U.S. Supreme Court Limits Liability in Private Actions under Rule 10b-5

June 14, 2011

On June 13, 2011, the U.S. Supreme Court held that only a person who “makes” a statement may be held liable in a private action under Rule 10b-5. Specifically, in Janus Capital Group Inc. v. First Derivative Traders, No. 09-525, the Court held that neither Janus Capital Management LLC (“Janus Capital Management”) nor its parent company, Janus Capital Group, Inc. (“JCG”) could be held liable for false statements made by Janus Investment Fund (the “Janus Fund”), an entity for which Janus Capital Management served as investment advisor and administrator.

Rule 10b-5, promulgated under Section 10(b) of the Securities Exchange Act of 1934, prohibits “any person, directly or indirectly, . . . [from] mak[ing] any untrue statement of a material fact.” While the Securities and Exchange Commission administers and brings enforcement actions under Rule 10b-5, the Court has previously held that Section 10(b) also implies a right for investors to bring an action seeking damages for any untrue statement of a material fact that causes investors harm. In Janus, shareholders of publicly-traded JCG brought suit under Section 10(b) of the Securities Exchange Act and SEC Rule 10b-5, as well as control person liability under Section 20(a) of the Securities Exchange Act, alleging that the value of their investment had declined due to false statements in prospectuses issued by the Janus Fund. Specifically, the JCG shareholders alleged that several prospectuses issued by the Janus Fund falsely stated that Janus Capital Management would implement policies to curb the practice of market timing. When it was revealed that Janus Capital Management entered into arrangements to permit market timing, investments in the Janus Fund and the fees that it paid to Janus Capital Management for its services declined. As the parent company of Janus Capital Management, the value of JCG’s common stock similarly declined.

JCG and Janus Capital Management argued that they could not be held liable for any false statement made by the Janus Fund—a separate corporate entity over which they did not exercise control. Reversing the Fourth Circuit, the Supreme Court agreed, holding that “the maker of a statement is the entity with authority over the content of the statement” and that  “[w]ithout control, a person or entity can merely suggest what to say, not ‘make’ a statement in its own right.” Therefore, because the Janus Fund was an independent entity over which neither JCG nor Janus Capital Management exercised control, the Court determined that only the Janus Fund could be held liable in a private action under Rule 10b-5.

In Janus, the Court specifically referenced its recent holding in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148, 165 (2008) that “nothing [the defendants] did made it necessary or inevitable for [the company] to record the transactions as it did” and cautioned against the expansion of the Court-created implied Rule 10b-5 private right of action. Id. at 161 and 165. In aligning Janus with Stoneridge, the majority of the Court appears to be recognizing and furthering a trend to limit the potential defendants in Rule 10b-5 private actions. The minority, in a dissent written by Justice Breyer, attempted to differentiate Janus and Stoneridge, while arguing for a more expansive definition of “making a statement” that would include liability for “certain individuals who play a part in preparing the registration statement.” Herman & MacLean v. Huddleston, 459 U.S. 375, 386, n. 22.

Ultimately, Janus provides bright line comfort for those Wall Street firms that provide investment advisory services to other firms. The decision does, however, leave unresolved the question of control person liability under Section 20(a) for corporate entities that are not involved in the alleged fraud and do not exercise control over the conduct at issue. Given that the Janus Fund was a wholly distinct legal entity, unrelated to Janus Capital Management or JCG, the Court apparently felt no need to reach the issue of control person liability or resolve the current circuit split over whether control person liability under Section 20(a) requires that the controlling entity “culpably participate” in the alleged fraud. This circuit split on control person liability could present the Court with yet another opportunity to further clarify the scope of securities fraud exposure in the not to distant future.