The thirteenth stroke: an approach to "ultimate authority" after Janus.

Author:Power, Andrew
Position:Janus Capital Group, Inc. v. First Derivative Traders - Authority to make statements in security filings

"For purposes of Rule 10b-5, the maker of a statement is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it."


    In Janus Capital Group, Inc. v. First Derivative Traders, (2) the Supreme Court produced a decision worthy of Janus, the two-faced Roman god whose image appears on Janus Capital's corporate logo. (3) The five-to-four opinion by Justice Thomas, while paying lip service to the private right of action under Rule 10b-5, effectively cut off that right for many plaintiffs. (4) The Court in Janus addressed the question of whether a mutual fund's management could be liable to investors in the fund's parent company for losses tied to misstatements in the fund's prospectuses. (5) Answering in the negative, the Court held only a third group--the fund's independent board of trustees--could have "made" those misstatements under Rule 10b-5. (6) Significantly, the Court concluded only those with "ultimate authority" over a statement are liable for making it--a new Rule 10b-5 standard apparently not limited to the unique structures of mutual fund families. (7)

    And so, in its zeal to extend the limitations of Central Bank of Denver v. First Interstate Bank of Denver (8) eliminating secondary liability for private plaintiffs under Rule 10b-5, the Janus majority provided a roadmap for avoiding primary liability, regardless of culpability. (9) Indeed, the dissent predicted "guilty" management may now be able to launder a false statement through an "innocent" board while avoiding liability for lack of the ultimate authority to make that statement. (10) Janus may have interpreted Rule 10b-5 so narrowly that conceivably no one could be primarily liable for "making" a demonstrably false statement-neither those who wrote it without the necessary authority nor those who approved it without the necessary intent. (11)

    Assuming the Court intended, as it said, to retain Rule 10b-5's private right of action--and assuming Congress, in enacting antifraud legislation, intended someone be held liable for material misstatements in securities filings--this Note recommends interpreting the phrase "ultimate authority," which is inadequately defined in Janus, to mean "ultimate control," a phrase appearing synonymously in the majority opinion. (12) As Justice Thomas reasoned, "[w]ithout control, a person or entity can merely suggest what to say, not 'make' a statement in its own right." (13) While the concept of ultimate authority leaves open the question of who is really responsible for a statement, the concept of ultimate control does not. (14) Ultimately, the legislative intent and policies behind Rule 10b-5 will be served best by a precise definition of its contours. (15)


    Rule 10b-5 is the leading antifraud provision available to investors in securities. (16) The rule states, in relevant part: "It shall be unlawful for any person ... [t]o make any untrue statement of a material fact ... in connection with the purchase or sale of any security." (17) The rule applies to "any person," and one of its prohibited acts is "[t]o make any untrue statement of a material fact." (18) And yet, federal courts have long struggled to develop a consistent definition of what it means to "make" an untrue statement of a material fact under Rule 10b-5. (19)

    Rule 10b-5 was promulgated under section 10(b) of the Securities Exchange Act of 1934. (20) The rule gives the Securities and Exchange Commission (SEC) broad latitude to police fraud in connection with the purchase or sale of securities. (21) Judicially implied in the rule is the right of individuals to enforce its provisions, a private right of action the Supreme Court has deemed essential to the SEC's fraud-fighting mission. (22) The following sections will briefly recount the "peculiar blend of legislative, administrative, and judicial history which now surrounds Rule 10b-5." (23)

    1. Statutory Roots

      Rule 10b-5 originated from the Securities Act of 1933 and the Exchange Act of 1934, which together embody a philosophy of full disclosure and high ethical standards adopted by Congress in response to the 1929 stock market crash and the Great Depression that followed. (24) The Securities Act of 1933 required complete disclosure of material information in the issuance of securities, and created penalties to fight fraud and promote fair dealing. (25) Section 17(a) of the Act, the "grandfather" of all federal antifraud provisions, was a primary source for the language in Rule 10b-5. (26) Section 17(a) makes it unlawful for any seller of securities to employ a scheme to defraud, make materially false statements or omissions, or engage in any fraudulent practices. (27)

