In a June 13, 2011 opinion written by Justice Clarence Thomas, the United States Supreme Court held, by a 5-4 margin, in the Janus Capital Group, Inc. v. First Derivative Traders case, that a mutual fund management company cannot be held liable for the alleged misstatements in the prospectuses of the mutual funds that the management company administered. Justices Ginsberg, Sotomayor and Kagan joined in Justice Stephen Breyer’s dissent. A copy of the June 13 opinion can be found here.
Janus Capital Group (JCG) is the holding company for a family of mutual funds. Janus Capital Management (JCM) is the funds’ investment advisor. In November 2003, JCG investors filed a complaint in the District of Maryland alleging that the two firms were responsible for misleading statements in the certain funds’ prospectuses. The allegedly misleading statements represented that the funds’ managers did not permit, and took active measure to prevent, "market timing" of the funds. The investors claim they lost money when market timing practices JCG and JCM allegedly authorized were made public.
In 2004, JCM reached a settlement with the SEC in connection with the market timing allegations in which the firm paid a disgorgement of $50 million and an additional $50 million in civil penalties. Information regarding the settlement can be found here.
The district court dismissed the shareholders suit in May 2007. The shareholders appealed to the United States Court of Appeals for the Fourth Circuit. In a May 7, 2009 opinion (here), the Fourth Circuit reversed the district court, finding that the shareholders had adequately stated a claim under the securities laws. The defendants’ filed a petition for writ of certiorari, which the Supreme Court granted on June 28, 2010. Refer here for further background regarding the case
The June 13 Opinion
The fundamental question before the court is whether or not the management company could be said to have made the statements in the funds’ prospectuses. The Court held that because the management company did not make the statement, it could not be held liable, reversing the Fourth Circuit.
Justice Thomas, writing for the majority, said that “one ‘makes’ a statement by stating it” and that for purposes of Rule 10b-5, “the maker of the statement is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it.”
With this analysis as the starting point, and following the Court’s prior decisions in the Central Bank and Stoneridge cases (about which refer here), the majority adopted the rule that “the maker of the statement is the entity with authority over the content of the statement and whether or how to communicate it. Without such authority, it is not ‘necessary or inevitable’ that the falsehood will be contained in the statement.”
The majority opinion went on to state that even if the management company may have been “significantly involved” in preparing the prospectus, this “assistance” was still subject to the ultimate control of the funds and their trustees. The majority analogized the management company’s role to that of a speechwriter; the ultimate speaker is the one that makes the speech. Because the management company did not make the alleged misstatements, they could not be held liable under Rule 10b-5.
In his dissent, Justice Breyer contended that that the majority “has incorrectly interpreted the Rule’s word ‘make.’” He argued that “both language and case law indicate that, depending on the circumstances, a management company, a board of trustees, individual company officers, or others, separately or together, might ‘make’ statements contained in a firm’s prospectus, even if a board of directors has ultimate content-related responsibilities.” Breyer further argued that Central Bank and Stoneridge were not controlling, as they concerned only secondary liability, whereas this case concerned primary liability.
Despite the narrow 5-4 split, this decision comes as no surprise (at least to me). The argument that a legally separate entity that assists with but does not actually make the statement would be very hard to distinguish from the kind of “aiding and abetting” liability the Court rejected in the Stoneridge case. Indeed, as I noted at the time, that may well be why the Supreme Court took this case, to clarify that the “substantial participation” test that the Fourth Circuit had enunciated was inconsistent not only with the holdings of the other Circuit courts but also with the Supreme Court’s precedents in Stoneridge and Central Bank.
The case does break the short streak the plaintiffs had been enjoying before the Court. Earlier in the term, the Court had ruled favorably to plaintiffs in the Matrixx Initiatives case (refer here) and more recently in the Halliburton case (refer here).
But while this case is favorable to the defendants, I don’t think it will result in any huge transformation in other cases going forward. The Fourth Circuit’s holding in this case was out of step with the holdings in the other circuits. While the outcome at the Supreme Court level might eliminate a pleading advantage the plaintiffs might have enjoyed in the Fourth Circuit, the result of this decision will really not change things elsewhere. Had the plaintiffs prevailed before the Supreme Court, the outcome would have had a significant impact on future cases. However, because the defendants instead prevailed, the impact of this decision will be limited and largely confined to the Fourth Circuit.
One final note for those readers who might have read the guest post of Brian Lehman published last Friday on this blog, in which Lehman attempted to predict the outcome of the Janus case, the case did not turn out as he had prognosticated. He had suggested that the Court might defer to the SEC’s interpretation, which the majority expressly declined to do in footnote 8, because the Court did not find the word “make” to be ambiguous.