Monday, May 12, 2014

The 4th Circuit's Two-Headed Interpretation of Janus Capital is Wrong

Rule 10b-5(b) makes it unlawful to make false or misleading statements in connection with the purchase or sale of a security. In Janus Capital [Janus Capital Group, Inc. v. First Derivative Traders, -- U.S. --, 131 S. Ct. 2296 (2011)], the Supreme Court limited the scope of 10b-5(b) by narrowly defining the term “make.” According to the court, a “maker” for purposes of 10b-5 liability “is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it.” One is not liable under Rule 10b-5(b) merely because one drafts or publishes a statement for someone else or even if, as in Janus, one posts that other person’s statement on one’s own web site.

Last week, in Prousalis v. Moore, a panel of the Fourth Circuit held that Janus applies only to private rights of action, not to criminal enforcement actions by the government. This interpretation of Janus is wrong. There's no justifiable reason not to apply the Janus Capital interpretation in criminal cases.

The Fourth Circuit begins by pointing out that Janus involved a private right of action, not a criminal action and the court’s holding is therefore limited to private rights of action. That’s correct, but tells us little. The court was interpreting the exact same text as that applied in criminal actions. Its holding should apply to criminal actions as well, unless there’s some strong argument to distinguish that context.

The court notes language in Janus expressing a general desire to narrowly circumscribe private rights of action. The majority opinion in Janus does include language to that effect. But Janus also contains a detailed analysis of the word “make” and concludes that its ordinary meaning is limited in accordance with the court’s holding. And nowhere does Janus indicate that criminal actions (or civil enforcement actions by the SEC, which Prousalis doesn’t even mention) would be treated any differently. In fact, Justice Breyer’s dissent in Janus criticized the majority opinion for the effect it would have on SEC enforcement actions. Justice Breyer argued that “under the majority’s rule it seems unlikely that the SEC itself in such circumstances could exercise the authority Congress has granted it to pursue primary violators who ‘make’ false statement or the authority that Congress has specifically provided to prosecute aiders and abettors to securities violations.”

The Fourth Circuit points out that Janus relied on two earlier opinions, Central Bank and Stoneridge Investment Partners, each of which also involved a private right of action. But lower court cases subsequently applied Central Bank to SEC enforcement actions until Congress amended the Exchange Act, correctly noting that nothing in Central Bank limited its holding to private rights of action.

The Fourth Circuit opinion next argues that interpretation of the text of Rule 10b-5 should depend on context, and criminal liability poses a different context than civil liability. The court is right that the word “make” can mean different things in different contexts. But the court isn’t interpreting two different clauses with the word “make” in them. The textual context is exactly the same because the court is interpreting exactly the same text as the Janus court.

The Fourth Circuit argues that considerations of legislative primacy and judicial restraint also support its conclusion. According to the court, it is up to Congress to determine the elements of a criminal offense and the court shouldn’t disturb what Congress has provided regarding criminal enforcement. However, Congress has said only that defendants may be criminally liable for willful violations of the Exchange Act and the rules adopted pursuant to the Exchange Act. See Securities Exchange Act § 32(a), 15 U.S.C. § 78ff(a). Congress has not specified the elements of a criminal violation of Rule 10b-5, except to say that the violation must be willful. The SEC drafted the rule, and notions of deference to Congress are out of place in interpreting the SEC’s language.

Finally, the Prousalis opinion notes that “no other appellate court has adopted Prousalis's argument; indeed, counsel was unable to identify a single district court that had applied Janus in the criminal context.” However, the Prousalis opinion itself fails to cite a single case consistent with its conclusion—that Janus does not apply in a criminal case. Why not? Because, as far as I know, there aren't any. And a number of cases asking whether Janus applies to provisions other than Rule 10b-5(b) have assumed that Janus does apply to civil enforcement proceedings by the SEC.

One can reasonably disagree with the holding in Janus Capital. But, as long as Janus Capital stands, Prousalis is wrong.

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