On June 13, 2011, the U.S. Supreme Court issued its ruling in Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. ___ (2011). In a five-to-four decision, the Supreme Court held that a mutual fund investment adviser cannot be held liable for fraud by the shareholders of the investment adviser’s publicly traded parent company under Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5 thereunder, where the investment adviser did not “make” the false statements in its mutual fund clients’ prospectuses.

The sole question before the Supreme Court was whether Janus Capital Management LLC (“JCM”), as investment adviser, could be held liable in a private action filed by the shareholders of the investment adviser’s publicly traded parent company under Rule 10b-5 for false statements included in its client Janus Investment Funds’ (the “Funds”) prospectuses. In their complaint, shareholders of parent company Janus Capital Group (“JCG”) sued both JCG and its subsidiary JCM for fraud under Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, as well as control person liability under Section 20(a) of the Exchange Act.^[1]According to the complaint, the Funds managed by JCM issued prospectuses creating the “misleading impression” that JCG and JCM would implement measures to “curb market timing” in the Funds. Following revelations that the Attorney General of the State of New York had filed a complaint against JCG and JCM alleging that JCG had actually permitted market timing in several of the Funds managed by JCM, investors withdrew money from the Funds, and JCG’s stock price fell nearly 25 percent. The plaintiffs alleged that JCG and JCM made false statements in prospectuses filed by the Funds and that those statements affected the price of JCG’s stock. The complaint, however, did not allege that defendants JCG or JCM actually issued the prospectuses containing the disclosures regarding the market-timing policies.

The District Court dismissed the complaint for failure to state a claim against JCG and JCM. The court concluded that JCM’s dissemination of the prospectuses did not rise to the level of making a misstatement and that the plaintiffs failed to demonstrate that the alleged fraud occurred in connection with the purchase or sale of a security because there was no nexus between plaintiffs, as JCG shareholders, and JCM. On appeal, the Fourth Circuit reversed—holding that the plaintiffs sufficiently alleged that “JCM, by participating in the writing and dissemination of the prospectuses, made the misleading statements contained in the documents” and that JCG could be held liable as a control person of JCM. 

The Supreme Court ruled that plaintiffs failed to state a Rule 10b-5 claim against JCM because only the Funds were ultimately responsible for making the alleged misstatements. Rule 10b-5 makes it unlawful, in connection with the purchase or sale of any security, for a person to directly or indirectly “make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made . . . not misleading.” The Court focused on the meaning of the word “make” and determined that JCM, as investment adviser, did not “make” the allegedly material misstatements in the Funds’ prospectuses. Specifically, the Court held that “[f]or Rule 10b-5 purposes, the 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.” The Court went on to note that “[o]ne who prepares or publishes a statement on behalf of another is not its maker.” The Court likened the relationship between an investment adviser and its mutual fund client to the relationship between a speechwriter and a speaker and rejected the analogy that an adviser is a “playwright whose lines are delivered by an actor.” Thus, even if an investment adviser assists with the drafting or distribution of a prospectus, the investment adviser is a mere speechwriter, and the mutual fund, as the speaker, has the ultimate responsibility for statements contained in a prospectus. Further, the Court noted that the Funds had ultimate responsibility for statements in their prospectuses because the Funds, unlike the investment adviser, are required to file their prospectuses with the SEC.

The Court acknowledged the plaintiffs’ argument that there is a “uniquely close relationship between a mutual fund and its investment adviser” but noted that each of the Funds was a legally independent entity with its own board of trustees, separate and apart from JCG and JCM. Further, the Court opined that “[a]ny reapportionment of liability in the securities industry in light of the close relationship between investment advisers and mutual funds is properly the responsibility of Congress and not the courts.” Thus, the Court held that plaintiffs had not stated a claim against JCM under Rule 10b-5.

The dissent took issue with the majority’s bright-line test for primary liability and its holding that a maker of a statement is the person who had “ultimate authority” over the statement. In the dissent’s view, neither common English nor the Court’s earlier cases limit the scope of the word “maker” to those with “ultimate authority” over a statement’s content. The dissent pointed out the close relationships alleged between JCM and the Funds, noting, “The relationship between [JCM] and the Fund could hardly have been closer. [JCM]’s involvement in preparing and writing the relevant statements could hardly have been greater.” Therefore, the dissent stated that “The specific relationships alleged among [JCM], the [Funds], and the prospectus statements warrant the conclusion that [JCM] did ‘make’ those statements,” and thus the plaintiffs’ allegations were legally sufficient to survive the motion to dismiss.

Key Takeaways

The Supreme Court’s recent decision in Janus Capital Group, Inc. v. First Derivative Traders seems to create a bright-line rule that a private cause of action under Rule 10b-5 may be brought only against a primary violator and not against a secondary actor, such as an investment adviser. Thus, this decision seems to foreclose potential future private securities fraud actions against other secondary actors, such as bankers, lawyers, auditors and accountants, who merely review or assist with a company’s public statements. However, this does not necessarily mean that investment advisers and other secondary actors are free from liability under the federal securities laws. The SEC and other regulators may still bring aiding-and-abetting charges under Rule 10b-5 against an investment adviser. See 15 U.S.C. § 78t(e). Moreover, the SEC may bring enforcement cases under many other sections of the federal securities laws, including Section 17(a) of the Securities Act of 1933, a general antifraud provision that applies to all securities transactions; Section 206 of the Investment Advisers Act of 1940, another antifraud statute applicable to advisers; and Section 34(b) of the Investment Company Act of 1940, which prohibits untrue statements and omissions in fund documents. Indeed, in the Janus situation, the SEC brought and settled charges against JCG resulting in disgorgement and fines totaling $100 million.

Finally, funds themselves have rights to bring suit against an investment adviser to redress damages caused by a breach of the adviser’s fiduciary duty and/or the terms of the investment advisory agreement or other applicable agreement (e.g., an administrative services agreement).