Janus Capital Group: how 'making' a statement leads to insulation from liability.

• Author: Talia, Colin

1. INTRODUCTION II. BACKGROUND A. Section 10(b) and Rule 10b-5 B. Central Bank of Denver v. First Interstate Bank of Denver C. Stoneridge Investment Partners v. Scientific-Atlanta D. Janus Capital Group v. First Derivative Traders E. The Supreme Court's Rationale as to Why JCM Did Not "Make" the Misleading Statement III. ANALYSIS A. Why JCM Did in Fact "Make" the Prospectuses B. Supporters of the Janus Decision and How a Sophisticated Company Can Take Advantage of the Court's Decision at the Expense of Investors 1. Supporters of the Janus Decision 2. Purposes of the Federal Securities Laws 3. The Holding of Janus May Encourage a Company to Separate Corporate Formalities to Avoid Liability Under Rule 10b-5 IV. RECOMMENDATION A. Congress Should Enact Legislation that Holds Entities Liable for Aiding and Abetting Under Rule 10b-5 B. Policy Arguments Made by Supporters and Opponents of Congress Enacting Legislation to Allow for a Private Cause of Action Under Rule 10b-5 1. There Is No Need to Fear an Increase in Meritless Litigation 2. The SEC Cannot Adequately Patrol Violations of Securities Fraud on Its Own 3. Any Legislation Enacted by Congress to Hold Entities Liable for Aiding and Abetting Would Help Deter Fraud V. CONCLUSION I. INTRODUCTION

   In the fall of 2001, the collapse of Enron Corporation shook the American stock market to its core. The once renowned energy and securities company completed a stunning collapse, fueled by management fraud and deceit, on December 2, 2001, by filing for bankruptcy. (1) In February 2001, newly appointed CEO Jeffrey skilling bragged to analysts that Enron stock should be trading at around $126 per share. (2) Just days before filing for bankruptcy, however, the stock closed for the last time at a mere 260 per share. (3)

   It was only after Enron's collapse that the extent of fraud and deceit among Enron's management became fully known to the public. (4) For years, Enron misled the public about the financial state of the company, inflating its financial statements to reveal a company with healthy profits and excess cash on hand. (5) In reality, however, Enron bled billions of dollars in liabilities, which its financial statements did not reflect. (6)

   In 2002, Enron shareholders filed suit against dozens of Enron executives, several prominent banks, and a few notable law firms. (7) The banks included J.P. Morgan Chase, Citigroup, and Merrill Lynch; (8) the law firms included Vinson and Elkins, and Kirkland and Ellis. (9) The financial institutions named in the complaint allegedly helped Enron set up secretly controlled partnerships, disguise loans via offshore companies, and sell overvalued Enron assets. (10) This activity allowed Enron to shift billions of dollars off of its balance sheets, creating an artificial stock price, and ultimately misleading investors. (11)

   The complaint alleged that the law firms helped issue false legal opinions, helped structure non-arm's length transactions, and helped Enron in its preparation of submitting false documents to the Securities and Exchange Commission (SEC). (12) Aside from helping Enron inflate its balance sheets, the banks, as underwriters of Enron securities, misled the public by approving incomplete or incorrect company statements. (13) The banks also engaged in complex financial maneuvers on behalf of Enron, intending to increase the value of Enron stock. (14)

   Ultimately, the shareholders in the suit did not prevail, with the Fifth Circuit not allowing securities fraud claims to extend to secondary actors who did not make any misrepresentations or omissions. (15) The Enron scandal influenced Congress to enact the Sarbanes-Oxley Act in 2002. (16) The collapse of Enron, although an extreme example, highlights the enormous impact securities fraud can have on investors and individuals.

   "Securities fraud" is an umbrella term for several causes of action, some of which are forms of core fraud and some of which are forms of misrepresentation. (17) The laws of securities fraud are extremely broad despite the amount of statutes and rules that govern them. (18) There are mainly three types of actions that can arise as a result of securities fraud: private lawsuits, SEC actions, and criminal prosecutions. (19) Of the three, this Note focuses on private actions.

