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136TH Year no.



FrIDaY, JanuarY 27, 2012

‘Janus’ Confusion
Jared Kopel
he U.S. Supreme Court’s decision last June in Janus Capital Group v. First Derivative Traders, 11 C.D.O.S. 7203, was intended to provide a “bright-line” demarcation for determining primary liability under §10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, the principal antifraud provisions of the federal securities laws. But the welter of lower court decisions since Janus have only created more confusion over primary liability that will require clarification by the appellate courts and perhaps a return visit to the Supreme Court. Janus sought to clarify issues raised by Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164 (1994) and Stoneridge Investment Partners v. Scientific-Atlanta, 552 U.S. 148 (2008). Central Bank held that Rule 10b-5 shareholder actions do not include aiding and abetting or other forms of secondary liability. Stoneridge held that there could not be primary liability for those whose deceptive actions were not publicly disclosed and therefore were not relied upon by investors in making investment decisions. In Janus, shareholders of Janus Capital Group filed a Rule 10b-5 class action alleging that JCG and its wholly-owned subsidiary, Janus Capital Management, had made materially false and misleading statements in mutual fund prospectuses filed by Janus Investment Fund for which JCM was the investment adviser and administrator. Plaintiffs alleged Jared L. Kopel is a partner at Wilson Sonsini Goodrich & Rosati in Palo Alto.


that the prospectuses falsely represented that the mutual funds were not vulnerable to market timing and that JCM would implement policies to prevent the practice. The Fourth Circuit Court of Appeals held that because of the general knowledge that investment advisers dominate the funds they advise and JCM’s publicly disclosed responsibilities for managing the funds, investors would reasonably infer that JCM participated in drafting the prospectuses and therefore attribute any false statements to JCM. Reversing in a 5-4 decision, with Justice Clarence Thomas writing for the majority, the Supreme Court focused on the text of Rule 10b-5(b), which makes it unlawful for “any person, directly or indirectly ... [to] make any untrue statement of a material fact” in connection with the purchase or sale of securities. Adopting a stringent definition, the court held that 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.” Plaintiffs’ allegations that JCM and the fund shared the same officers and that JCM helped draft the allegedly false statements in the prospectuses were not sufficient to show that JCM was the “maker” of the allegedly false statements. The court noted that the fund was a distinct legal entity from JCM with its own board of trustees, there was no allegation that JCM had filed the prospectuses and falsely attributed them to the fund, and there was nothing on the face of the prospectuses indicating that any statements were made by JCM. Although JCM, like a speechwriter, may have helped craft the statements in the prospectuses, the court held that did not make JCM the “maker” of the statements, observing that “[E]ven when a speechwriter drafts a speech, the content is entirely within the control of

the person who delivers it.” The court stated that its holding also supported the “narrow scope” that must be given an implied right of action under Rule 10b-5. The court ruled that ordinarily “attribution within a statement or implicit from surrounding circumstances is strong evidence that a statement was made by — and only by — the party to whom it is attributed.” Yet, the Fourth Circuit’s ruling that the court rejected was based on a finding that the surrounding circumstances would lead investors to attribute the prospectuses’ contents to JCM. The court’s effort to establish a brightline standard for Rule 10b-5 primary liability has turned into an ever-growing muddle as lower courts reach conflicting results concerning whether Janus applies only to legally distinct entities; what constitutes “ultimate authority” over a statement; whether claims relying on “scheme liability” under Rule 10b-5(a) or (c) are treated differently than 10b-5(b) claims; when is attribution implicit from surrounding circumstances; and whether the court’s analysis is inapplicable to statutes providing an express causes of action.

Ultimate aUthority
For example, in In re Merck Securities Derivative & ERISA Litigation, 1658 (SRC) (D.N.J. Aug 8, 2011), the court rejected arguments that claims against an executive vice president should be dismissed because he did not have “ultimate authority” over even those statements attributed to him or for SEC filings he signed. The court appeared to conclude that Janus applied only to situations concerning legally independent entities, and did not alter the wellestablished rule that “a corporation can act only through its employees and agents.” See also Local 703 Grocery and Food Employees Welfare Fund v. Regions Financial, CV:10-2847-IPJ (N.D. Ala.

