Yesterday, in a 5-4 split decision, the United States Supreme Court ruled that for purposes of SEC Rule 10b-5, a mutual fund investment advisor cannot be held liable for material misstatements in its client’s prospectus because those statements are ultimately controlled by the client.  Janus Capital Group, Inc. v. First Derivative Traders, No. 09-525, slip op. (U.S. June 13, 2011).  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 sale or purchase of securities.  17 C.F.R. § 240.10b-5 (2010). 

Justice Thomas, writing for the majority, began the opinion by interpreting “to make”:

[f]or purposes of Rule 10b-5, the maker of the statement is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it.  Without control, a person or entity can merely suggest what to say, not “make” a statement in its own right.  One who prepares or publishes a statement on behalf of another is not its maker. 

Slip op. at 6. 

The Court rejected the argument that in light of the “‘well-recognized and uniquely close relationship between a mutual fund and its investment adviser,’” the adviser “should generally be understood to be the ‘maker’ of statements by its client mutual fund.”  Slip op. at 9.  The Court noted that its ruling followed from its earlier holding in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 180 (1994), where the Court held that Rule 10b-5’s private right of action does not include suits against aiders and abettors who contribute “substantial assistance” to the making of a statement.  Slip op. at 7. 

The plaintiffs, shareholders of Janus Capital Group (JCG), brought securities fraud claims against Janus Investment Fund’s investment advisor, Janus Capital Management (JCM), and also JCG.  The JCG shareholders contended that the Fund’s disclosure documents misrepresented that JCG and JCM would implement policies to curb strategies based on delays in fund valuations.  The plaintiffs alleged that in 2003, when the market learned that the Fund permitted “market timing,” after JCG was sued by New York’s Attorney General, investors withdrew their money from the Fund to the detriment of JCG’s stock price.  Importantly, the complaint did not allege that JCG or JCM issued the inaccurate prospectuses.     

Justice Breyer, in his dissent, worries that the new rule creates a gap in the law and may immunize “guilty management” from liability under Rule 10b-5: “Every day, hosts of corporate officials make statements with content that more senior officials or the board of directors have ‘ultimate authority’ to control.”  Slip op., dissent, at 3.  He asks, “what is to happen when guilty management writes a prospectus (for the board) containing materially false statements and fools both the board and public into believing they are true?  Apparently under the majority’s rule, in such circumstances no one could be found to have “ma[d]e” a materially false statement….”  Slip op., dissent, at 9-10.

The court’s clarification of primary liability under the securities laws will potentially impact all investment advisers, lawyers, accountants, and others who help prepare financial disclosures for issuers but do not control the ultimate statement, and may impact other litigation brought under Rule 10b-5.