   Part II of this Note discusses section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, which allows investors to recover from fraudulent actors in securities markets. Part II also discusses the United States Supreme Court decisions in Central Bank of Denver v. First Interstate Bank of Denver, Stoneridge Investment Partners v. Scientific-Atlanta, and Janus Capital Group v. First Derivate Traders. The cases deal with investors and their ability to hold primary and secondary actors liable for violations of section 10(b) via private causes of action. Finally, Part II discusses the decision of the Court in Janus and explains in detail why the Court decided Janus Capital Management (JCM) did not "make" the statement First Derivate Traders relied on.

   Part III begins by explaining why, despite the Court's holding otherwise, JCM for all intents and purposes did, in fact, make the misstatements that First Derivate Traders relied on. Part III provides an overview and explanation of the regulatory structure of mutual funds (although not central to the Note itself, an explanation of mutual funds is necessary to understand why Janus Capital Group did "make" the statements that caused the suit). Part III also identifies the supporters of the Janus decision and discusses the mechanics of how a sophisticated company may be able to take advantage of the Court's holding in Janus at the expense of investors.

   Part IV offers a recommendation that Congress enact legislation allowing a private cause of action to hold third parties liable for aiding and abetting under Rule 10b-5. There are both supporters and opponents of this type of legislation, and Part IV also addresses the policy arguments made in support of and in opposition to this type of legislation. Part IV then attempts to undermine the arguments of those that are in opposition to such legislation. Lastly, Part IV argues that Congress should ignore the critics and enact laws allowing a private cause of action for aiding and abetting because it will help deter fraud. Part V offers a brief conclusion.

2. BACKGROUND

   The stock market crash of 1929 and the ensuing depression are generally credited as the driving factors in Congress's decision to provide for federal securities legislation. (20) The first securities act Congress created was the Securities Act of 1933. (21) However, this Note largely references the Securities Exchange Act of 1934 (Exchange Act). (22) The primary goal of the Exchange Act "was to regulate the post-distribution trading of securities, including providing continuing information about issuers whose securities are traded in public marketplaces." (23) Furthermore, it provides remedies for fraudulent securities trading, manipulation of the securities markets, regulations pertaining to "insider trading" transactions, and regulation of the securities markets. (24) Certain rules within the Exchange Act, such as Rule 10b-5, do not provide guidance for the courts, and accordingly, case law has further developed those rules. (25)

   1. Section 10(b) and Rule 10b-5

      "Section 10(b) proscribes, generally, any manipulation or deception intended to mislead investors in the course of a securities offering." (26) "Pursuant to the statute, the [SEC] promulgated Rule 10b-5(b), a general anti-fraud [statute] prohibiting, in relevant part, the making of untrue statements and material omissions in regard to material facts." (27) A private Rule 10b-5 complaint consists of six requisite elements. (28) The main concern of this Note is the element that a defendant "make[s]" a misrepresentation to investors. (29)

      It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce ... 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. (30) Another important element of a 10b-5 complaint is the requirement that the plaintiff rely upon the misrepresentation. (31) There was little statutory guidance as to who could bring a private cause of action under section 10(b) and Rule 10b-5. (32) A significant development in this area of the law occurred in the last 20 years due in large part to three United States Supreme Court cases. (33)

   2. Central Bank of Denver v. First Interstate Bank of Denver

      For approximately 60 years following the enactment of section 10(b) and Rule 10b5, federal courts consistently recognized a private cause of action against defendants who themselves made material misstatements or omissions (primary actors), and also against defendants who aided and abetted such material misstatements or omissions (secondary actors) under section 10(b) of the Exchange Act. (34) Although neither section contains a provision that explicitly provides for a private cause of action, the United States Supreme Court has implicitly recognized such a right. (35) However, the decision of the Court in Central Bank marked an end to the Court recognizing a private cause of action for aiding and abetting under section 10(b). (36)

      The dispute in the case arose from bond offerings issued by the Colorado Spring-Stetson Hill Public Building Authority (Authority) in 1986 and 1988. (37) Central Bank served as the indenture trustee for the bond issues. (38) Landowner assessment liens secured the bonds, with the bond covenants requiring that the land subject to the liens be worth at least 160% of the bonds' outstanding principal and interest. (39) There were two offerings, and no...