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

At oral argument in the Janus case, Justice Ruth Bader Ginsburg placed Janus Capital Management LLC (“JCM”) in the “driver’s seat” for purposes of primary liability under Section 10(b) of the Securities Exchange Act. Shortly thereafter, Justice Antonin Scalia put David Frederick, counsel for Respondent in the hot seat.

Before he completed a sentence or two, Frederick faced immediate challenges from Justice Scalia. Scalia inquired whether Frederick agreed with the phrasing of the legal question before the Court. Frederick postured that the question presented was not an accurate description of the 4th Circuit holding. In other words, Frederick insisted that: “this case is not about service providers, but it is about Janus Capital Management being the primary violator. They were the ones who had the motive to lie, they had the incentive to lie, and they did lie.”

Did JCM “Make” the Misstatements or is JCM a Mere “Speech Writer”?

Scalia closely questioned Frederick, asserting that JCM did not “make” the misstatements about market-timing, but was like a speech writer.  “If someone writes a speech for me,” the Justice began, “one can say he drafted the speech, but I make the speech.” Scalia observed that whether the statement was deceptive is a separate question from who made it.

Frederick defended this view by explaining that through the funds prospectus, “it is absolutely clear that what Janus Capital Management is telling all of the mutual fund investors of the world: If you invest in Janus, we will protect your long-term investments.”

Scalia disagreed, contending that JCM had not made any representation to the public, and that the cause of action here would be by the mutual funds (the business trusts) against JCM.

Is JCM an “Issuer” or a Mere “Courier?”

Chief Justice Roberts asked Frederick, who “issued” the mutual fund prospectuses? Frederick responded by stating that JCM had “disseminated it on the web site” and that investors knew to inquire of JCM with any questions about the funds.  Justice Scalia, however, likened this to an agent carrying a letter and filing it on behalf of a principal. Scalia insisted that JCM did not file on its own behalf.

Frederick disagreed, reminding Scalia that “That's how mutual funds work. Managers create them, they lure investors to them, they get money by having a percentage of assets under management.”

Lying about a Product

Frederick shared the Respondent’s view:

“What we're talking about here is a company with a product, and they lie about the product. And in that instance, it's no different from the Vioxx case last year with Merck or the difference from the cold remedy case you are going to hear argument in next term. The mutual funds happen to be the product of the company. They make misstatements about the product.” 

Back to the Oil Company: Primary Violator or Aider and Abettor?

Justice Breyer returned to the oil company hypothetical. And challenged Frederick to explain why JCM is more like the manager of the oil company than an outside lawyer. He noted that in contrast to actions brought by private litigants, in SEC enforcement proceedings, only “substantial assistance” must be shown to establish aiding and abetting liability. However, Frederick agreed that there does not need to be aiding and abetting liability under Section 10(b) in order for Respondents to prevail. The pleading, in his view, was sufficient to establish primary liability by JCM.

Sotomayor was skeptical that if the “puppet” was not duped, but instead complicit, whether JCM can be a primary violator. Alito pushed Frederick to articulate a distinction between a principal from an aider and abettor. Frederick said the distinction was who has “substantive control.” 

Scalia picked up on that and said couldn’t the funds themselves exercise control. Scalia insisted that the funds had substantive control.  Frederick disagreed, and said if the funds had had substantive control, they would not have allowed the statement to be made.

Kennedy appeared to be siding with Petitioners when he insisted that “there is nothing in the record to indicate that that statement was attributed to JCM.”

No Relief for Stockholders

During rebuttal, counsel for Petitioners was asked by Justice Kagan:

“Mr. Perry, on the allegations of this complaint, these plaintiffs were harmed by the misrepresentations, the alleged misrepresentations from JCM to the fund. So if the fund was duped, would these shareholders, JCM’s shareholders, have any relief?” 

Perry responded, “These shareholders – JCG’s shareholders have no relief.”


Ideally, what Supreme Court Justices will consider in Janus is the unique nature of mutual fund operations. They hopefully will appreciate how a particular mutual fund is created and controlled by its investment adviser.  With this background, the Court might focus on the question of whether a entity acting as an investment manager (with near total dominion over the operations) of a mutual fund (that has no or few independent employees of its own) can avoid securities fraud actions brought by its own shareholders if it causes that mutual fund to make public misstatements.  

Another way to pose the question would be whether a corporation can immunize itself from private securities fraud claims by making statements about its own products and services through a separate trust that it controls.

As stated so well in the Brief by Professors William A. Birdthistle, Tamar Frankel, Lyman P.Q. Johnson, Donald C. Langevoort, and Manning G. Warren III as Amici Curiae in Support of Respondent:

“The scope of petitioners’ Janus-faced, heads-I- win-tails-you-lose theory may apply at present only to the unique structure of mutual funds, but success before this Court would furnish a blueprint for wide- spread impunity from securities violations. Any corporation that publicly claims to police the quality of its products while surreptitiously soliciting douceurs to compromise that quality – as an investment manager does in a market-timing fraud – would receive a tutorial on how to evade legal liability. Following petitioners’ example, such perpetrators would need only to replicate the structure of mutual funds by forming ‘another,’ ‘different’  .  . .  and judgment- proof entity to furnish – via contract – all management functions externally.”

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