Supreme Court Decides Janus Capital Group, Inc. v. First Derivative Traders

On June 13, 2011, the Supreme Court decided Janus Capital Group, Inc. v. First Derivative Traders, No. 09-525, holding that Rule 10b-5 provides a private right of action for securities fraud only against the person or entity with ultimate authority over the alleged false statement in a prospectus, and thus a mutual fund manager who influenced the content in a prospectus could not be held liable under the rule.

Rule 10b-5 promulgated by the SEC makes it unlawful "[t]o make any untrue statement of a material fact" in connection with the purchase or sale of securities. 17 CFR §240.10b–5(b). The rule does not create a private cause of action, but the courts have inferred one. The question presented in Janus Capital is which persons or entities can be sued under the private right of action for having "made" false statements in a mutual fund prospectus.

Janus Capital Group, Inc. (JCG) created the Janus family of mutual funds, which are organized in a Massachusetts business trust called The Janus Investment Fund (the "Fund"). The Fund is a separate legal entity owned entirely by mutual-fund investors. The Fund retained JCG's wholly-owned subsidiary, Janus Capital Management, LLC (the "Investment Adviser"), to be its investment adviser and administrator with respect to the Fund. The Investment Adviser is also a separate legal entity from the Fund.

The Fund issued prospectuses describing the Fund's investment strategy and operations. Some prospectuses stated that the Fund was not suitable for market timing and allegedly implied that the Fund would take steps to curb the practice if detected.

In 2003, the Attorney General of the State of New York alleged that JCG entered into secret arrangements to permit market timing in several of the Janus funds that the Investment Adviser ran. After those allegations became public, investors withdrew significant amounts of money from the Fund, which led to a dramatic decrease in the management fees paid to the Investment Adviser (the management fees were based on the value of the Fund), which in turn led to a decrease in JCG's income (because the Investment Adviser was JCG's wholly-owned subsidiary). JCG's stock price fell.

First Derivative Traders owned stock in JCG. It sued JCG and the Investment Adviser under Rule 10b-5 and Section 10(b) of the Securities Exchange Act of 1934, alleging that JCG and the Investment Adviser caused the issuance of prospectuses that had misleading statements regarding market timing, and that those misleading statements led to the decrease in JCG's stock price. First Derivative alleged that JCG should be held liable for the Investment Adviser's actions as a "controlling person" under Section 20(a) of the Act.

The trial court dismissed First Derivative's complaint for failure to state a claim. The Fourth Circuit reversed, holding that First Derivative had sufficiently alleged that JCG and the Investment Adviser, by participating in the writing and dissemination of the prospectuses, "made" the misleading statements in the prospectuses. The Fourth Circuit held that investors would infer that the Investment Adviser played a role in preparing or approving the content of the prospectuses, but that investors would not infer the same thing about JCG, which could be held liable only as a "control person" of the Investment Adviser under Section 20(a).

The Supreme Court reversed, holding that the Investment Adviser did not "make" the misstatements in the prospectuses. The implied private right of action under Rule 10b-5, wrote the Court, has "narrow dimensions." The ordinary meaning of a "maker" of a statement is "the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it." Other parties might suggest what to say, or prepare or publish a statement on behalf of another (for example, a speechwriter), but those parties do not "make" the statement because the content of the statement is within the control of the person who delivers it.

Under this logic, the Court rejected the argument that the close relationship between a mutual fund and its investment adviser dictates that an investment adviser should be understood to "make" the statements in the mutual fund's prospectuses. This would disregard the corporate form, as the Fund and the Investment Adviser were separate legal entities that maintained their legal separation. To rule otherwise, the Court stated, would also effectively overrule Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994), which held that Rule 10b-5 does not extend liability to alleged aiders and abettors who gave "substantial assistance" to the making of a false statement.

Because only the Fund, and not JCG or the Investment Adviser, filed and issued the prospectuses, only the Fund "made" the statements in the prospectuses. The fact that the Investment Adviser may have been significantly involved in preparing the prospectuses does not mean that the Investment Adviser "made" the statements any more than a speechwriter "makes" the statements delivered by a speaker.

Justice Thomas delivered the opinion of the Court in which Chief Justice Roberts and Justices Scalia, Kennedy, and Alito joined.  Justice Breyer filed a dissenting opinion in which Justices Ginsburg, Sotomayor, and Kagan joined. 

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