Friday, June 24, 2011

Rule 10b-5 and the "Maker" of a statement: Janus Capital v. First Derivative

Last week, in a 5-4 verdict, the US Supreme Court once again narrowly interpreted Rule 10b-5, this time holding that only the “maker” of a false statement could incur 10b-5 liability: “maker” in this context being defined as “person or entity with ultimate authority over the statement.” The case, Janus Capital Group Inc. v. First Derivative Traders, reversed the Fourth Circuit's holding that liability under Rule 10b-5 could be more expansive. Justice Thomas delivered the majority opinion, with a strong dissent by Justice Breyer.

Briefly, the facts were that Janus Capital Group, Inc. (JCG) was a publicly traded company which created the Janus family of mutual funds. These funds were organized in a business trust, the Janus Investment Fund (JIF). JIF retained Janus Capital Management (JCM) to be its investment adviser and administrator. JCM was a wholly owned subsidiary of JCG. The issue before the Court was whether JCM could be liable in a private action under Rule 10b-5. The plaintiffs alleged that JCM had substantially caused the prospectuses issued by the Janus mutual funds to contain misleading statements, and on this basis argued that JCM could be liable under Rule 10b-5. The Fourth Circuit held in favour of the plaintiffs, holding that “[JCG and JCM] by participating in the writing and dissemination of the prospectuses, made the misleading statements contained in the documents.” [Emphasis in original] It was found that a reasonable investor could easily have inferred that “JCM played a role in preparing or approving the content of the Janus fund prospectuses.”

Rule 10b-5 makes it unlawful for “any person, directly or indirectly…  to make any untrue statement of a material fact”. By majority, on the basis of a literal reading of the word “make”, the Supreme Court reversed the Fourth Circuit. The majority opinion states:

One “makes” a statement by stating it… For purposes of Rule 10b–5, the maker of a statement is the person or entity with ultimate authority over thestatement, including its content and whether and how tocommunicate it. Without control, a person or entity canmerely suggest what to say, not “make” a statement in its own right. One who prepares or publishes a statement on behalf of another is not its maker… This rule might best be exemplified by 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…

Arguments based on the close relationship of the investment adviser and the funds were also rejected:

“For its part, [the plaintiff] suggests that the “well recognized and uniquely close relationship between a mutual fund and its investment adviser” should inform our decision… It suggests that an investment adviser should generally be understood to be the “maker” of statements by its client mutual fund, like a playwright whose lines are delivered by an actor. We decline this invitation to disregard the corporate form. Although First Derivative and its amici persuasively argue that investment advisers exercise significant influence over their client funds… it is undisputed that the corporate formalities were observedhere. JCM and Janus Investment Fund remain legally separate entities, and Janus Investment Fund’s board of trustees was more independent than the statute requires… Any 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, only JIF was the maker of the statement in its prospectus, and its advisers, including advisors from within the same corporate group, could not be treated as “makers” according to the majority. Thus, Rule 10b-5 will not render third party advisers liable – the only liability is on the “maker” of the statement, being the person with ultimate responsibility for the statement.

[Justice Breyer’s dissent is based on a more contextual understanding of the word “make”: “… the majority has incorrectly interpreted the Rule’s word “make.” Neither common English nor this Court’s earlier cases limit the scope of that word to those with “ultimate authority” over a statement’s content. To the contrary, both language and case law indicate that, depending upon the circumstances, a management company, a board of trustees, individual company officers, or others, separately or together, might “make” statements contained in a firm’s prospectus—even if aboard of directors has ultimate content-related responsibility. And the circumstances here are such that a court could find that Janus Management made the statements in question.”]

The Harvard Corporate Governance Forum has a note on the ruling here. Race to the Bottom has a three-part critique of the ruling – Part 1, Part 2, and Part 3.


vswami said...

A good and timely write-up.

What one is obliged to painfully observe is that, - even such simple concepts as - 'make', statement' and 'ultimate authority' required to be taken to courts for elucidation and adjudication.

No wonder the common belief that, 'law's an ASS' has come to be underlined,rather demonstrated, repetitively, day in day out,in rw3ecent times.

Mandar Kagade said...

On the 7th para, it ought to read: "JIF" was the maker of the statement..."

Mihir Naniwadekar said...

Thanks, it is corrected now