The U.S. Supreme Court is considering whether investors can sue companies that directly participated in or directed the making of fraudulent statements that harmed investors.
A mutual fund is an investment company that pools money from many people and invests the money in stocks, bonds, short-term money-market instruments, other securities, or some combination of these instruments.
Janus Capital Group provided the initial seed capital of $100,000 (required by federal law) to start up a mutual fund known as the Janus Mercury Fund. Janus Capital Group self-identifies in its own corporate materials as a company that “sponsors, markets and provides investment advisory, distribution, and administrative services primarily to mutual funds.” In those roles, it registered the Janus Mercury Fund with the federal Securities and Exchange Commission (SEC) and selected the third parties needed to launch and operate the fund.
The Fund’s investment adviser, a wholly owned subsidiary of the holding company that sponsored the startup of the Fund, with the backing of Janus Capital Group, produced a prospectus for the Fund that contained alleged significant misrepresentations, statements which investors claimed amounted to fraud. Investors sued the Fund investment advisers and Janus Capital Group, arguing that both entities were so closely linked to the Fund that they were liable for the alleged fraud that was carried out through publication of the prospectus. Janus and its investment adviser subsidiary argue that they should not be liable to individual investors because U.S. Supreme Court precedent insulates aiders and abettors in securities fraud cases.
The U.S. Court of Appeals for the Fourth Circuit disagreed with the Janus entities and ruled that they could be held liable to the investors because they were much closer to the alleged fraudulent misconduct than were the defendants in prior cases on which Janus relied. . Janus Capital Group and Janus Mercury Fund appealed to the U.S. Supreme Court.
Attorneys with AARP Foundation Litigation filed a “friend of the court” brief with the North American Securities Administrators Association in Janus Capital Group v. First Derivative Traders.
The brief points out that private enforcement action (the ability of investors to sue directly) in both the mutual fund and the more traditional securities arenas is critically important as a vehicle to enforce investors’ rights. Federal and state governments are too overwhelmed and cash-strapped to effectively enforce laws protecting all investors from industry misconduct, and in fact government initiatives account for only about ten percent of securities actions brought in courts.
Governments are generally strangers to the transactions that give rise to allegations of fraud, while investors have more information at hand that allows them to uncover and prosecute frauds. Moreover, private actions have a broader reach, as the government is limited in its oversight – particularly so in the case of mutual funds. Private enforcement actions are the only way to adequately compensate victims – governmental agencies can impose fines but often not to the level of the ill-gotten gains, and even when there are significant fines, they rarely go to compensate victims of the fraud.
And finally, private actions send a strong message to financial industry professionals that their duties of transparency and responsibility will be enforced, a message which is also important for investors to hear in order to have confidence in the markets; without such confidence, the financial markets can be shaken. As evidence of this, the brief points out, once the flaws in Janus Mercury Group materials were shown, investors departed from the fund in droves.
What’s at Stake
A major AARP priority is to assist people in accumulating and effectively managing retirement assets. The shift away from traditional defined benefit pension plans (in which employers bear the responsibility of asset accumulation and the risk of loss) to defined contribution plans (under which plan participants bear those responsibilities and risks) places a significant weight on individuals, including many first-time investors, to have the confidence in the markets so as to permit them to make appropriate investment choices. Investors must have not only accurate and complete information about their investment vehicles, but must also be armed with the tools necessary for enforcement of their rights.
More people than ever are investing in financial products and securities on their own and through Individual Retirement Accounts, employer-sponsored 401(k)s, and similar plans, and misconduct by industry professionals can harm all market participants.