Court’s Decision

On June 13, 2011, the Supreme Court held that, in private actions brought under Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”), only the party with ultimate control over a statement in a mutual fund prospectus “makes” the statement and therefore can be liable under Rule 10b-5, as promulgated under the Exchange Act (“Rule 10b-5”).¹ Rule 10b-5 prohibits any act or omission resulting in fraud or deceit in connection with the purchase or sale of a security.

The Court ruled in favor of Janus Capital Group, Inc. and its wholly owned subsidiary, Janus Capital Management LLC (“JCM”), an investment adviser to Janus Investment Fund, a mutual fund, finding that the adviser was not the “maker” of statements contained in the prospectuses of the mutual fund and therefore did not have primary liability under Rule 10b-5. The Court declined to consider the “uniquely close relationship between a mutual fund and its investment adviser”, to mean that an adviser should generally be considered to be the “maker” of statements made by its fund.² It reasoned that to do so would disregard the corporate form.³

The Court found the following facts regarding the relationship between the fund and the adviser to be important in its decision:

• The fund was a separate legal entity owned entirely by the investors.
• It was undisputed that the corporate formalities were observed.
• Only one member of the fund’s board of trustees was associated with the adviser, which made the board more independent than required by statute.
• The fund filed the prospectuses with the Securities and Exchange Commission.
• There was nothing on the face of the prospectuses to indicate that any statements came from the adviser instead of the fund.

Implications for Mutual Funds

This decision should make it extremely difficult for plaintiff shareholders to prevail in suits under Rule 10b-5 against investment advisers for misrepresentations made in mutual fund prospectuses so long as the corporate formalities have been observed, the fund complies with the independence requirements in the Investment Company Act of 1940, and the offering documents do not attribute the misleading statements to the adviser. The Court did not indicate whether it would have reached a different conclusion had any of these factors not been true, nor did it indicate how much weight was placed on any individual factor.

This decision is also a reminder to mutual funds that they are primarily liable for the information contained in their registration statements and other filings. The directors and officers of mutual funds executing a fund’s registration statement should remember that they have certain responsibilities for the statements made in the registration statement. In light of this responsibility, mutual fund directors should take time to revisit the fund’s processes for ensuring the adequacy of compliance, investment, and legal disclosures to make certain the directors are comfortable with the procedures and the level of diligence.

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¹ Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. ___ , No. 09-525, slip op. at 12 (June 13, 2011).

² Id. at 9.

³ Id. at 9-10.