Implications of 'Janus' for Securities Fraud Liability of Corporate Insiders

G THE B IN EN V C R H E S A N 8 D 8 B 18 AR SINCE WWW. NYLJ.COM VOLUME 245—No. 84 MONDAY, OCTOBER 31, 2011 Outside Counsel Expert Analysis Implications of ‘Janus’ for Securities Fraud Liability of Corporate Insiders o be liable under Section 10(b) of the “strong evidence” that only the party to whom Securities Exchange Act of 1934 and Rule it was attributed is the “maker.” 10b-5,1 a defendant must have “made” Applying its rule, the Court found that the By a misstatement or omission of material Scott M. fund alone made the statements since only it was T 2 fact. This “attribution” requirement Himes obligated to file the prospectuses, and nothing mandates that a statement (or omission) must indicated that statements came from JCM. That be attributed to a particular defendant at the time JCM “was significantly involved in preparing the of dissemination for liability to attach. In Janus prospectuses” did not change this result. Capital Group Inc. v. First Derivative Traders, the Dissent’s Focus on Insiders Supreme Court set forth a new, and seemingly cat- ciently alleged that ‘JCG and JCM, by participating egorical, rule for defining attribution: “the maker in the writing and dissemination of the prospec- Justice Stephen Breyer dissented, joined by Jus- of a statement is the person or entity with ulti- tuses, made the misleading statements.’”4 tices Ruth Bader Ginsburg, Sonia Sotomayor and mate authority over the statement, including its In a 5-4 opinion by Justice Clarence Thomas, Elena Kagan. Taking a broader view of the word content and whether and how to communicate the Supreme Court held that JCM did not make “make,” Justice Breyer contended that “depending it.”3 This rule has important implications for the the misstatements.5 The Court emphasized that upon the circumstances, a management company, liability of corporate officers and directors, as because a §10(b) private right of action is implied, a board of trustees, individual company officers, so-called “insiders,” that the lower courts have it must be given “‘narrow dimensions.’” Adopt- or others, separately or together, might ‘make’ only started to address. ing a literal view, the Court held that Rule 10b- statements contained in a firm’s prospectus—even The ‘Janus’ Case 5’s language “[t]o make…any statement” is “the if a board of directors has ultimate content-related responsibility.” Janus Capital Management LLC (JCM), a mutual Justice Breyer posited that the Court’s rule fund adviser, was sued under Rule 10b-5 for alleged The ‘Janus’ test poses further issues for could immunize even “guilty management” from misrepresentations in prospectuses issued by its liability: client, Janus Investment Fund. The fund had been insider liability. When does a particu- What is to happen when guilty management created by Janus Capital Group Inc. (JCG), which lar officer or director have ‘ultimate writes a prospectus (for the board) contain- owned JCM, but both JCG and JCM were legally authority’ over the financial disclosures ing materially false statements and fools both separate from the fund. of a public company? board and public into believing they are true? The prospectuses stated that the Janus funds Apparently under the majority’s rule, in such were not suitable for market timing and that poli- approximate equivalent of ‘to state.’” Thus, the circumstances no one could be found to have cies would limit the practice. New York’s Attor- “maker” is whoever has “ultimate authority over “ma[d]e” a materially false statement—even ney General sued, asserting that JCG had secretly the statement, including its content and whether though under the common law the manag- permitted market timing. The allegations led to a and how to communicate it.” Absent control, one ers would likely have been guilty or liable precipitous drop in JCG’s stock price. can “merely suggest what to say.” The Court analo- (in analogous circumstances) for doing so as A JCG shareholder then brought a class action gized that a speechwriter drafts a speech, but principals (and not as aiders and abettors). against JCM and JCG. The U.S. Court of Appeals for the speaker controls the content. Accordingly, Justice Breyer expressed concern that cor- the Fourth Circuit ruled “that [Plaintiff] had suffi- one who “prepares or publishes a statement on porate insiders would avoid Rule 10b-5 liability behalf of another is not its maker.” for misrepresentations in their company’s filings Rejecting a “create” contention, the Court because “ultimate authority” lies with the board stated that one does not “make” a statement by of directors. In his view, the relationships alleged providing information or even by participating among JCM, the fund and the prospectus state- SCOTT M. HIMES is a member of Stillman & Friedman. He in drafting. Still, “attribution within a statement ments “warrant the conclusion that [JCM] did focuses his practice on complex commercial litigation. or implicit from surrounding circumstances” is ‘make’ those statements.” MONDAY, OCTOBER 31, 2011 Post-‘Janus’ Decisions In Hawaii Ironworkers Annuity Trust Fund v. Judge Colleen McMahon in the Southern District Cole,9 shareholders alleged that corporate officers recently applied Janus to dismiss claims against The handful of cases that have applied Janus falsified financial information that contributed to corporate officers.SEC v. Kelly14 was a securities are already divided as to its meaning. other officers’ misrepresentations. Defendants fraud enforcement action against three former SEC v. Daifotis6 addressed a reconsideration unsuccessfully moved to dismiss on the grounds corporate managers who allegedly engaged in motion based on Janus. The SEC alleged that two that they did not make any statements to inves- improper transactions. After Janus, two of the executives of Charles Schwab Corp., Randall Merk tors. On reconsideration, however, the court held defendants moved for judgment on the plead- and Kimon Daifotis, violated Rule 10b-5 by making that Janus had “changed the doctrine of securi- ings (as well as for reconsideration of a previ- misstatements concerning management of Schwab ties liability under Rule 10b-5(b),” and partially ously denied summary judgment decision). They bond funds. The defendants conceded that they reversed its earlier opinion.10 argued that since the SEC had alleged only that “made” several of the statements under Janus—a The court rejected the argument that Janus they engaged in conduct that “caused,” rendered registration filing signed by Merk; a website Q&A did not apply because defendants were corporate them “responsible” for, or “substantially contrib- that listed Merk as the author; advertising materi- insiders. It stated that Janus had “‘adopt[ed] a uted” to statements by others, they did not come als that quoted Daifotis; and Daifotis’ statements rule’” defining “maker” for purposes of Rule 10b-5 within Janus’ ultimate authority rule.15 in conference calls. Furthermore, the allegations and had not limited this construction to disclo- The SEC conceded that, given Janus, its mis- that Daifotis had “reviewed” an allegedly false sures involving legally separate entities. Rather, statement claim failed under subsection (b). document before it issued were sufficient under the separation between entities simply informs the Nonetheless, the SEC pressed its “scheme liabil- Janus. analysis of where ultimate authority lies. The court ity” claim under subsections (a) and (c) (which However, the court held that Daifotis did not explained that it disagreed with Merck’s insider/ do not use the language “to make”) premised on “make” alleged misstatements in advertising separate-entity distinction, but noted that Merck’s defendants’ alleged participation in the improp- materials merely because his picture appeared outcome was correct because the defendant there er transactions. Judge McMahon acknowledged in the materials. Moreover, the SEC conceded that was “the speaker” since he signed SEC filings and that Janus did not address scheme liability, but other previously upheld allegations, which pled was quoted in company materials.11 held that where the main purpose and effect of that defendants had participated in or contrib- an asserted scheme is to make a misrepresenta- uted to various misstatements, were insufficient tion or omission, “courts have routinely rejected under Janus.7 Importantly, the court addressed the SEC’s attempt to bypass” the elements for Janus even though defendants, unlike the legally In one decision, Judge John G. Koeltl misstatement liability under subsection (b) “by separate entities in Janus, were insiders who par- applied ‘Janus’ to insiders based on labeling the alleged misconduct a ‘scheme’ rather ticipated in their company’s statements. whether they had signed their com- than a ‘misstatement.’” To permit scheme liabil- By contrast, some courts have refused to pany’s filings. He held that various ity based upon an alleged false statement when apply Janus to corporate insiders. For instance, officers and directors ‘made’ statements the defendant did not “make” the misstatement In re Merck & Co. Sec., Deriv. & “ERISA” Litiga- “would render the rule announced in Janus mean- tion8 involved securities fraud claims against because they had signed the filings, ingless.” Merck and several of its officers, including but that two insiders were not liable for Most recently, in another Southern District Edward Scolnick, based on alleged misrepre- alleged misrepresentations in one filing decision, City of Roseville Employees’

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