Janus Capital, the US Supreme Court and Political Decision Making: Result Oriented Legal Analysis (Part 3)
We are discussing the recent decision by the Supreme Court in Janus Capital v. First Derivative, a case that involved allegedly false disclosure in a prospectus issued by a mutual fund.
The decision in Janus Capital turned entirely on the meaning of the word "make" in Rule 10b-5. The Rule includes within the definition of fraud persons who directly or indirectly "make any untrue statement of a material fact" (emphasis added). The opinion focused on this single word.
- One “makes” a statement by stating it. When “make” is paired with a noun expressing the action of a verb, the resulting phrase is “approximately equivalent in sense” to that verb. 6 Oxford English Dictionary 66 (def. 59) (1933) (hereinafter OED); accord, Webster’s New International Dictionary 1485 (def. 43) (2d ed. 1934) (“Make followed by a noun with the indefinite article is often nearly equivalent to the verb intransitive corresponding to that noun”). For instance, “to make a proclamation” is the approximate equivalent of "to proclaim,” and “to make a promise” approximates “to promise.” See 6 OED 66 (def. 59). The phrase at issue in Rule 10b–5, “[t]o make any . . . statement,” is thus the approximate equivalent of “to state.”
The conservative majority, therefore, seemed to focus the analysis on the person who actually issued the false statement.
But had that been the case, liability would have been imposed not on an individual but an entity. After all, the allegedly false statement was made in a prospectus issued by Janus Fund, a Massachusetts business trust. Entities themselves are pieces of paper filed with the relevant state agency. They can only act through their agents.
The Court, therefore, had to determine who inside the entity was responsible for the false disclosure. In doing so, the conservative majority drew an arbitrary line.
- For purposes of Rule 10b–5, 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. Without control, a person or entity can merely suggest what to say, not “make” a statement in its own right. One who prepares or publishes a statement on behalf of another is not its maker. And in the ordinary case, 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.
Essentially, therefore, only those with "ultimate authority" over content could "make" the statement for purposes of liability under Rule 10b-5.
The analysis is not really an interpretation of the word "make" at all. After all, in the most literal sense, it was the Fund that made the statement. Instead, the conservative majority was determining who connected to an entity was responsible for the false disclosure. The court's choice, those with "ultimate authority" over the disclosure, is neither consistent with traditional principles under the securities laws nor state corporate law.
With respect to securities law principles, the dissent correctly notes that fraud actions have long been allowed where companies distributed false information to the public through third parties. Termed the "conduit" theory, companies giving false information to analysts or the press could be liable as if they had made the statement directly. This approach has been uncontroversial and widely accepted. See Chapter 8, The Regulation of Corporate Disclosure. It prevents an obvious circumvention of the antifraud provisions by preventing issuers from using third parties to indirectly convey false information to the market. By limiting antifraud actions to those with "ultimate authority" over disclosure, the conservative majority arguably overturns the conduit
With respect to corporate law principles, "ultimate authority" as a legal matter rests with the board of directors. See DGCL 141(a) ("The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation."). Yet as a practical matter, this does not actually reflect the division of authority within a company. Directors do not excercise day to day authority but delegate these decisions to others, particularly the CEO.
The reference to "ultimate authority" seems to focus on legal responsibility and does not take into account actual practice. As a result, the conservative majority effectively attributed "maker" status to the persons who, while having legal responsibility, have no actual involvement in the disclosure process and, in many cases, do not even know the disclosure has occurred. This is supported by the analysis in the case where the conservative majority simply ignored the day to day control exercised by the advisor with respect to fund activities.
In short, the reliance on the persons with ultimate authority is a test that finds no support in the securities laws or traditional principles of corporate law.