The currently mandated myopia of Rule 10b-5: pay no attention to that manager behind the mutual fund curtain.

• Author: Kibble, Kelly S.
• Position: Continuation of III. The Turnabout Trilogy C. Janus 2. The Decision through VII. Conclusion, with footnotes, p. 205-241

Rejecting the Government's contention that "make" should be interpreted as "create[,]" (189) the majority continued its abstruse analysis:

The Government contends that "make" should be defined as "create." Brief for United States as Amicus Curiae 14-15 (citing Webster's New International Dictionary 1485 (2d ed. 1958) (defining "make" as "[t]o cause to exist, appear, or occur")). This definition, although perhaps appropriate when "make" is directed at an object unassociated with a verb (e.g., "to make a chair"), fails to capture its meaning when directed at an object expressing the action of a verb. (190) The majority's curt dismissal of the SEC's interpretation of its own rule (191) is mystifying and is in contradiction to the deference given the SEC by the New Deal Court. (192)

In his dissent, Justice Breyer countered:

But where can the majority find legal support for the rule that it enunciates? The English language does not impose upon the word "make" boundaries of the kind the majority finds determinative. Every day, hosts of corporate officials make statements with content that more senior officials or the board of directors have "ultimate authority" to control. So do cabinet officials make statements about matters that the Constitution places within the ultimate authority of the President. So do thousands, perhaps millions, of other employees make statements that, as to content, form, or timing, are subject to the control of another. Nothing in the English language prevents one from saying that several different individuals, separately or together, "make" a statement that each has a hand in producing. (193) In a logical leap, the Court opined that Central Bank's ban on private aiding and abetting liability under Rule 10b-5 required its ruling adopting the "ultimate authority" test. (194) Drawing "a clean line" between those who are primarily liable and those who are secondarily liable, the Court held that "the maker is the person or entity with ultimate authority over a statement and others are not." (195) Thus, according to the majority's test, only those with "ultimate authority" can be held primarily liable under Rule 10b-5 as the "maker" of a statement.

The dissent, emphasizing Central Bank's secondary liability subject matter, countered that Central Bank "no more requires the majority's rule than free air travel for small children requires free air travel for adults." (196) Rather, the dissent viewed Central Bank as dealing with aiding and abetting liability with respect to those who did "not engage in the proscribed activities at all, but who gave a degree of aid" to those who did. (197) Further, it concluded that Central Bank supports the proposition that, under the right circumstances, numerous parties involved in the development of a prospectus might "make" materially false statements that would invoke primary liability. (198) The dissent highlighted the majority's cautionary language in Central Bank that it did

... "not mean that secondary actors in the securities markets are always free from liability under the securities Acts. Any person or entity, including a lawyer, accountant, or bank, who employs a manipulative device or makes a material misstatement (or omission) on which a purchaser or seller of securities relies may be liable as a primary violator under 10b-5, assuming all of the requirements for primary liability under Rule 10b-5 are met." (199)

The majority and dissenting opinions also diverged in their interpretations of Stoneridge. Emphasizing Stoneridge's holding that "nothing [the defendants] did made it necessary or inevitable for [the company] to record the transactions as it did[,]" (200) the majority opined that, likewise, nothing that Adviser did "made it necessary or inevitable" for Fund to include the market timing misstatements in its prospectuses. The majority saw "no reason to treat participating in the drafting of a false statement differently from engaging in deceptive transactions [as in Stoneridge], when each is merely an undisclosed act preceding the decision of an independent entity to make a public statement." (201) As discussed below, this is a misunderstanding of the facts alleged by First Derivative and the realities of mutual fund prospectus preparation. (202)

The dissent countered that the Stoneridge Court "did not deny that the equipment suppliers had made the false statements contained in the letters, contracts, and conversations", but rather ruled that there was not '"the requisite proximate relation to the investors' harm.'" (203) Further, the dissent clarified that the Stoneridge decision was based on a lack of reliance on the false statements made by the suppliers, and that the suppliers' fraudulent conduct "'took place in the marketplace for goods and services, not in the investment sphere.'" (204) As such, the dissent's bewilderment regarding the majority's assertion that Stoneridge supported its ruling (205) was well-founded.

