Janus Capital Group v. First Derivative Traders: Supreme Court to Decide Key Questions Regarding Secondary Actor Liability
The scope of securities fraud liability for service providers to publicly held companies (such as investment advisers and attorneys) may increase depending on the forthcoming decision of the U.S. Supreme Court in Janus Capital Group v. First Derivative Traders. Oral arguments were heard on December 7, 2010, and the Supreme Court will soon decide whether a service provider may be held primarily liable in a private securities fraud action for (1) “helping” or “participating in” another company’s publicly available misstatements or (2) publicly available misstatements that were not directly and contemporaneously attributed to the service provider.
Janus Capital Management Group, Inc. (Janus Capital) is a publicly traded asset management firm that, directly or through subsidiaries, sponsors and markets mutual funds and provides investment advice and other services to those funds. Janus Capital Management LLC (Janus Management) is a wholly owned subsidiary of Janus Capital that acts as the primary operating company for Janus Capital. Janus Management serves as the investment adviser for and administrator of various Janus mutual funds.
Shares in the Janus funds were offered for sale by prospectuses that Janus Capital and Janus Management allegedly caused to be issued and made available to the investing public. The prospectuses for a number of the Janus funds stated that the funds discouraged market-timing trades.1 However, in 2003, the New York State Attorney General charged a hedge fund with market-timing trading in certain Janus mutual funds. This disclosure allegedly caused investors to withdraw nearly $14 billion from various Janus funds and, as a result, the stock price of Janus Capital fell considerably.
Several Janus Capital shareholders filed private securities fraud actions—which were subsequently consolidated in the District of Maryland—against both Janus Capital and Janus Management. Specifically, plaintiffs sued Janus Capital and Janus Management, seeking to hold them liable for fraud under Section 10(b) of the Securities and Exchange Act of 1934 and under the Securities and Exchange Commission (SEC) Rule 10b-5. Plaintiffs alleged that Janus Capital and Janus Management were primarily liable for unlawfully making misleading statements in prospectuses about various Janus funds, most notably that Janus funds’ managers did not permit, and took active measures to prevent, “market timing” of the funds. Plaintiffs also alleged a “control person” claim against Janus Capital, asserting that Janus Capital controls Janus Management and is responsible for Janus Management’s claimed violations.
Janus Capital and Janus Management argued in response that they were mere outside service providers or “secondary actors,” so they could not be held liable for unattributed misstatements made by the Janus funds in the funds’ respective prospectuses, even if they helped to draft or distribute such misstatements. The district court dismissed the complaint, holding that the plaintiffs failed to state a claim.
The U.S. Court of Appeals for the Fourth Circuit reversed. First, the Fourth Circuit found the allegation that Janus Capital and Janus Management “caused mutual fund prospectuses to be issued for Janus mutual funds and made them available to the investing public” to be sufficient to plead that Janus Capital and Janus Management “made” the misleading statements in the prospectuses. See In re Mutual Funds Inv. Litig., 566 F.3d 111, 121 (4th Cir. 2009). Second, the Fourth Circuit held that if an interested investor could have attributed the alleged misstatement to the defendant service provider, then it is unnecessary for a plaintiff to allege that the misleading statements were contemporaneously attributable to the service provider. See id. at 127. This test is to be applied on a case-by-case basis to determine whether investors “would attribute to the defendant a substantial role in preparing or approving the allegedly misleading statement.” Id. at 124. The Fourth Circuit held that Janus Management had a substantial management role and had inherent responsibilities with the Janus mutual funds; therefore, the Fourth Circuit reasoned that an investor could have reasonably assumed that Janus Management had control over the allegedly misleading content placed in the Janus funds’ prospectuses. Id. at 127.
Issues and Potential Impact
It has long been held that there is no aiding-and-abetting liability in private actions under Section 10(b) of the Securities Exchange Act of 1934. See Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1944). When Congress passed the Private Securities Litigation Reform Act of 1995, it allowed the SEC to prosecute aiders and abettors under Section 10(b), but Congress did not provide a private cause of action. Therefore, a service provider, such as an auditor, attorney, bank or investment adviser, that provides assistance to a company that makes a public misstatement cannot be held liable in a private securities fraud action for that misstatement. See Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148 (2008).
If the Supreme Court upholds the decision of the Fourth Circuit, primary liability under Section 10(b) of the of the Securities and Exchange Act of 1934 will extend to an investment adviser where such adviser exercises day-to-day management over a mutual fund. Taken further, if the Supreme Court upholds the Fourth Circuit decision, the amount of litigation against service providers—such as bankers, lawyers, auditors and accountants who review a company’s public statements—may increase. Indeed, if the Supreme Court adopts the Fourth Circuit’s test, a private plaintiff may only need to allege that a service provider played a “substantial role” in the drafting, making or disseminating of a misleading public statement in order to sufficiently allege a private securities fraud cause of action against that provider. On the other hand, if the Supreme Court overturns the Fourth Circuit decision and adopts a more stringent pleading standard for service providers’ liability, that may greatly reduce litigation against and liability of secondary actors in several different fields.
1 Market timing refers to the practice of rapidly trading in and out of a mutual fund to take advantage of inefficiencies in the way the fund values its shares.