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Argument preview: May a party face primary liability under the federal securities laws for alleged misstatements attributed to another party?

Primary liability and a private right of action exists under the federal securities laws against a party who “directly or indirectly. . . make[s] any untrue statement of a material fact.”  In contrast, the Supreme Court has consistently declined  – most recently in Stoneridge Investment Partners, LLC v. Scientific-Atlantic, Inc. (2008) – to find a private right of action against secondary parties for aiding-and-abetting securities fraud committed by a primary violator.  Such aiding-and-abetting claims under the federal securities may be pursued only in enforcement actions by the Securities and Exchange Commission (SEC).

In Janus v. First Derivative Traders (2009), the Fourth Circuit addressed the question of whether a company may have primary liability under the federal securities laws even if the alleged misstatements that are the basis for the violation are explicitly attributed to another company.  The Fourth Circuit answered in the affirmative and reversed the lower court’s dismissal of securities fraud claims against investment adviser Janus Capital Management LLC (JCM) that were based on allegations that it had committed a primary violation of the securities laws by participating in the writing and dissemination of false and misleading prospectuses issued by Janus Funds (the Funds).     Janus filed a petition for certiorari, which the Court granted in June 2010. 

Merits Briefing

Janus makes three primary arguments for reversal of the decision of the Fourth Circuit.  First, it claims that it cannot have primary liability as a matter of law because under the Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A. (1994), it is merely a service provider to Janus Funds; under Central Bank, persons or entities “who provide services” to an issuer in connection with an offering are secondary actors regardless of the nature and extent of those services.  Second, Janus asserts that it did not “make” any misstatement because it is the issuer, rather than any other party, that “makes” the statements in a prospectus as a matter of law (“Just as the President rather than his speechwriters ‘makes’ a speech, an issuer rather than its service providers ‘makes’ the statements in a prospectus.”)  Finally, Janus argues that even if it could be said that it had “made” any of the alleged misstatements, First Derivative has not alleged adequately the required element of reliance because none of the alleged misstatements were directly attributed to it.  

First Derivative counters that the Fourth Circuit found properly that Janus “made” the misstatements based on allegations in the complaint that Janus operates the Funds and, indeed, created and disseminated the alleged misrepresentations in the prospectuses.  Next, First Derivative asserts that no direct attribution is required for a party to face primary liability under the federal securities laws for three reasons.  First, it claims that the Court has never recognized such a requirement and to do so “would contravene congressional policy that promotes honesty and transparency in the Nation’s securities markets.”  Second, it asserts that, in any event, a reasonable investor would attribute the alleged misstatements in the prospectuses to Janus “given the publicly disclosed facts confirming [Janus’s] day-to-day control of the Funds.”  Finally, First Derivative claims that a bright-line requirement of direct attribution for primary liability would “provide a roadmap for unscrupulous companies to commit securities fraud” by creating a shell company and creating and disseminating misrepresentations in the shell corporation’s name. 

The United States Weighs In

At the Court’s invitation, the United States filed a brief in which it supports First Derivative but suggests a narrower basis for primary liability.

The United States focuses on the unique relationship between a mutual fund and its adviser and emphasizes First Derivative’s allegation below that Janus was responsible for the “day-to-day” management of the Funds to whom the misstatements were attributed.  In doing so, the United States contrasted allegations regarding the unique role played by Janus – which, it contends, makes Janus essentially a corporate insider – from that of typical “service providers” such as accountants, law firms and banks.  Finally, while asserting that First Derivative had successfully pleaded a claim for primary liability against Janus, the United States acknowledges that, “[b]ecause the typical outside service provider (such as a law firm or accountant) is not responsible for the ‘day-to-day’ management’ of the clients it advises, a claim that the outside provider ‘made’ a statement issued in the company’s name might require more particularized factual allegations regarding the provider’s role in the statement’s drafting and dissemination.”

Potential Significance

The Court’s decision could carry potentially great significance to all parties that play a role in preparation of the corporate documents, including accountants, lawyers and bankers.   If affirmed, the ruling below could open the door for creative securities plaintiffs to assert primary liability against a host of such secondary actors based on allegations that they share responsibility for alleged misstatements based on their participation in the drafting and dissemination of documents notwithstanding the fact that the documents and alleged misstatements remain explicitly attributed to the issuing party.

Recommended Citation: Steven Kaufhold, Argument preview: May a party face primary liability under the federal securities laws for alleged misstatements attributed to another party?, SCOTUSblog (Dec. 5, 2010, 9:00 AM),