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

Janus v. First Derivative Traders was argued December 7, 2010 before the US Supreme Court. The case involves certain purchasers of stock in Janus Capital Group (“JCG”) who watched the JCG stock price (NYSE: JNS) drop by nearly 24% in a matter of weeks. Represented by lead plaintiff, First Derivative Traders, the putative class members believe they bought stock in JCG at inflated prices which deflated upon the public disclosure that the defendants authorized market-timing. Accordingly, the class members seek compensation from JCG and JCM for losses caused by these material misstatements.

Legal Claims

In 2003 and 2004, purchasers of JCG common stock initiated assorted legal actions against JCG. The separate cases were coordinated in the U.S. District Court for the District of Maryland, at Baltimore. First Derivative Traders was named the lead plaintiff. An amended complaint was filed, adding JCM as a defendant and alleging that JCG and JCM are liable for fraud under Section 10(b), of the Securities Exchange Act of 1934 (the “34 Act)” and related SEC Rule 10b-5. In addition, the amended complaint alleges that JCG violated Section 20(a) of the 34 Act as a “controlling person” of JCM.

Under Section 10(b) it is:

“unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange . . . [t]o use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.”

And Rule 10b-5 deems it

“unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange . . . .To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading . . .in connection with the purchase or sale of any security.”

As stated in Stoneridge, citing Dura,  in a private 10(b) action, a plaintiff must prove each of the following:

"(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation."

Section 20(a) provides that:

“Every person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable, unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action.”

District Court Ruling

In February 2006, the District Court granted Petitioners’ motion and dismissed the complaint, but allowed Respondent to file a second amended complaint. The grounds for dismissal had been a defect in the proposed definition of the class. Then, in May 2007, the District Court granted Petitioners’ second motion to dismiss. The Court held that JCG did not violate Section 10(b) because the Court believe that JCG did not “make” the misstatement in the Janus mutual fund prospectuses. The Court did not reach the question of whether JCM made the misstatements, however, and simply dismissed the 10(b) claim against JCM stating there was no nexus between the shareholders of JCG and JCM. In addition, the District Court found that the 20(a) claim against JCG could not survive when there was no viable 10(b) claim against JCM.

Fourth Circuit Ruling

In May of 2009, the Fourth Circuit reversed and remanded. The Court held that a viable claim of primary liability under Section 10(b) had been plead against JCM. In other words in the majority’s view, JCM did indeed “make” the misrepresentations in the Janus mutual fund prospectuses and that these misstatements were about JCM’s own policy on market timing. 

The Court held that: JCM and JCG, “made the statements in question by participating in the preparation of the prospectuses.” In addition, in terms of reliance, the Court held that

”In light of the publicly available material, interested investors would have inferred that if JCM had not itself written the policies in the Janus fund prospectuses regarding market timing, it must at least have approved these statements. This circumstance is sufficient to support the adequacy of plaintiff’s pleading of fraud-on-the- market reliance as to JCM.”

However the majority did not believe the disseminating the prospectuses on the Janus website was sufficient to “infer that interested investors would believe that JCG had prepared or approved the Janus fund prospectuses.”

Regarding the element of loss causation, the Court also held that: “Plaintiffs’ allegations are therefore sufficiently specific to establish that the misleading statements in the prospectuses were a substantial factor in the decline in the value of JCG’s common stock.”

In addition, the Court held that a claim that JCG was a control person of JCM under Section 20(a) was adequately pled. The opinion stated that: 

“allegations of complete ownership of JCM by JCG, overlapping management between JCG and JCM, control of JCM by JCG executives, and presumptive authority by JCG to regulate market timing activity in the Janus funds are sufficient to plead a prima facie case of control person liability.”

In a separate concurrence, Judge Shedd noted he would have held that a claim of primary liability under Section 10(b) against JCG was properly plead.  

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