On June 13, 2011, the U.S. Supreme Court decided Janus Capital Group, Inc. v. First Derivative Traders, No. 09-525, holding that a mutual fund investment adviser may not be sued for federal securities fraud for alleged misstatements in the fund’s prospectus. In doing so, the Court narrowly construed the meaning of a fundamental element necessary to plead a private securities fraud claim under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 – that a party “makes” an untrue statement of material fact in connection with the purchase or sale of securities. The Court ruled “that the maker of a statement is the entity with authority over the content of the statement,” and not one who assists in preparing the statement or influences its content. Although concerning the liability of an investment adviser to a mutual fund, the Janus decision provides greater clarity regarding the liability of any service provider or so-called secondary actors (e.g., investment advisers, lawyers, accountants, and bankers) in private actions under Rule 10b-5.

This is the third time since 1994 that the Supreme Court has addressed the question of civil liability for a party who participated in a statement made by another to the public markets. The Court, in Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164 (1994), held that a private right of action under Rule 10b-5 does not include suits against entities that substantially assist in the making of a statement, but do not actually make it themselves. More recently, in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 522 U.S. 148 (2008), the Court rejected a private Rule 10b-5 suit against customers and suppliers which allegedly agreed to deceptive transactions with an issuer that were later incorporated into the issuer’s false public financial statements.

Here, it was alleged that Janus Capital Group, Inc. (“JCG”) created the Janus family of mutual funds, the Janus Investment Fund (the “Fund”). The Fund retained JCG’s wholly owned subsidiary, Janus Capital Management, LLC (the “Investment Adviser”), to be the Fund’s investment adviser and administrator. The Fund issued prospectuses describing the Fund’s investment strategy and operations, including representations regarding the Fund’s policies to prevent the practice of market timing. In 2003, after the New York Attorney General alleged that JCG had entered into secret arrangements to permit market timing in the Fund, investors in the publicly traded JCG, including First Derivative Traders, sued JCG and the Investment Adviser under Rule 10b-5, alleging that the Fund’s prospectuses had misleading statements regarding its practices regarding market timing. The complaint acknowledged that the Fund had actually issued the prospectuses, but alleged that the Investment Adviser was liable under Rule 10b-5 because it exercised significant influence over the Fund and was significantly involved in preparing the prospectuses.

The trial court dismissed First Derivative Traders’ complaint for failure to state a claim. The Court of Appeals for the Fourth Circuit reversed, holding that the allegation that the Investment Adviser had participated in drafting and issuing the prospectuses satisfied the requirement that it had “made” the statements in the prospectuses. The Court of Appeals also found that because the Investment Adviser had a significant role with the Fund, investors could have reasonably assumed that it had control over the statements in the prospectuses.

In a 5-4 majority decision, the Supreme Court overturned the decision of the Fourth Circuit. The Court set out a bright line test for determining who “makes” a statement for purposes of Rule 10b-5, holding that “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.” Finding that “[o]ne who prepares or publishes a statement on behalf of another is not its maker,” the Court drew an analogy to the relationship between a speechwriter and a speaker. “Even when a speechwriter drafts a speech, the content is entirely within the control of the person who delivers it. And it is the speaker who takes credit – or blame – for what is ultimately said.” Under this analysis, the Court held that it was the Fund, and not the Investment Adviser, that “made” the statements in the prospectuses.

The Court, relying on its decision in Stoneridge, also rejected the argument that the “uniquely close relationship” between the Investment Adviser and the Fund and the “significant influence” the Investment Adviser had over the statements in the prospectuses gave rise to Rule 10b-5 liability for the Investment Adviser.

The Supreme Court’s holding in Janus is consistent with the its precedent limiting the scope of a private right of action under Rule 10b-5 and provides greater clarity going forward regarding the liability of advisers and other secondary actors who are involved in preparing, but do not ultimately control, an issuer’s public statements.

If you have any questions concerning this, please contact your primary attorney at Seward & Kissel LLP.