Aug. 23, 2011) (defendants liable under Janus where they allegedly signed false Sarbanes-Oxley certifications). However, in Hawaii Ironworkers Annuity Trust Fund v. Cole, 3:10CV371 (N.D. Ohio Sept. 1, 2011), the court held that “nothing” limited Janus to legally separate entities. Thus, the court granted a motion to dismiss claims against two middle-level corporate officials because plaintiffs had alleged that these officials had been directed by senior executives to inflate the company’s earnings and therefore they did not “make” the false statements. The court noted that while it disagreed with the rationale of Merck, the outcome was correct, because the defendant there was plainly alleged to be the “speaker” of the statements attributed to him. Similarly, the court in In re Coinstar Securities Litigation, C11-133 MJP (W.D. Wash. Oct. 6, 2011), held that Janus required dismissal of Rule 10b-5(b) claims against a company’s president, executive vice president and general counsel, where the alleged misstatements were made by other corporate officers at various conferences. These decisions represent merely the opening salvos of what promises to be a judicial struggle to determine who has “ultimate authority” over, and therefore liability for, allegedly misleading corporate statements, which are in reality usually the product of a collective effort by senior and even middle management — the “speaker” of the statement to whom it may be attributed (Merck and Coinstar), or the person who had control over the contents of the statement and the decision to issue it (Cole), or a combination of both.

Scheme liability
The Cole court, however, refused to dismiss claims under Rules 10b-5(a) and (c), which make it unlawful for a person to “employ any device, scheme or artifice to defraud” or to “engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person.” The court held that Janus did not require attribution for a person to be liable under these provisions, and therefore the defendants could be liable for deceptive conduct that included participating in the drafting of false statements. This analysis, however, was rejected in Coinstar and SEC v. Kelly, 08 Civ. 4612(CM)

(S.D.N.Y. Sept. 22, 2011), which both held that “scheme liability” under Rules 10b-5(a) and (c) did not apply to conduct that became deceptive only because of a misstatement or omission, as opposed to inherently deceptive conduct like market manipulation. Courts have differed on Janus’ application to legally distinct entities. In City of Roseville Employees Retirement System v. EnergySolutions, 09 Civ.8633 (JGK) (S.D.N.Y. Sept. 30, 2011), the court held that Janus did not bar a shareholder class action against a company, ENV, based on allegedly false statements in registration statements for public offerings by another company, ES, where ENV held 100 percent of the stock of ES prior to its initial public offering and retained a controlling interest after the IPO, where ENV directly controlled transactions of ES, and where there was public disclosure that the sponsors of ES operated through their ownership of ENV. Thus, it could be “implicit from the surrounding circumstances” that ENV had “ultimate authority” over ENV’s disclosures. But another judge in the Southern District of New York reached a different result in In re Optimal U.S. Litigation, Civ. 4095 (SAS) (S.D.N.Y. Oct. 13, 2011). Plaintiffs brought a shareholder class action against Optimal Strategic U.S. Fund which allegedly invested 100 percent of its assets with Bernard Madoff, and the fund’s investment manager, Optimal Investment Management Services. Plaintiffs sought to hold OIS and its parent liable for allegedly false statements made in Explanatory Memoranda — described as the Bahamian equivalent of prospectuses — that were issued by Optimal Multiadvisors. Plaintiffs asserted that OIS had “ultimate authority” over the statements in the EM because, among other things, OIS owned 100 percent of the voting shares in Multiadvisors; OIS could appoint and remove Multiadvisors’ directors at will; OIS’ CEO was a director of Multiadvisors who signed the agreement between OIS and Multiadvisors on behalf of both parties; and the in-house counsel at OIS suggested disclosure in the EM that was adopted almost verbatim. Plaintiffs also alleged that disclosures in the EM concerning OIS’ role in managing Multiadvisors were sufficient to attribute the allegedly false statements to OIS. The Optimal court reversed its pre-

Janus bench ruling that OIS could be held liable for the false statements in the EM. The court’s prior ruling that OIS’ 100 percent ownership of Multiadvisors was a basis for attributing the EM’s statements to OIS was no longer valid because Janus made clear that expanding the narrow scope of a private right of action under §10(b) was not proper where control person liability under §20(a) was available. Further, the statements in the EMs concerning OIS could no longer be considered attribution, but merely discussed the typical responsibilities of an investment adviser, and Janus precluded Rule 10b-5 liability for an adviser based on its unique relationship to a fund. The court distinguished City of Roseville “because the indicia of control here are not so overwhelming,” although the distinctions drawn by the court appear too thin to provide a meaningful analytical basis.

