Wednesday, December 8, 2010
Yesterday the U.S. Supreme Court heard oral argument in Janus Capital Group, Inc. v. First Derivative Traders, 566 F.3d 111 (4th Cir. 2009) and once again dealt with the difficulty issue of distinguishing primary and secondary liability under Rule 10b-5. Plaintiff in the case represent shareholders of Janus Capital Group (JCG), the asset management firm that sponsors the Janus funds. They sued JCG and its subsidiary, Janus Capital Management (JCM), the investment adviser to the funds, alleging they were responsible for statements appearing in prospectuses for a number of the Janus funds that represented that the funds' managers did not permit market-timing and took measures to prevent market-timing. Plaintiffs allege that they purchased JCG shares at inflated prices and suffered damages when the funds' market-timing practices became known. The Fourth Circuit, reversing the district court, held that plaintiff's Rule 10b-5 primary liability claim againsst JCM and its 20(a) control person claim against JCG were sufficiently pled to overcome defendant's motion to dismiss.
The question presented, as framed by petitioners, was:
There is no aiding-and-abetting liability in private actions brought under Section 10(b)
of the Securities Exchange Act of 1934. Central Bank of Denver, N.A. v. First Interstate
Bank of Denver, N.A., 511 U.S. 164 (1994). Thus, a service provider who provides
assistance to a company that makes a public misstatement cannot be held liable in a
private securities-fraud action. Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc.,
128 S. Ct. 761 (2008). In the decision below, however, the Fourth Circuit held that an
investment adviser who allegedly "helped draft the misleading prospectuses" of a
different company, ''by participating in the writing and dissemination of [those]
prospectuses," can be held liable in a private action "even if the statement on its face is
not directly attributed to the [adviser]." App., infra, 17a-18a, 24a (emphases added).
The questions presented are: 1. Whether the Fourth Circuit erred in concluding-in direct
conflict with decisions of the Fifth, Sixth, and Eighth Circuits-that a service provider can
be held primarily liable in a private securities fraud action for "help[ing]" or
"participating in" another company's misstatements. 2. Whether the Fourth Circuit
erred in concluding-in direct conflict with decisions of the Second, Tenth, and Eleventh
Circuits-that a service provider can be held primarily liable in a private securities-fraud
action for statements that were not directly and contemporaneously attributed to the
The attorney for the petitioners established his theme in his opening sentences: "Affirming the judgment below would authorize private securities fraud class actions against every service provider that participates in the drafting of a public company's prospectus. It is therefore nothing less than a frontal assault on this Court's decisions in Central Bank and Stoneridge." Justice Sotomayor wanted to know how these facts differed from the situation where a company, through market analysts, disseminates misleading statements to the marketplace. Petitioners' attorney emphasized throughout his argument that the funds whose prospectuses contained the misstatements were separate legal entities from JCM, the investment adviser that allegedly violated the market-timing policy. The Justices explored the separateness of the legal entities as a practical matter, asking a number of questions about whose lawyers wrote the relevant statements, who paid their salaries, were the officers of the funds also employees of JCM. The import of the Fourth Circuit's opinion, according to Justice Ginsburg, was that "JCM was in the driver's seat. It was running the show." Petitoners' attorney reiterated that there are no cases imposing liability on an investment adviser for statements in the fund prospectuses.
The attorney for respondents was immediately asked by Justice Scalia about the scope of the question the Court was to decide -- wasn't it to decide whether a "service provider" could be held primarily liable for helping or participating in another company's misstatements? No, that was too broad -- this case deals only with the primary liability of JCM, which was responsible for the prospectuses in all their aspects. There was again considerable back-and-forth over the allocation of responsibilites between the funds and the investment adviser and the role of the funds' independent trustees. Finally, Justice Breyer raised the fundamental question -- how do we distinguish an aider and abettor from the principal violator. The Justices did not appear to be satisfied that this question was answered.
Indeed, the distinction between primary , secondary and control person liability was the issue that Justice Sotomayor immedately raised with the government attorney, who appeared as amicus curiae in support of respondent, and, in particular, how those definitions would exclude lawyers, auditors and other corporate advisers. This was clearly a crucial question for the Justices, and it does not appear that they found a solution in the government attorney's answers.
Taking advantage of this, in his rebuttal the attorney for petitioners hammered home the message that this is an area that needs bright lines. He also emphasized that the shareholders in the funds had received compensation from an SEC settlement; the plaintiffs here were investors in the parent company that were seeking damages for misstatements contained in fund prospectuses.
Of course, it's probably foolhardy to predict how Justices will come out based on oral argument, but it was clear that the Justices remain troubled about expanding Rule 10b-5 liability in private actions. This may well continue the message of Central Bank and Stoneridge.