(CN) – Investment adviser Janus Capital Management cannot be held liable under a Securities and Exchange Commission regulation against making false statements in clients’ prospectuses because the clients were responsible for their own statements, a divided Supreme Court ruled Monday.
The adviser and its parent, Janus Capital Group, were sued by New York and then state Attorney General Eliot Spitzer in 2003 for allegedly allowing market timing in several of the funds that the advisement branch ran. Market timing is a strategy in which investors buy and sell frequently to try and profit from short-term market cycles.
When the allegations became public, investors bailed on Janus’ funds and the group’s stock price fell nearly 25 percent. By August 2004, the SEC found that Janus Capital Management had entered into market timing agreements with 12 entities, and failed to notify its shareholders. The agreements permitted the 12 entities to perform more than the commonly allowed four transactions per year, without paying redemption fees. Since waiving these fees imposes the administrative and transaction costs of frequent trading on all the shareholders, Janus had a conflict of interests that it failed to disclose to the board of trustees.
Under the settlement, Janus agreed to reduce its fees by $125 million, and pay $50 million in disgorgement and $50 million in civil penalties.
First Derivative Traders then filed a class action on behalf of investors that owned Janus stock, claiming that the companies “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 [Janus] would implement measures to curb market timing in the Janus [mutual funds].”
Though the Janus parent company created the family of mutual funds organized under the Janus Investment Fund trust, that trust is a separate legal entity, according to the high court.
After a federal judge dismissed the complaint for failure to state a claim, the 4th Circuit revived it, finding that the false statements were made in the prospectuses.
On Monday, the Supreme Court tossed the holding, emphasizing that the advisers never literally “made” the statements in question.
“[First Derivative] suggests that an investment adviser should generally be understood to be the ‘maker’ of statements by its client mutual fund, like a playwright whose lines are delivered by an actor,” Justice Clarence Thomas wrote for the five-member majority. “We decline this invitation to disregard the corporate form. Although First Derivative and its amici persuasively argue that investment advisers exercise significant influence over their client funds, it is undisputed that the corporate formalities were observed here. JCM [Janus Capital Management] and Janus Investment Fund remain legally separate entities, and Janus Investment Fund’s board of trustees was more independent than the statute requires. Any 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.”
“Under this rule, JCM did not “make” any of the statements in the Janus Investment Fund prospectuses; Janus Investment Fund did,” Thomas added. “Only Janus Investment Fund – not JCM – bears the statutory obligation to file the prospectuses with the SEC. The SEC has recorded that Janus Investment Fund filed the prospectuses. There is no allegation that JCM in fact filed the prospectuses and falsely attributed them to Janus Investment Fund. Nor did anything on the face of the prospectuses indicate that any statements therein came from JCM rather than Janus Investment Fund – a legally independent entity with its own board of trustees.”
Justice Stephen Breyer authored a dissenting opinion joined by Justices Ruth Bader Ginsburg, Sonia Sotomayor and Elena Kagan.
“In my view, however, the majority has incorrectly interpreted the Rule’s word ‘make,'” Breyer wrote. “Neither common English nor this Court’s earlier cases limit the scope of that word to those with ‘ultimate authority’ over a statement’s content. To the contrary, both language and case law indicate that, depending upon the circumstances, a management company, a board of trustees, individual company officers, or others, separately or together, might ‘make’ statements contained in a firm’s prospectus – even if aboard of directors has ultimate content-related responsibility. And the circumstances here are such that a court could find that Janus Management made the statements in question.”