In Janus Capital Group, Inc. v. First Derivative Traders, (1) the Supreme Court held that even if a mutual fund advisory firm had caused a lie about its late trading and market timing policies to appear in a prospectus issued by a mutual fund that it managed, it did not make a misrepresentation within the meaning of Rule 10b-5 because the prospectus in which the lie appeared was filed by and in the name of the mutual fund, not the adviser. According to the Court, the word "make" in Rule 10b-5 refers only to a statement by the person with ultimate legal authority over the filing and public dissemination of the document. (2) In so holding, Justice Clarence Thomas and the rest of the majority joined a seemingly short list of judges who suggest that legal formalism is a particularly good weapon with which to fight securities fraud.
To some, Janus may be just another float in the current Court's tiresome pro-business parade, one that celebrates the Court's contempt for securities class actions. But that impression may be unfair. Janus was one of three securities class action cases decided in 2011, the other two of which held for the plaintiffs in ways that disappointed those on the defense side. Matrixx Initiatives Inc. v. Siracusano, (3) for instance, passed on an opportunity to rein in the otherwise fact-intensive approach to materiality on which defense motions to dismiss often stumble, and applied the heightened pleading requirement for scienter fairly liberally.
Janus's punch line is the "ultimate authority" test, but its defining image is the distinction between a speaker and a speechwriter (4): Only the speaker, according to the Court, can reasonably be deemed the maker of any misrepresentation contained in the speech. Even if all the ideas, and even the exact language--including any deliberate deception--come from the speechwriter, she does not "make" the speech and thus is not primarily liable for the fraud. (5) That means that we might well have deliberately deceptive speech with no liability at all under Rule 10b-5. The speaker does not know of or recklessly disregard the fraud, and thus has no scienter. The person acting with scienter is not the maker. So far as Rule 10b-5 is concerned, we can have lies without liars. (6)
This disconnect surely frustrates any purposive effort to fight securities fraud. There is nothing in the language or history of Rule 10b-5, a straightforward prohibition against securities fraud, to suggest that the SEC intended for its words to be limited so that the person or entity with the greatest causal responsibility for a misrepresentation or actionable omission escapes its reach. Janus leaves legal scholars and practicing lawyers to explain how the majority so confidently came to the conclusion that Rule 10b-5 means otherwise.
Besides the purely political account noted earlier, a common explanation is that the Court simply failed to appreciate the unfortunate consequences of its rigid ruling, especially in the mutual fund context] My argument is entirely different. (8) The Janus opinion is a text woven from many different threads, including many made by the skilled appellate advocates who represented the business interests and knew particularly well how to resonate with the current Justices. (9) Understanding the Court's opinion requires that we willingly enter into the interpretive milieu of conservative public law jurisprudence. While the rough outlines of conservative thinking--textualism and strict interpretation--are familiar enough to most securities lawyers and academics, its nuances tend to be of little interest. Those who work entirely in the "private law" domain of corporate-securities law instinctively evaluate legal issues in terms of instrumental outcomes, asking what is best in terms of protecting investors, capital formation or some form of economic efficiency. Conservatism in this domain reflects the law and economics legacy that has influenced this field for the last three decades, with its strong preference for private ordering. (10) Ideologically heated disagreements often arise about the law's proper scope, but these remain debates ultimately about strategy. This instrumentalist form of conservatism is amply visible in recent case law interpreting Rule 10b-5. There are repeated references to unnecessary litigation and preserving the competitiveness of American business, which infuriates those who instinctively look to the courts to help advance the cause of investor protection.
