Supreme Court Limits the Meaning of "Making" a Statement Under Rule 10b-5 of the Securities Exchange Act

On June 13, 2011, the United States Supreme Court issued a 5-4 decision in Janus Capital Group, Inc. v. First Derivative Traders, holding that "the maker of a statement" under Rule 10b-5 of the Securities Exchange Act of 1934 is limited to "the person or entity with ultimate authority over the statement including its content and whether and how to communicate it." The Court's definition is narrow in scope, adopting a bright line test that specifically excludes "[o]ne who prepares or publishes a statement on behalf of another." Justice Thomas authored the Court's opinion and Justice Breyer wrote the dissent.

The Janus Litigation

Janus Capital Group ("JCG"), a publicly traded company, created and operates a family of mutual funds that is organized as a trust and is known as the Janus Investment Fund (the "Fund"). The Fund is a separate legal entity that is owned entirely by mutual fund investors. JCG's wholly owned subsidiary, Janus Capital Management ("JCM"), is an investment adviser that manages and administers the Fund. A group of investors sued JCG and JCM, under Rule 10b-5, for knowingly making material false or misleading statements in prospectuses issued by the Fund.

The Fund issued prospectuses describing the investment strategy and operations of its constituent mutual funds. The prospectuses contained statements about implementing strategies to curb a trading strategy known as "market timing," which concerns a time delay in daily valuation of mutual fund shares. For example, one prospectus stated that the fund is "not intended for market timing" and "may reject any purchase request . . . attributable to market timing."

In 2003, New York's attorney general filed a complaint, alleging that JCG had entered into secret arrangements that permitted market timing in several funds administered by JCM. When these allegations became public, investors withdrew significant amounts of money from the Fund's mutual funds and the losses caused a 25% drop in JCG's stock price as well.

First Derivative Traders ("First Derivative") then brought a securities fraud action against JCG and JCM on behalf of JCG shareholders. First Derivative alleged, under Rule 10b-5 of the Exchange Act, that JCG and JCM "caused mutual fund prospectuses to be issued for Janus mutual funds and made them available to the investing public, which created the misleading impression that [JCG and JCM] would implement measures to curb market timing in the Janus [mutual funds]." The complaint also alleged that JCG should be held liable as a "control person" for JCM's acts pursuant to Section 20(a) of the Exchange Act.

Although the District Court dismissed the complaint for failure to state a claim, that decision was reversed by the United States Court of Appeals for the Fourth Circuit. It held that the allegations were sufficient because "JCG and JCM, by participating in the writing and dissemination of the prospectuses, made the misleading contained in the documents." In re Mutual Funds Inv. Litigation, 566 F.3d 111, 121 (2009) (emphasis in original). The Supreme Court granted certiorari to determine whether JCM could be liable in a private action under Rule 10b-5 for making false statements included in the Fund's prospectuses.

The Supreme Court's Opinion

Rule 10b-5 provides in principal part that: "It shall be unlawful for any person, directly or indirectly . . . 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." The Supreme Court ruled that the "maker of a statement" subject to liability under Rule 10b-5 is only "the person or entity with ultimate authority over the statement."

The majority opinion explained that the term "to make a statement" means the same thing as "to state." It reasoned, based on dictionary definitions, that "[w]hen 'make' is paired with a noun expressing the action of a verb, the resulting phrase is 'approximately equivalent in sense' to that verb." As a consequence, the "maker" of a statement can only be the one controlling the statement "including its content and whether and how to communicate it."

According to the majority, others can make suggestions about the statement, but if those persons or entities do not "control" the statement, they cannot be said to have "made" it. Thus, the Court determined that "[o]ne who prepares or publishes a statement on behalf of another is not a maker." It reasoned by analogy to the relationship between a speechwriter and a speaker. "Even when a speechwriter drafts a speech, the content is entirely within the control of the person who delivers it. And it is the speaker who takes credit – or blame – for what is ultimately said."

The majority emphasized that private 10b-5 actions are not explicitly authorized by the Exchange Act but are implied and an "implied private right of action" should be "accord[ed] . . . narrow scope." Consistent with this principle, therefore, the Court declared that "we will not expand [10b-5] liability beyond the person or entity that ultimately has authority over the false statement."

The majority also rooted its holding in two prior supreme court opinions, Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994) and Stoneridge Investment Partners LLC v. Scientific-Atlanta, Inc., 552 U.S. 148 (2008). In Central Bank, the Supreme Court held that private 10b-5 actions cannot be brought against aiders and abettors. In Stoneridge, a company's customers and suppliers, who entered into deceptive arrangements facilitating the company's financial misstatements, could not be sued for the misstatements.

The majority rejected arguments made by the United States as Amicus Curiae that the term "make" in Rule 10b-5 should be defined as "create." First, the Court explained that defining "make" as "create" would only be "appropriate when 'make' is directed at an object unassociated with a verb (e.g. 'to make a chair')" but does not "capture its meaning when directed at an object expressing the action of a verb."

Second, defining "make" as "create" would extend private 10b-5 liability to persons who provide false or misleading information that others put into the statements. The majority considered such expansion of liability to be inconsistent with Stoneridge in which liability was not extended to companies that engaged in deceptive practices even though the deceptive information was later incorporated into the false public statements. As the Court explained, "[w]e see no reason to treat participating in the drafting of a false statement differently from engaging in deceptive transactions, when each is merely an undisclosed act preceding the decision of an independent entity to make a public statement."

Finally, the Court refused to disregard corporate formalities even though there is a close relationship between a mutual fund and its investment adviser.

The Dissent

The dissent disagreed with the Court's holding both in terms of the textual analysis and the understanding of precedent. The dissent stated: "Neither common English nor this Court's earlier cases limit the scope of th[e] word ['make'] to those with 'ultimate authority' over a statement's content."

Unlike the majority's reliance on grammar and dictionary definitions of the term "make," the dissent focused on the practicalities and context of its common usage. The dissent wrote: "Every day, hosts of corporate officials make statements with content that more senior officials or the board of directors have 'ultimate authority' to control." Depending upon context, the dissent explained, "several different individuals, separately or together, [can] 'make' a statement that each has a hand in producing."

According to the dissent, Central Bank is inapposite because it addresses whether "secondary liability" exists for private 10b-5 claims and not the scope of "primary liability." That is, Central Bank is a case about "liability attaching, not to an individual making a false statement, but to an individual helping someone else do so." In contrast, the Janus litigation "is about primary liability – about individuals who allegedly themselves 'make' material false statements, not about those who help others to do so."

The dissent also criticized the majority's reliance on Stoneridge because the issue in that case was not about whether false statements had been made. Rather, Stoneridge concerned whether a "deceptive statement . . . was not actionable because it did not have the requisite proximate relation to the investors' harm." Stoneridge, 522 U.S. at 158-59.

The dissent determined that JCM could be the maker of misstatements in the prospectuses because of the particularly close relationship between the Janus management and the Fund. In advising the fund, Janus management was responsible for the day to day management of the Fund, "furnish[ing] advice and recommendations concerning the fund's investments, as well as administrative, compliance and accounting services." The management disseminated the prospectuses and drafted and reviewed them, including the language about market timing. As a result, the dissent concluded: "Given these circumstances, as long as some managers, can be held to have 'ma[d]e' a materially false statement, Janus Management can be held to have done so on the facts alleged here. The relationship between Janus Management and the Fund could hardly have been closer."

The dissent, therefore, objected to the Court's holding as "adopt[ing] a formal rule . . . 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."