August 2011 The Supreme Court’s Janus Decision: No Inside this issue: Secondary Liability, but Many Secondary The Supreme Court’s Janus Questions Decision: No Secondary Liability, but Many Secondary Questions .................................. 1 The U.S. Supreme Court’s recent decision in Janus Capital Group, Inc. v. First Derivative Traders raises questions for fund directors about the allocation of D.C. Circuit Strikes Down liability for prospectus errors and whether directors should take additional SEC Proxy Access Rule ............ 5 measures either to protect their funds and themselves from liability for Congressional Panel prospectus errors or to provide their funds’ investment adviser with Considers Systemic Risk of additional incentive to ensure the accuracy and completeness of fund Mutual Funds............................. 6 prospectuses. Floating NAV Proposal The Janus Decision. The Janus case is unusual in that the plaintiffs, who Dominates SEC Systemic alleged that the prospectuses of certain Janus funds contained material Risk Roundtable ........................ 8 misstatements, were suing as shareholders of the investment adviser’s parent Custodians Alleged to company, Janus Capital Group, Inc. (“Janus Capital”), not as fund shareholders. Overcharge in Foreign Plaintiffs claimed that shares of Janus Capital lost value when its assets under Exchange Transactions ............. 9 management declined because of regulatory action against company affiliates in SEC Issues Report on the 2003 market-timing scandal. Review of Reliance on Plaintiffs brought an action against Janus Capital for alleged misstatements about Credit Ratings............................ 9 market timing in the funds’ prospectuses, under the Securities Exchange Act of 1934 (“1934 Act”) Rule 10b-5, which declares it unlawful “to make any untrue statement of a material fact” in a prospectus. The Court, in a 5-4 decision, ruled in favor of Janus Capital, finding, in effect, that the only person who can be liable under Rule 10b-5 is the person “making” the statement, in this case the K&L Gates includes lawyers practicing funds that issued the prospectuses. The Court held that the Janus funds out of 37 offices located in North ultimately controlled the content of their own prospectuses; therefore, the funds, America, Europe, Asia and the Middle and not the other persons or entities who contributed information to the East, and represents numerous GLOBAL document, were the makers of the statements in question. 500, FORTUNE 100, and FTSE 100 corporations, in addition to growth and The Court observed that the Securities and Exchange Commission (“SEC”) middle market companies, has authority to bring a case for aiding and abetting violations of Rule entrepreneurs, capital market 10b-5, under which the various contributors to the prospectus might have participants and public been liable, but that there is no private right of action for aiding and sector entities. For more information, abetting such a violation. The Janus decision represents a determined effort by visit www.klgates.com. the Court not to allow such secondary liability to slip in through a back door. The decision is noteworthy for the complete absence of language found in many earlier decisions stating that the federal securities laws are “remedial statutes” and should be interpreted broadly in accordance with their remedial intent. Allocation of Liability After Janus . The Janus decision did not significantly change registration statement liability for funds, their directors or their advisers. However, given the structure of the typical investment company complex, in which the funds have no employees of their own and employees of the adviser and the administrator provide all of the funds’ officers and all services necessary to the funds’ day-to-day operation, the decision has left many in the industry
scratching their heads. If the adviser is not directors, precisely because they are insiders, may have a more difficult time than would the responsible for the prospectus content, who is? independent directors in establishing that they did Some have expressed concern that under the Janus not know the truth of the matter at the heart of the ruling, fund directors may face increased liability plaintiff’s claim. for prospectus errors. They question whether, if the adviser is not the maker of the statements in Advisers and their affiliates are potentially the fund’s prospectus, that leaves fund directors in liable under other provisions of the federal the position of being the only responsible party. securities laws as well. For example, plaintiffs But is that right? The role of a board of may sue a fund’s distributor – often an affiliate of the adviser – under Section 12 of the 1933 Act for directors is generally oversight, not execution. Rather, it is the officers of a corporation who are selling shares by means of a materially false responsible for its executive function. It is prospectus. Additional provisions of the federal arguable whether even they would be deemed to securities laws, enforceable only by the have made the statements contained in a fund’s government, also might be used to impose prospectus under the Supreme Court’s new monetary liability and other penalties on an interpretation of Rule 10b-5, but one would think adviser for misstatements in the fund’s the light would shine on them before it falls on prospectus. Thus, the Janus case did very little independent directors. to alter the potential liability of advisers, funds, or fund officers and directors in cases Perhaps more to the point, very few prospectus where a fund’s prospectus is arguably false. liability cases are brought under Rule 10b-5. The rule imposes on the plaintiff the burden of proving That said, however, the discussion generated by that the defendant acted with scienter (or at least the case would seem to present directors with with recklessness), and that the plaintiff (or the the opportunity to consider several matters market) relied on the false statement. Plaintiffs’ that could be important in allocating liability in a case alleging a false prospectus. These counsel typically find it much more appealing to bring prospectus cases under Section 11 of matters are (1) the best way for fund directors the Securities Act of 1933 (“1933 Act”), which to carry out their “due diligence” regarding imposes liability for losses stemming from a the content of fund registration statements; (2) registration statement that was materially false or the provisions of advisory, administrative and misleading at the time it went effective. distribution contracts that allocate liability between those entities and the fund for prospectus Section 11 liability falls on the fund, its directors, certain officers and anyone who has misstatements and omissions; and (3) various “expertised” the allegedly false portion of the avenues for indemnification and shared prospectus ( e.g. , the auditors). The plaintiff is liability, including D&O/E&O coverage and an not required to prove scienter or even indemnification agreement with the adviser. recklessness. Defendants in such cases may have Due Diligence. As noted, Section 11 of the 1933 defenses available, but they are just that – Act provides fund directors, among others, with a defenses. The burden falls on the defendants to defense against liability based on their having establish those defenses once the plaintiff has performed due diligence to assure themselves of asserted a prima facie case . the accuracy and completeness of the registration Clearly, the Janus case did nothing to change statement. In the wake of Janus, some boards of liability under Section 11, since that question directors are reviewing carefully the manner in was not before the Court. And although the which such a defense might be established. The adviser itself may not be a defendant in a investment process is largely intangible, and Section 11 case, the fund’s inside directors and director due diligence might therefore be certain officers, who typically are significant enhanced by a focus on process and players in the advisory organization, likely would safeguards. be defendants. Fund officers and directors do • Certainly, it may be important to show that have available under Section 11 a “due diligence” a director or his/her delegate ( e.g. , a board defense; however, the officers and inside 2 August 2011
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