U.S. Supreme Court Clarifies the Scope of Private Liability Under Rule 10b-5

June 13, 2011

Janus Capital Group Inc. v. First Derivative Traders, No. 09-525

On June 13, 2011, the U.S. Supreme Court concluded that Janus Capital Management (JCM) cannot be held liable in a private suit under the Securities and Exchange Commission’s Rule 10b-5 for drafting allegedly misleading prospectuses for the mutual funds it advises.  Reversing a contrary decision by the Fourth Circuit, the Court held in Janus Capital Group Inc. v. First Derivative Traders, No. 09-525, that the only proper defendant in a private Rule 10b-5 suit is the "maker" of a statement—"the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it," slip op. at 6—and that "[t]he statements in the [mutual fund] prospectuses were made by [the mutual funds], not by JCM," id. at 12.

JCM is a registered investment adviser that, among other things, advises the Janus family of mutual funds; the Janus Funds are governed by an independent Board of Trustees, and are not owned or controlled by JCM.  First Derivative Traders invested in the stock of JCM’s parent company, Janus Capital Group Inc. (JCG).  It alleged that the price of JCG’s stock was artificially inflated as a result of misleading statements in the Janus Funds’ prospectuses, and that JCM had drafted those statements.  Although the district court dismissed the operative complaint for failure to state a claim, the Fourth Circuit reversed, holding that, "by participating in the writing and dissemination of the prospectuses," JCM "made the misleading statements contained in [those] documents."  Slip op. at 4 (emphasis in original).

The Supreme Court granted JCM’s petition for a writ of certiorari and, after briefing and argument, reversed the Fourth Circuit’s judgment in a 5-4 opinion authored by Justice Thomas.  The Court held that "the maker of a statement is the person or entity with ultimate authority over the statement."  Slip op. at 6.  "Without control," the Court explained, "a person or entity can merely suggest what to say, not ‘make’ a statement in its own right," and therefore "[o]ne who prepares or publishes a statement on behalf of another is not its maker."  Id. at 6.

The Court noted that it had previously distinguished "between those who are primarily liable (and thus may be pursued in private suits) and those who are secondarily liable (and thus may not be pursued in private suits)."  Slip op. at 7 n.6.  To ensure that this distinction "ha[s] any meaning," the Court "dr[e]w a clean line between the two—the maker is the person or entity with ultimate authority over a statement and others are not."  Id.  Thus, the Court emphasized, it "will not expand liability beyond the person or entity that ultimately has authority over a false statement."  Id. at 8.

Applying this test, the Court concluded that "JCM did not ‘make’ any of the statements in the [Janus Funds] prospectuses" because its alleged "involvement in preparing the prospectuses" was "subject to the ultimate control" of the Janus Funds.  Slip op. at 11-12.  Although First Derivative Traders argued that JCM had a "uniquely close relationship" with the Janus Funds, the Court "decline[d] this invitation to disregard the corporate form," id. at 9, and explained 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," id. at 10.  Accordingly, the Supreme Court concluded that "First Derivative has not stated a claim against JCM under Rule 10b-5."  Id. at 12.

The Supreme Court’s decision should bring much-needed certainty and predictability to the securities markets by clarifying who are the proper defendants in a private Rule 10b-5 class action.  By essentially limiting the universe to issuers and certain others specified by Congress, the Court has made clear that the vast array of service providers to public companies—including bankers, lawyers, accountants, investment and financial advisers, and others—will not generally be subject to suit in private Rule 10b-5 suits.

Gibson, Dunn & Crutcher LLP   

Gibson Dunn partner Mark A. Perry led the team that won the Janus case in the Supreme Court.  He can be reached at 202-887-3667 or [email protected].

© 2011 Gibson, Dunn & Crutcher LLP

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