One week from today, the Supreme Court will take another dip in the parlous waters of securities class actions when it hears oral argument in Janus v. First Derivative Traders. Two years ago, the Court launched a thousand law review articles on this topic with its decision in Stoneridge v. Scientific-Atlanta, when the justices firmly squelched liability for secondary actors in cases of securities fraud. The question in Janus concerns who precisely are these aiders and abetters (impervious to suit) and who are primary violators (susceptible to suit). In conceptually dividing these two populations, the Court could with one drawing of a line immunize almost all public corporations from private suit and virtually eliminate the securities class-action lawsuit.
The Court has famously demonstrated its taste for constricting civil lawsuits generally in Iqbal and Twombly and securities litigation specifically in Central Bank and Stoneridge. The Court’s appetite for more of this dish appears to be notably sharp in Janus: in considering certiorari, the justices took the relatively unusual step of inviting the Solicitor General to express the views of the United States on whether to hear the case; then when the SG recommended denying certiorari, the justices took the highly unusual step of granting it anyway. At least four justices, then, appear to have a particular craving for this case, which perhaps bodes ill for the winner in the court below: the plaintiff.
In Janus, the underlying allegations of market-timing fraud –- which the Court will assume as true for the purposes of this interlocutory appeal –- are particularly intriguing: the plaintiff has essentially accused the investment manager Janus of acting like a craven Mayor of Amityville: telling investors that the water in Janus mutual funds is safe for swimming, then letting the market-timing sharks in amongst them. Of course, in mutual funds, the investment adviser charges fees to both the swimmers and the sharks. (The prospectuses of Janus mutual funds stated that market timing was prohibited; meanwhile, Janus allegedly accepted payments from hedge funds to market-time those funds and thus to siphon returns from long-term investors.)
In this case, the manager’s defense is something like, “I didn’t say the water is safe, my megaphone did –- and thus only my megaphone should be held liable.” That is, Janus argues that because the funds are separate legal entities from the manager, any actions Janus took with respect to fraudulent statements in the funds’ prospectuses are necessarily secondary and thus immune. Janus further argues that finding the investment manager liable here would inevitably expose lawyers, bankers, accountants, and other service providers to crippling lawsuits. (At trial, they argued successfully that the funds shouldn’t be held liable either because there’s nothing in those funds except shareholder assets.)
The countervailing arguments, some of which I made in an amicus brief supporting the respondent, point out that investment managers totally dominate and control their funds: they form them, incubate them, name them (branding them with the adviser’s own name), provide all management, write their prospectuses, and otherwise maintain the funds on critical life support. Under Stoneridge, the managers thus are sufficiently proximate to the fraud to be held liable as primary violators. As for the sky-falling arguments about collateral victims, the distinction between managers (who dominate their funds) and lawyers, bankers, and accountants (who merely report to clients) is a fairly easy one to draw.
The only worrisome consequential argument, I argue in my brief, would come from the Court’s provision of a blueprint for widespread impunity from securities violations:
Any corporation that publicly claims to police the quality of its products while surreptitiously soliciting douceurs to compromise that quality –- as an investment manager does in a market-timing fraud –- would receive a tutorial on how to evade legal liability. Following petitioners’ example, such perpetrators would need only to replicate the structure of mutual funds by forming “another,” “different” (Pet. Br. 8, 9), and judgment proof entity to furnish – via contract – all management functions externally.
Circularity and overcompensation are widely recognized problems with securities class actions and certainly counsel in favor of the limited application of such suits. But class actions might still have the benefit of providing deterrence in arenas that require it. The market-timing, late-trading, and now insider-trading allegations against mutual fund advisers (including last week's subpoena sent to Janus Capital Group) suggest that this may be one such arena.
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