Supreme Court Forecloses Primary Liability for Secondary Actors in Securities Offerings

by Ropes & Gray LLP

The Supreme Court today held in Janus Capital Group, Inc. v. First Derivative Traders that investors cannot sue a mutual fund’s investment adviser for misrepresentations in a mutual fund prospectus, even though it was alleged to have participated in drafting the disclosure document. According to the Court, only the issuer of the prospectus “makes” a statement within the meaning of the antifraud laws. The Court rejected arguments by investors and the SEC that the close relationship between a mutual fund and its adviser, and the externalization of the fund’s management and operations, meant that a fund’s prospectus disclosures could be attributed to those entities. To “make” a statement, the Court held, literally means only to actually “make” a statement – but does not embrace drafting, preparation, or anything else. The decision means that the plaintiffs’ bar will not be able to sue peripheral players as primary violators in prospectus disclosure cases.

The case arises out of the mutual fund market timing scandal that erupted some eight years ago. Prospectuses issued by Janus mutual funds stated that the funds had policies in place to discourage market timing and that the funds took action to deter such behavior. When the New York Attorney General complained that those representations were false, investors withdrew from the mutual funds, and the adviser and its parent lost substantial fees as assets under management fell, causing the market price of the management company to fall substantially. Stockholders sued, claiming that the adviser and parent “made” the false statements in the mutual fund prospectus upon which they relied to their detriment.

The District Court dismissed the complaint. It held that the plaintiffs failed to allege that Janus Capital Management “actually made or prepared the prospectuses, let alone that any statement. . . . [were] directly attributable to it.” According to the District Court, participating in the preparation and dissemination of a misleading document is not “tantamount to making a misstatement for securities fraud purposes.” The Fourth Circuit Court of Appeals reversed. It held that Janus Capital Management “made” the misleading statements by participating in the writing, preparation, and dissemination of the prospectuses. The Supreme Court granted Janus Capital Management’s petition for certiorari and heard oral argument on December 7, 2010.

In a long-awaited decision issued this morning, a sharply divided Supreme Court rejected the Fourth Circuit’s interpretation of the word “made” in favor of a strict, literal application of the word. Only the prospectus issuer – in this case the mutual fund – “made” any false statement. Justice Clarence Thomas wrote for the Court, which was divided 5–4 along ideological lines.

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