Supreme Court Narrows Securities Fraud Liability to Persons with "Ultimate Authority" over a Statement, Bloomberg Law Reports®
Abandoning its previous unanimous decisions on federal securities law issues, a deeply divided U.S. Supreme Court, in a 5-4 decision, held that liability under Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) andRule 10b-5 thereunder is limited to persons who “make” a false or misleading statement. According to the majority, only a person with “ultimate authority” over the statement truly makes it.
Legally Separate Entities
In a decision by Justice Thomas, joined by Chief Justice Roberts and Justices Alito, Scalia, and Kennedy, the Court explained that mutual fund investment adviser Janus Capital Management LLC (JCM) could not be held liable for false statements made in prospectuses issued by its mutual fund client Janus Investment Fund (Fund). The Court noted that JCM is a wholly-owned subsidiary of Janus Capital Group, Inc. (JCG). Although JCG created the Fund, it is organized as a Massachusetts business trust and is a distinct legal entity owned entirely by investors. All of the Fund’s officers also served as officers of JCM, but the Court said, only a single member of the Fund’s board of directors is associated with JCM. The Court stressed that the independent members of the Fund’s board far exceeded the statutory limitation against more than 60 percent of a mutual fund board being interested persons.
Although JCM provided day-to-day management and advisory services to the Fund, the Court explained that the Fund issued the prospectuses containing allegedly false and misleading statements. Specifically, the prospectuses stated that the Fund was not appropriate for market timing and “can be read to suggest that JCM would implement policies to curb the practice.” Nevertheless, market timing allegedly was rampant, and condoned by JCM and JCG. After the New York Attorney General filed suit against JCM and JCG, investors withdrew from the Fund, lowering JCM’s management fees and reducing JCG’s income. Declining revenue at JCG led to a 25 percent decrease in its stock price and a class action securities fraud lawsuit.
Who “Made” the Statement?
Informing its decision, the Court explained, was the implied right to a private cause of action under Section 10(b). “‘[T]he judicial creation of a private cause of action caution[s] against its expansion,’” said the Court. Moreover, Congress has maintained the “‘narrow dimensions’” of Section 10(b) even as it has “‘revisited the law.’” Accordingly, the Court turned to the plain language of Rule 10b-5 that “it is unlawful for ‘any person, directly or indirectly, . . . [t]o make any untrue statement of material fact’ in connection with the purchase or sale of securities.”
The Court reasoned that “[o]ne ‘makes’ a statement by stating it.” Indeed, the Court stated that “to make” is “‘the approximate equivalent of ‘to state.’” Under Rule 10b-5 then, “the maker of a statement is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it.” Otherwise, a person only suggests what to say. Using the analogy of a speechwriter, the Court observed that the drafter of the language does not control it; the person who delivers the speech controls the final content and “takes credit—or blame—for what it ultimately said.”
Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994) and Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148 (2008), the Court said, supported its decision. It explained that Central Bank denied liability for entities that provide “substantial assistance,” but do not actually make a statement. “A broader reading of ‘make,’ including persons or entities without ultimate control over the content of a statement, would substantially undermine Central Bank.” Stoneridge, the Court continued, denied liability where defendants’ actions did not “‘make it necessary or inevitable’” that a company would record fraudulent transactions. According to the Court, without “authority over the content of the statement . . . it is not ‘necessary or inevitable’ that any falsehood will be contained in the statement.”
The Court declined to interpret “make” as “create,” noting that participation in drafting a false statement is only “an undisclosed act preceding the decision of an independent entity to make a public statement.” Moreover, the Court refused to “disregard the corporate form.” Despite the close relationship between JCM and the Fund, the Court determined that “[a]ny reapportionment of liability in the securities industry in light of the close relationship between investment advisers and mutual funds is properly the responsibility of Congress and not the courts.”
Despite the fact that JCM allegedly drafted the prospectuses and misrepresented its position on market-timing, the Court held that the Fund, which bore the statutory responsibility to file the prospectuses, made the statements. Accordingly, the Court reversed the decision of the U.S. Court of Appeals for the Fourth Circuit.
Justice Breyer, joined by Justices Ginsburg, Sotomayer, and Kagan, dissented from the majority’s opinion. Justice Breyer first took issue with the majority’s reading of “to make” as requiring “ultimate authority” over a statement. He noted that “[n]othing in the English language prevents one from saying that several different individuals, separately or together, ‘make’ a statement that each has a hand in producing.” Breyer also found a distinct difference between this case and Central Bank and Stoneridge where defendants only assisted an issuer in making false statements. As Breyer explained, the Central Bank defendant allegedly delayed valuation checks, allowing an issuer to falsely overstate the value of certain property backing bonds sold to investors. Central Bank, said Breyer, dealt with secondary liability where the defendant did not engage in proscribed activity. In Stoneridge, defendants entered into sham transactions that allowed an issuer to overstate revenue. While the Stoneridge defendants allegedly did make false statements, the statements were not shared with the public, undermining Section 10(b)’s reliance requirement. In contrast, Breyer continued, the current case asks whether JCM is liable for statements that it included in the prospectuses. In his view, JCM’s actions fit Central Bank’s acknowledgment that any person or entity, including a lawyer, accountant, or bank, who employs a manipulative device or makes a material misstatement (or omission) on which a purchaser or seller of securities relies may be liable as a primary violator under 10b–5, assuming all of the requirements for primary liability under Rule 10b–5 are met.
The majority’s opinion, Breyer said, results in a paradox where “guilty management writes a prospectus (for the board) containing materially false statements and fools both the board and public into believing they are true.” Under the majority’s reasoning, Breyer explained, no one is liable for the false statements—the board lacks knowledge of the false statements and management did not “make” the statements. Even the Securities and Exchange Commission (SEC) could find its authority limited by the majority’s rule. Under either a primary theory of liability or aiding and abetting, which the SEC alone may allege, the lack of a primary violator who “made” a false statement impedes prosecution of the federal securities laws.
Asking whether JCM should be held liable for violating Section 10(b), Breyer answered in the affirmative. He focused on the relationship between JCM and the Fund, under which JCM “is responsible for the day-to-day management of [the Fund's] investment portfolio and other business affairs of the funds, “as well as “administrative, compliance and accounting services for the funds.” Moreover, JCM drafted, prepared, and disseminated the prospectus. Indeed, JCM allegedly prepared the market timing information in the prospectuses and withheld the truth concerning the policy from the Fund’s board. Nevertheless, Breyer noted that JCM only escapes liability because the majority has adopted a rule that “would arbitrarily exclude from the scope of the word ‘make’ those who manage a firm—even when those managers perpetrate a fraud through an unknowing intermediary.”
Liability & Defense
Securities Fraud [Section 10(b)]
Investment Companies/Mutual Funds
This document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. Bloomberg Finance L.P. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.