Sec enforcement actionS
Courts also have rendered conflicting rulings on the applicability of Janus to Securities and Exchange Commission actions under §17(a) of the Securities Act of 1933. The court in SEC v. Daifotis, C 11-00137 WHA (Aug. 1, 2011) held that Janus was limited only to Rule 10b-5 violations. First, Janus specifically addressed the meaning of the word “make” in Rule 10b-5 which was absent from the operative language in §17(a), which makes it unlawful to employ any device, scheme or artifice to defraud; to obtain money or property by means of an untrue statement; or to engage in any transaction, practice or course of business that operate or would operate as a fraud. Second, the Daifotis court held that the Supreme Court’s desire to limit the scope of an implied private right of action was inapplicable to §17(a), for which no implied shareholder right of action exists. Indeed, the court held that Janus did not apply to the SEC’s claim under §34(b) of the Investment Company Act even though the word “make” appears in the statute’s operative language, because the statute does not provide for an implied right of action. But the opposite conclusion was reached in SEC v. Kelly, where the court noted that §17(a) and Rule 10b-5 have been held to have essentially the

same elements, and although their language is not precisely identical, §17(a)(2) and Rule 10b-5(b) “have the same functional meaning [when] it comes to creating primary liability.” Thus it would be “inconsistent” for Janus to require a defendant to be the “maker” of a misleading statement under 10b-5(b), but not 17(a) (2). Subsequently, an SEC administrative law judge, confronted with the conflicting decisions in Daifotis and Kelly, held without analysis that Janus applied to the SEC’s §17(a) claims. In the Matter of John P. Flannery , Admin. Proc. 3-14081 (Oct. 28, 2011).

remaining UnreSolved iSSUeS
Janus also raises other issues beyond the scope of this article. In response to the assertion by the dissent in Janus that the decision could eliminate any liability for entities that commit fraud through innocent intermediaries — be-

cause §20(a) and aiding and abetting liability apply only to those who control or substantially assist primary violators — the majority suggested in a footnote that liability might exist under §20(b) of the exchange act, which makes it unlawful for any person, directly or indirectly, to do any act or thing which would be unlawful for such person to do through or by means of another person. But there is an absolute dearth of authority concerning the scope of §20(b), including whether an implied shareholder private right of action exists. Another unresolved issue is whether a person who makes a statement may avoid liability by disclaiming “ultimate authority” over the content and timing of the statement. Still another issue is whether the restriction of primary liability under §10b-5 will result in a more expansive judicial reading of control person liability under §20(a), as suggested in Optimal and Wirth v. Taylor, 2:09-CV-127

TS (D. UT. Sept. 8, 2011) (holding that Janus’ rejection of a broad construction of Rule 10b-5 helped plaintiffs establish control person liability). Finally, Janus sounded the death knell of the Ninth Circuit’s standard for holding defendants primarily liable under Rule 10b-5 if they were intricately involved or substantially participated in making misstatements, as set forth in In re Software Toolworks, 50 F.3d 615 (9th Cir. 1994) and Howard v. Everex Systems, 228 F.3d 1057 (9th Cir. 2000). While this standard should not have survived Stoneridge, it is no longer defensible after Janus, as was tacitly recognized by the Ninth Circuit itself in Reese v. BP Exploration (Alaska), 643 F.3d 681 (2011). While not expressly overruling Toolworks and Howard, Reese noted that Janus “sets the pleading bar even higher in private securities fraud actions seeking to hold defendants primarily liable for the misstatements of others.”

Reprinted with permission from the january 27, 2012 online edition of The Recorder. © Copyright 2012. ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, call 415.490.1054 or