      With the Securities Exchange Act of 1934, Congress intended to deter the manipulation of stock prices through regulation and reporting requirements; to that end, Congress created the Securities and Exchange Commission (SEC) and endowed it with flexible enforcement powers. (28) In support of its disclosure and market-regulation mechanisms, the 1934 Act included provisions to combat securities fraud and manipulation. (29) Among the Act's antifraud provisions, section 10(b) makes it unlawful for a person to use a manipulative or deceptive device in connection with the purchase or sale of a security in contravention of SEC rules. (30) Thomas G. Corcoran, one of its principal drafters, described the subsection as "a catch-all clause to prevent manipulative devices." (31) Corcoran summed up the intent of section 10(b)'s drafters as follows: "Thou shalt not devise any other cunning devices." (32)

    2. Writing the Rule

      Rule 10b-5 itself had "modest aims and origins." (33) It was drafted by two SEC attorneys on Monday, May 18, 1942. (34) That morning, Mayer Newfield met his colleague, Milton Freeman, at SEC headquarters in Philadelphia. (35) Newfield had been reviewing monthly reports from the SEC's regional offices and noticed a pattern of apparently fraudulent practices by corporate insiders in the purchase of securities. (36) The SEC's preferred tool for antifraud enforcement, section 17(a) of the 1933 Act, did not work in these cases, because its use was limited to fraud in the sale, not the purchase, of securities. (37) Freeman suggested combining section 17(a) of the 1933 Act with section 10(b) of the 1934 Act to create a new rule that would apply to fraud in both the purchase and sale of securities. (38)

      The Commission met at three o'clock that afternoon, and the proposed Rule X-10B-5 was on the agenda. (39) The presentation lasted about fifteen minutes. (40) Freeman and Newfield appeared before the Commission and "passed a piece of paper around to all the commissioners. All the commissioners read the rule and they tossed it on the table, indicating approval. Nobody said anything except Sumner Pike who said, 'Well,' he said, 'we are against fraud, aren't we?'" (41) The rule took effect on Thursday, May 21, 1942. (42) Based on Freeman's account, the Supreme Court later concluded Rule 10b-5 was "a hastily drafted response to a situation clearly involving intentional misconduct." (43)

    3. The Private Right of Action

      In 1946, a district court judge in Philadelphia implied a private right of action in Rule 10b-5. (44) The decision transformed the rule into something far greater than its drafters intended. (45) In Kardon v. National Gypsum Co., Judge Kirkpatrick gave individuals the right to bring civil suits to enforce Rule 10b-5 under the "deeply ingrained" canon that violation of a statute creates civil liability. (46) For twenty-five years after Kardon, federal courts implied a private right of action into Rule 10b-5, until the Supreme Court confirmed the right in a footnote. (47) Justice Rehnquist famously characterized the expansion of Rule 10b-5 via the private right of action as "a judicial oak which has grown from little more than a legislative acorn." (48) Even Freeman observed, "you have very little to do about what happens to your children when they grow up." (49)

      In the 1960s, the Court applied the rule "not technically and restrictively, but flexibly to effectuate its remedial purposes." (50) By the 1970s, after a period of expansive construction, the pendulum began to swing the other way: The Court expressed concern that the rule was becoming a tool of "vexatious litigation" in the hands of unscrupulous practitioners out to squeeze lucrative settlements from meritless claims. (51) The Court paid particular attention to the private right's potential for nuisance suits, in which companies seeking to avoid discovery or business disruption would pay out disproportionate settlements. (52) In construing Rule 10b-5, the Court began to place greater emphasis on the textual limitations of section 10(b). (53) As a result, the rule's impact in private actions has been limited substantially over the past three decades. (54) Those limitations became even more explicit following Central Bank. (55)


    The importance of distinguishing primary from secondary liability in Rule 10b-5 claims originated in 1994 with Central Bank, which involved a section 10(b) aiding-and-abetting claim. (56) It was to be the last such claim, because the Court, in a five-to-four decision, foreclosed aiding-and-abetting liability in private actions under section 10(b). (57) The Court offered three reasons for its decision. (58) First, the text of section 10(b) does not specifically prohibit aiding and abetting. (59) Second, allowing aiding-and-abetting liability would circumvent the element of reliance required for Rule 10b-5 claims. (60) Third, the Court could find no evidence of congressional intent to impose aiding-and-abetting liability in private actions under section 10(b). (61)

    The Court's 2008 decision in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc. reaffirmed that...

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