Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Sunday, November 18, 2012

Jeffries on Janus and Collective Scienter

The Implications of Janus on the Liability of Issuers in Jurisdictions Rejecting Collective Scienter, by N. Browning Jeffries, Atlanta's John Marshall Law School, was recently posted on SSRN.  Here is the abstract:

This article addresses the increasing limitations placed on both the Securities and Exchange Commission (“SEC”) and private litigants to pursue claims of fraud against wrongdoers under the federal securities laws, specifically for claims of misrepresentation under Section 10(b) of the Securities Exchange Act of 1934 and the SEC’s Rule 10b-5. The most recent and glaring example of this curtailment occurred in 2011 with the United States Supreme Court’s decision in Janus Capital Group, Inc. v. First Derivative Traders. For a defendant to be liable for a misrepresentation, Rule 10b-5(b) requires that the defendant be the “maker” of the false statement. The Janus decision significantly limits the universe of individuals who can be considered a “maker” of a misstatement for purposes of 10b-5 liability. After Janus, merely participating in the preparation or publication of a statement, even if that involvement is significant, is not sufficient to subject one to 10b-5 liability as a “maker.”

As lower courts have interpreted Janus, they have extended its holding to corporate insiders such as officers, directors, and employees of an issuer. Though lower courts have not found that Janus serves as an outright bar to bringing claims against corporate insiders, in order to satisfy the definition of “maker” set forth in Janus, it appears that the misrepresentation must have been publicly attributed to the insider for liability to attach. But the person to whom public statements are publicly attributed is not necessarily the same person who has scienter, a required element for establishing 10b-5 liability. As such, scenarios will frequently arise where a plaintiff is unable to establish liability of any insider because the individual with scienter is not considered the “maker” after Janus, and the only insider who may be viewed as the “maker” had no reason to know that the public statements attributed to him or her contained misrepresentations.

Even more troubling than the impact of Janus on the potential liability of culpable insiders, however, is the fact that, in many jurisdictions, Janus may thwart claims against even the issuer to which the misstatement is attributed. Although a plaintiff typically can establish the scienter of a corporation by imputing to the corporation the scienter of one or more culpable officers, directors, or employees, some jurisdictions require, for imputation purposes, that the individual with the requisite scienter also be the “maker” of the statement. Such jurisdictions have rejected the theory commonly referred to as “collective scienter,” which allows a court to impute to the corporation the scienter of some or all of the employees, even where none of the wrongdoers are necessarily the “maker” or where the wrongdoer has not yet been identified. As such, in jurisdictions rejecting collective scienter, courts may refuse to impute the sceinter of the individual to the corporation where the individual with scienter is not the person who made the misrepresentation. In the wake of Janus, which curtails the universe of potential “makers” of a statement, plaintiffs in such jurisdictions may not be able to identify any defendant with the requisite scienter – not even the issuer itself. Consequently, plaintiffs may have no defendant against whom they can pursue a 10b-5 claim, even in the face of blatant fraud. And since Janus has been extended beyond private suits to SEC enforcement actions as well, this significant limitation has an even greater impact.

This article explores the implications of Janus on the liability of primary actors – the issuer itself and its corporate insiders. The article analyzes the lower courts’ interpretations of Janus in the year since it was decided, and addresses the liability gaps the decision has created, particularly when viewed in connection with previously-existing precedent in jurisdictions rejecting collective scienter. The article argues that the limitations imposed by Janus do not accurately reflect the realities of the marketplace, where statements made available to the public are a product of diffuse responsibility of a team of individuals, rather than attributable to one and only one “maker.” After discussing policy considerations that weigh in favor of warranting a more expansive view of liability for fraudulent misrepresentations than that permitted by Janus, the article proposes some potential solutions to the liability gaps established by Janus, including a call for legislative action.

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