June 14th, 2011
Econintersect: The Supreme Court ruled Monday (June 13) that, while a mutual fund is responsible for statements made in its prospectus, the parent company has no liabilty. Certain Janus mutual funds settled claims in a 2003 with the SEC over statements in fund prospectuses that were misleading with regard to the practice of allowing select fund shareholders to make rapid trades of fund shares to the detriment of long-term shareholders. The practice, which a number of mutual fund families allowed in addition to Janus, allowed some mutual fund shareholders (mostly hedge funds) to engage in market timing practices that prospectuses implied were not allowed. Follow up:
Follow up:The Supreme Court decision was supported a lower court decision of a class action suit brought by First Derivative Traders who claimed they (and others) bought shares in Janus Capital Group between 2000 and 2003 at prices that were inflated because Janus concealed from investors the practices for which the company's funds later paid a total penalty of $326 million. Janus shares alter lost value in the aftermath of the revelations and settlements.
By a 5-4 vote in a narrow decision, the justices overturned a ruling by a U.S. appeals court that a class-action securities fraud lawsuit could go forward.
In backing the Denver-based Janus, one of the largest mutual fund companies, the high court's decision will mean few changes for the way big asset managers govern themselves -- structures that could have faced a major overhaul if the ruling had gone the other way.
Janus, in appealing to the Supreme Court, argued that the funds were separate legal entities and that neither the parent company nor its subsidiary was responsible for the prospectuses and could not be held liable.
The high court agreed. It ruled the alleged false statements in the prospectuses were made by an investment fund, not Janus Capital, and that Janus and the subsidiary therefore cannot be held liable in a private securities fraud lawsuit.
The majority decision was written by Justice Clarence Thomas. From Bloomberg:
The case was a follow-up to a 2008 Supreme Court decision that curbed securities suits against a company’s banks and business partners. In his opinion for the court today, Justice Clarence Thomas said the shareholders were seeking to “create the broad liability that we rejected” in the 2008 case.
“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,” Thomas wrote.
Thomas said those entities [Janus Capital Group and Janus Capital management LLC] were legally distinct from Janus Investment Fund, the investor-owned trust responsible for issuing the prospectuses.
“There is no allegation that JCM in fact filed the prospectuses and falsely attributed them to Janus Investment Fund,” Thomas wrote. “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 directors.”
“The relationship between Janus Management and the fund could hardly have been closer,” Breyer wrote for the group. “Janus Management’s involvement in preparing and writing the relevant statements could hardly have been greater. And there is a serious suggestion that the board itself knew little or nothing about the falsity of what was said.”
William Birdthistle, an associate professor at the Chicago-Kent College of Law, called the ruling a "pretty simplistic" one (Reuters) that will leave the basic structure of the mutual fund industry unchanged. Birdthistle had written an amicus brief on behalf of First Derivative Traders.
Further from Reuters about Birdthistle:
He said the ruling's most dramatic impact could be to encourage other industries to adopt the split management structure of the mutual funds sector as a way to avoid liability.
"What this ruling says is that as long as there are separate legal entities, even if management totally dominates all aspects, there's no liability," Birdthistle said. "This is going to open the eyes of those not in the funds industry who are going to say: 'Wow, those guys are bulletproof'," he said.
The Obama administration backed the shareholders at the Supreme Court. Janus was backed by the U.S. Chamber of Commerce.
Bill Singer, writing at Forbes, opined that the majority Opinion "...reads as much as a legal dissertation as a High School grammar lesson, the Court tries to determine what is meant by “making” a misstatement."