceived investors millions.

Rule 10b-5 of the securities laws prohibits “mak[ing] any untrue statement of a material fact.” In this case, the deception about market timing certainly qualified as an untrue material statement. However, the pro-corporate majority decided Janus Capital could not be liable because it had not “made” the statement, only Janus Investment Fund had. It arrived at this fiction by concluding that only the party with “ultimate authority” over a statement can “make” it. A speechwriter does not a make a statement, only the speaker does, the majority reasoned.

The dissent attacked this conclusion as a distortion of the common use of the English language. “Every day, hosts of corporate officials make statements with content that more senior officials of the board of directors have ‘ultimate authority’ to control…. 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.”

The tipping point between these competing visions should turn on whether one believes Congress, in drafting Rule 10b-5, intended to immunize corporate fraud or protect investors. The pro-corporate majority argues that Rule 10b-5 must be read narrowly, which in this instance would immunize corporate fraud. As Justice Breyer noted in dissent, the majority’s interpretation would often leave no one accountable under the securities laws, even for fraud committed through intentional lying, if the subsidiary’s board was as deceived as investors were by the original perpetrator’s lies.  It is difficult to imagine that Congress intended to open such a gaping loophole in the law.

Janus Capital Group v. First Derivative Traders is number three on AFJ’s Worst Decisions of the 2010-11 Corporate Court term because, as one article put it, “[t]he U.S. Supreme Court has shown mutual fund bosses an easy way to skirt class-action lawsuits.”

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