566 F.3d 111 (4th Cir. 2009), cert. granted, 78 U.S.L.W. 3762 (June 28, 2010) (No. 09-525)
Can a service provider be held primarily liable in a private-securities fraud action for "helping" or "participating in" another company's misstatements?
In Janus, the Supreme Court will address the question of whether an investment adviser to a mutual fund made misleading statements by participating in the drafting and dissemination of misleading prospectuses of the mutual fund it managed and whether the misleading statements must be explicitly attributable to the investment adviser at the time of dissemination in order to establish reliance.
Plaintiffs are owners of Janus Capital Group ("JCG") common stock. Plaintiffs filed suit under § 10(b) of the Securities Exchange Act of 1934 against JCG and Janus Capital Management ("JCM"), a subsidiary of JCG and the investment adviser to the Janus funds. Several Janus fund prospectuses explicitly stated that the funds would not engage in market timing. In 2003, however, the New York attorney general revealed that several of the funds had engaged in market timing. Following this revelation, several JCG and JCM executives resigned, $14 billion was withdrawn from the Janus funds and the value of JCG common stock dropped approximately 25 percent.
The plaintiffs allege that the defendants are liable for "'caus[ing] [the] mutual fund prospectuses to be issued for Janus funds and ma[king] them available to the investing public,' through filings with the SEC, and dissemination on a joint website [controlled by JCG, JCM, and the Janus funds]." In re Mutual Funds Investment Litigation, 566 F.3d 111, 121 (4th Cir. 2009).
The District Court granted the defendant's motion to dismiss, holding that the plaintiffs had failed to state a claim under § 10(b) because the plaintiffs failed to allege that either JCG or JCM prepared the prospectuses or made the statements contained within them, and that the alleged dissemination did not rise to the level of making a misstatement for securities fraud purposes. Id. at 118.
The Fourth Circuit Court of Appeals reversed, finding that the plaintiffs had properly pled a claim of primary liability against JCM. The Fourth Circuit first concluded that the complaint properly alleged that the defendants had made the statements contained in the prospectuses. The court reasoned the allegations in the complaint, "taken together, allege that JCG and JCM, by participating in the writing and dissemination of the prospectuses, made the misleading statements contained in the documents." Id. at 121. The court then concluded that it was unnecessary for the plaintiffs to allege that the statements were contemporaneously attributable to the defendants, but instead required a showing that the interested investors would have attributed the statement to the defendants. Id. at 123-24. The court determined that due to JCM's management role and its inherent responsibilities, the investors would have reasonably assumed that JCM had control over the content placed in the prospectuses and on the joint website. Id. at 127. The court found JCG could be liable under § 20(a) as a "control person." Id. at 131. The defendants subsequently petitioned the Supreme Court arguing that a party cannot be liable in a private cause of action for aiding and abetting in a § 10(b) claim, or for statements that are not attributable to them at the time of dissemination.
The Supreme Court eliminated any liability for aiders and abettors under § 10(b) in Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164 (1994). In 1995, Congress partially overturned Central Bank through the Private Securities Litigation Reform Act (PSLRA). The PSLRA permitted the SEC to prosecute aiders and abettors under § 10(b), but did not restore a private cause of action. The court reaffirmed this prohibition under the PSLRA in Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, 552 U.S. 148 (2008).
In Stoneridge, the court also held that "the investors cannot be said to have relied upon any of respondents' deceptive acts in the decision to purchase or sell securities; and as the requisite reliance cannot be shown, respondents have no liability to petitioner under the implied right of action." Id. at 166-67. The circuit courts have struggled to determine the degree and manner in which reliance must be shown. In the Second and 11th circuits, the plaintiffs must allege that at the time of dissemination the misrepresentation was directly attributable to the defendant. Wright v. Ernst & Young LLP, 152 F.3d 169, 175 (2d Cir.1998); Ziemba v. Cascasda Int'l, Inc., 256 F. 3d 1194 (11th Cir. 2001). In contrast, the Ninth Circuit has not required attribution, stating that "substantial participation or intricate involvement in the preparation of fraudulent statements is grounds for primary liability even though that participation might not lead to the actor's actual making of the statements." Howard v. Everex Sys. Inc., 228 F.3d 1057, 1061 n.5 (9th Cir. 2000). The 10th Circuit has held "false and misleading representations in connection with the purchase or sale of any security, if made with the proper state of mind and if relied upon by those purchasing or selling a security, can constitute a primary violation." Anixter v. Home-Stake Prod. Co., 77 F.3d 1215, 1226 (10th Cir. 1996).
With respect to whether a defendant is liable for "participating" in the drafting of a misrepresentation, AARP will attempt to differentiate Janus from traditional aiding and abetting cases. For instance, in Stoneridge the defendants engaged in sham transactions that enabled the primary party to produce false financial statements. In Janus, however, the defendants are alleged to have participated in the creation and dissemination of the actual misrepresentation. AARP believes that such involvement raises the significance of the defendants' actions beyond mere aiding and abetting.
With respect to the required degree of attribution, the Supreme Court has stated that reliance upon a misrepresentation must be shown in order to bring a claim. It does not follow, however, that an investor must attribute the misrepresentation to the defendant in order for the investor to rely upon it. AARP will argue in its amicus brief that the court should adopt either the Ninth Circuit's substantial participation analysis or the Fourth Circuit's holding in Janus, which allows for liability when it can be shown that investors would have attributed the misrepresentation to the defendant.
AARP will also argue that private liability for "participating in" a § 10(b) violation and not requiring direct attribution is consistent with Congress' intent. A major purpose in enacting the Securities Exchange Act of 1934 was to "insure honest securities markets and thereby promote investor confidence." United States v. O'Hagan, 521 U.S. 642, 658 (1997). Since the passage of the act, investment activities have changed greatly and outside parties play a larger role than ever in financial fraud. A private cause of action could prevent future fraud on a massive scale. For example, the alleged auditing and reporting failures that surrounded Enron's catastrophic collapse might have been averted if there was third-party exposure to private claims.