By contrast, Janus comes from an entirely different vision of legal analysis, where simply being against fraud is not enough. Genuine conservative interpretivism can be deliberately indifferent to policy effects; even seemingly absurd consequences may not necessarily be a reason to depart from a faithfully text-driven reading of a statute or rule. (11) This philosophy is about respecting strict separation of powers, appreciating the complexities of law-making, and preserving individual freedom and autonomy (economic and otherwise) absent legitimate governmental intervention. (12) My aim here is not to take on any of the myriad contemporary public law debates about textualism as applied to administrative agency rulemaking, but instead simply to suggest that understanding decisions like Janus requires a different lens than the one securities academics and litigators normally use. By taking the conservative view more seriously, we might better understand how and why the case law has come to be as it is, and perhaps more importantly, anticipate other issues that are currently taken for granted but might similarly be contested.
To this end, Part I analyzes Janus's interpretive methodology, arguing that it is more persuasive even within a faithfully conservative textualist framework if read as addressing only the implied private fight of action under Rule 10b-5, not SEC enforcement proceedings or criminal prosecutions. Part II then traces the route to Janus in terms of precedent--both the more recent cases defining secondary liability and the early battles over the text of the "in connection with" requirement under Rule 10b-5. It claims that there are underappreciated historical links between secondary liability and the "in connection with" language, and that Janus is likely to prompt a reexamination of the scope of that language, too, at least as applied in private litigation. Part III surveys the open questions that are being litigated after Janus, such as how to address liability where there is no obvious sense of "authority" over more informal corporate publicity, what scheme liability means apart from making particular misstatements, and how to address cases where the deception was not directly aimed at investors but instead targeted at other parties, such as auditors or independent directors on an audit committee. Part IV offers a brief conclusion.
READING JANUS CAREFULLY
The question presented in Janus was whether Janus Capital Management (JCM), an investment advisor, "made" a misrepresentation about the market timing and late trading policy that appeared in prospectuses issued and filed by Janus Investment Fund (JIF), which JCM was advising. (13) Given that phrasing of the question, one would think that the lawsuit here was being brought by JIF investors who said they relied to their detriment on the falsity. (14) Instead, and essential to a critical reading of the opinion, this was a "fraud-on-the-market" class action brought by investors in a separate legal entity, Janus Capital Group (JCG), JCM's publicly-traded parent company, after JCM was sanctioned by federal and state authorities for breach of fiduciary duty in the well-publicized market timing scandals of the mid-2000s. (15) The penalties and attendant reputational damage from its subsidiary's behavior caused JCG's stock price to drop, for which the class-period purchasers wanted compensation. (16)
Plaintiffs' claim was based on the failure by JCG to reveal JCM's misconduct and the threat that it posed. Yet under the securities laws, there is no automatic duty to reveal cheating or other fiduciary breaches simply because of their materiality. (17) So, the plaintiffs had to look for affirmative misstatements that might have been made materially misleading by the omission of the cheating. The plaintiffs came up empty with respect to JCG's own public disclosures, but did find what they believed were misleading statements in the JIF prospectuses. (18)
The core of plaintiffs' fraud-on-the-market argument was that what was stated in JIF's mutual fund prospectuses distorted the market price of JCG securities. This was something of a stretch. To be sure, if the prospectus had revealed JCM's inclination to allow market timing by favored fund investors, there might have been unfavorable publicity and an adverse price effect. But since neither JIF nor JCM had an explicit duty to reveal these intentions, liability could have been avoided simply by silence or vagueness. Plaintiffs were thus fortunate to find something in a document for which they were not the intended beneficiaries--otherwise they would have had no case under Rule 10b-5, even assuming the market timing misbehavior occurred. The Janus Court likely sensed that there was some overreaching by the plaintiffs, which could well have affected how it viewed the ultimate question of who "made" the statements in the JIF disclosures. This was hardly the ideal factual scenario, from the perspective of the plaintiffs' bar, for testing the limits of primary liability.
In other work, I have stressed that the presumption of reliance that supports the fraud-on-the-market theory is an entitlement--an act of juristic grace (19)--afforded to investors in order to promote the truth-telling goals of the securities laws. But any such entitlement goes only as far as courts think is necessary or just. One can easily see how the Court might doubt both the necessity and...