A recent ruling in favor of the Janus mutual funds’ adviser in the Supreme Court is continued fall out from the mutual fund market timing scandal from almost a decade ago. The prospectuses for several Janus funds represented that the funds were not suitable for market timing and could be read that Janus Capital Management LLC, the mutual fund’s investment adviser, would implement policies to curb market timing. They didn’t and certain traders were able to engage in market timing.
First Derivative Traders represented a class of plaintiffs who owned the stock of the Janus Capital Group, the publicly traded company that owned the investment adviser. After the allegations of market timing surfaced the share price of Janus fell precipitously.
First Derivative alleges that JCG and JCM “caused mutual fund prospectuses to be issued for Janus mutual funds and made them available to the investing public, which created the misleading impression that [JCG and JCM] would implement measures to curb market timing in the Janus [mutual funds]. … Had the truth been known, Janus [mutual funds] would have been less attractive to investors, and consequently, [JCG] would have realized lower revenues, so [JCG’s] stock would have traded at lower prices.
That sounds like very tentative claim to me, especially when you insert the legal fiction that a mutual fund is separate from the fund’s advisers.
The issue is whether the adviser can be held liable in a private action under Rule 10b-5 for false statements in the mutual fund’s prospectus. Under Rule 10b–5, it is unlawful for “any person, directly or indirectly, . . . [t]o make any untrue statement of a material fact” in connection with the purchase or sale of securities. 17 CFR §240.10b–5(b). To be liable, the adviser must have “made” the material misstatements in the prospectuses.
The US Supreme Court says no. It was the fund itself that made the false statement, not the investment adviser. They are legally separate entities with separate boards. In fact, the board of the Janus fund was more independent than required by statute. Only the fund, not the adviser, has the obligation to file the prospectuses with the SEC.
This rule follows from Central Bank of Denver, N. A. v. First Interstate Bank of Denver, N. A., 511 U. S. 164 (1994). The Court held that Rule 10b–5’s private right of action does not include suits against aiders and abettors. Suits against entities that contribute substantial assistance to the making of a statement may be brought by the SEC. Private parties can only bring suit for direct statements. A broader reading of “make,” including persons or entities without ultimate control over the content of a statement, would substantially undermine Central Bank, said the Court, If persons or entities without control over the content of a statement could be considered primary violators who “made” the statement, then aiders and abettors would be almost nonexistent.
It’s not that Janus didn’t suffer for allowing market timing. In 2004, Janus reached a settlement with the SEC for market timing allegations Janus paid $100 million in disgorgement and civil penalties. A big chunk of that cash was returned to the fund shareholders.
The Supreme Court decision merely draws the line at a derivative lawsuit by the adviser’s corporate shareholders.
- Janus Capital Group, Inc. v. First Derivative Traders (.pdf) (09-525)
- Supreme Court Holds Fund Management Company Cannot Be Held Liable for Funds’ Statements by Kevin LaCroix in the D&O Diary
- Supreme Court Rules Fund Adviser Not Liable for Any Misstatements in Fund Prospectus; Strongly Reaffirms Central Bank in Jim Hamilton’s World of Securities Regulation
- Janus Capital Management Fair Fund