In response to the assertions by First Derivative and its amici that an investment adviser is generally understood to be the "maker" of statements by a mutual fund, (206) the majority opined in a terse, cavalier manner: "We decline this invitation to disregard the corporate form." (207) The majority simply de dined to participate in a more mature analysis of the complex issues presented, stating, "Any reapportionment of liability in the securities industry in light of the close relationship between investment advisers and mutual funds is properly the responsibility of Congress and not the courts." (208)

In contrast, the dissent viewed other cases as supporting the consideration of the close relationship between advisors and mutual funds. Rejecting the majority's "ultimate authority" test, the dissent listed a long line of cases holding that, under certain circumstances, corporate officials and others can be liable under Rule 10b-5 for having made a materially false statement that appears in a document or is made by a third person who is not legally controlled by such officials. (209) The dissent also cited a string of cases holding that corporate officials may be liable for making false statements where they use innocent parties as conduits to the public (even where such statements are not attributed to such corporate officials). (210) The dissent concluded:

In sum, I can find nothing in [section] 10(b) or in Rule 10b-5, its language, its history, or in precedent suggesting that Congress, in enacting the securities laws, intended a loophole of the kind that the majority's rule may well create. .... ... The relationship between ... [Adviser] and ... [Fund] could hardly have been closer.... [Adviser's] involvement in preparing and writing the relevant statements could hardly have been greater. And there is a serious suggestion that the board itself knew little or nothing about the falsity of what was said.... Unless we adopt a formal rule (as the majority here has done) that would arbitrarily exclude from the scope of the word "make" those who manage a firm--even when those managers perpetrate a fraud through an unknowing intermediary--the management company at issue here falls within that scope. We should hold the allegations in the complaint in this respect legally sufficient. (211) Finally, the majority considered First Derivative's arguments in light of [section]20(a) of the 1934 Act. It viewed the theory of liability proposed by First Derivative as resembling but "broader in application than" control person liability under [section]20(a) of the 1934 Act, (212) which, as discussed above, establishes liability for persons that directly or indirectly control violators of the securities laws. The majority refused to expand on the liability expressly created by Congress in [section]20. The dissent disagreed, noting that the "possibility of an express remedy under the securities laws does not preclude a claim under [section] 10(b)." (214) Critically, the dissent emphasized that, if an actor exploited an innocent intermediary, [section]20(a), which requires primary liability by the controlled party, would not apply. (215) Further, the dissent emphasized that it was quite possible that Fund's board of trustees knew nothing about the misstatements in the prospectuses, in which case, [section] 20(a) would be inapplicable: (216)

The possibility of guilty management and innocent board is the 13th stroke of the new rule's clock. What is to happen when guilty management writes a prospectus (for the board) containing materially false statements and fool both board and public into believing they are true? Apparently under the majority's rule, in such circumstances no one could be found to have "ma[d]e" a materially false statement--even though under the common law the managers would likely have been guilty or liable (in analogous circumstances) for doing so as principals (and not as aiders and abettors). (217) In such circumstances, under the majority's rule, the dissent cautioned that even the SEC might be prohibited from asserting primary liability or aiding and abetting liability. (218) Paving the way for the next prominent case in securities fraud law, the Court reserved the issue of whether Congress had created liability for entities acting through innocent intermediaries in [section] 20(b). (219)

Although the Janus Court intended to create a workable, bright line test regarding Rule 10b-5 liability, the decision has confounded scholars, practitioners and judges since it was penned. Part IV explores why the decision is particularly impractical in the mutual fund context, and Part V summarizes the resulting confusion in the lower courts.

IV. THE PRACTICAL REALITIES AND DOCTRINAL FOUNDATIONS OF THE MUTUAL FUND/ ADVISER RELATIONSHIP

As noted above, the Janus decision precipitated a barrage of criticism from scholars and practitioners. (220) A New York Times Editorial stated:

Justice Thomas's opinion is short and, from the...