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Wednesday
Jan122011

Will Bad Funds Make Good Law?: Janus v. First Derivative Traders Part IV

The underlying factual allegations in Janus v. First Derivative Traders – that the operators of the Janus mutual funds permitted market timing by a dozen favorite investors  - gave rise to other legal actions. For example, in 2004 Janus Capital Management LLC (“JCM”), a wholly-owned subsidiary of Janus Capital Group, Inc. (“JCG”) paid $100 million to settle with the Securities and Exchange Commission. The proceeds of the $100 million settlement were to be distributed to accounts of investors who owned the 7 mutual funds between 2001 and 2003, for which JCM acted as the investment adviser. This settlement focused on the bad actions of JCM with respect to the Janus mutual fund investors.

This settlement did not provide relief to the stockholders of Janus Capital Group.  It is important to emphasize this point. Instead, it focused on the fund investors -- those "customers" who purchased the products that JCG via JCM produced. However, the order is very instructive and useful given that the SEC holds JCM responsible for false statements it made regarding market timing policies of the Janus mutual funds.

The order also noted that:

“The market timing agreements financially benefited JCM in that JCM realized additional advisory fees from the timed funds and sticky assets under its management . . . JCM had a conflict of interest with the Janus mutual funds subject to the market timing agreements. JCM failed to disclose the conflict of interest to the Board of Trustees and the shareholders of the affected mutual funds, thereby breaching JCM's fiduciary duty to the mutual funds.”

The order also made clear that trading policies were JCM’s policies, created and policed (or ignored) by JCM:

“At the same time JCM entered into and maintained market timing agreements, the prospectuses for the funds being timed stated, or at least strongly implied, that JCM did not permit frequent trading or market timing in these funds. In addition to the prohibitions against market timing contained in its prospectuses, JCM regularly monitored and policed market timing and frequent trading in the Janus funds and took steps to stop such trading when it was identified, including barring shareholders from the funds.”

The SEC identified the federal securities laws violations:

“JCM willfully violated Sections 206(1) and 206(2) of the Advisers Act in that, while acting as an investment adviser, it employed devices, schemes, or artifices to defraud clients or prospective clients, and engaged in transactions, practices, or courses of business which operated or would operate as a fraud or deceit upon clients or prospective clients. Specifically, JCM entered into agreements with the Market Timers, which created a conflict of interest that JCM knowingly or recklessly failed to disclose to the Board of Trustees of the funds, and which were inconsistent with the funds' prospectus disclosures.”

In addition, the order stated that:

“JCM willfully violated Section 34(b) of the Investment Company Act in that it made an untrue statement of material fact in a registration statement, application, report, account, record, or other document filed or transmitted pursuant to the Investment Company Act, or omitted to state therein any fact necessary in order to prevent the statements made therein, in the light of the circumstances under which they were made, from being materially misleading. For example, JCM filed several registration statements with the Commission containing prospectuses that falsely stated or otherwise represented that JCM did not permit frequent trading or market timing in its mutual funds.”

The SEC also declared that:

“JCM, an affiliated person of the timed mutual funds, willfully violated Section 17(d) of the Investment Company Act and Rule 17d-1 thereunder, in that, while acting as a principal, it participated in and effected transactions in connection with joint arrangements in which the funds were participants without filing an application with the Commission and obtaining a Commission order approving the transactions.”

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