Argument recap: Justices grapple with the distinction between primary and secondary liability and what it means to “make” a statement under the federal securities laws

At oral argument on Tuesday in Janus Capital v. First Derivative Traders (No. 09-525), the Court addressed in the context of mutual funds and mutual fund advisors (1) whether a service provider can be held primarily liable in a private securities-fraud action for “help[ing]” or “participating in” another company’s misstatements; and (2) whether a service provider can be held primarily liable in a private securities-fraud action for statements that were not directly and contemporaneously attributed to the service provider?

 Arguing for Janus, Mark Perry portrayed mutual fund advisors as mere “service providers” with respect to drafting and issuance of mutual fund prospectuses issued by mutual funds, and he labeled the decision of the Fourth Circuit below as “nothing less than a frontal assault on this Court decisions in Central Bank and Stoneridge.”  Perry argued that these prior decisions foreclosed any possibility for service providers to have primary liability under the federal securities laws even if they are alleged to have been “help[ing” or “participating in” another company’s misstatements.  Justice Sotomayor challenged the proposition that Janus could avoid primary liability based solely on the fact that the statements at issue were attributed to the mutual funds instead of the advisors that drafted the statements asking, “Do you mean to tell me that puppets become a legal defense for someone who intentionally manipulates the market information?”  Perry responded that Congress addressed such a situation in Section 20, which First Derivative was not invoking.  When Justice Sotomayor noted that the misstatements alleged below had been made without the knowledge of the mutual fund’s board of directors, Perry affirmed, “our position is nobody had scienter, and every adjudicator to look at these facts – Judge Motz in the district court, the ALJ of the SEC, has found there was no scienter anywhere up and down the line.” 

Justice Kagan focused on the actual drafting of the challenged prospectus language, which was done by attorneys whose fees were paid by in-house counsel for the investment advisor.  Perry responded that it did not matter which attorneys drafted the challenged language or who employed them because, “[i]n house counsel, outside counsel, once they draft materials and present them to their client, it becomes the client’s statement when adopted by the client.”  He emphasized that the mutual fund’s board of trustees had reviewed and adopted the challenged language.  In response to a question from Justice Kennedy, Perry asserted that it would not have mattered if the challenged language had been drafted by the advisor’s principal officers and managers – rather than in-house counsel – because “when the statement is adopted by the issuer, it becomes the issuer’s statement.  Only an issuer can make the statement.”

Under questioning from Justices Kennedy and Sotomayor, Perry asserted that First Derivative Traders’ allegations that the investment advisor controlled the day-to-day operations of the mutual fund did not change the result because, with respect to potential primary liability, “the mutual funds, are separately owned, separately governed”; with respect to potential secondary liability, First Derivative had not pursued a claim based on control person liability under Section 20.   In response to a hypothetical question from Justice Breyer regarding whether the president of a company could have primary liability making a misstatement that was then issued in the company’s name, Perry agreed liability could be possible but distinguished the hypothetical company executive from Janus because the mutual fund and fund advisors are separate legal entities.  Perry’s argument concluded with Justice Scalia redirecting the argument from whether the advisor had “control” over the mutual fund to the issue of whether “help[ing]” or “participating” in the misstatement of another company could ever be sufficient to support primary liability.

Arguing for First Derivative Traders, David Frederick responded immediately to questioning from Justice Scalia by narrowing the focus of the argument from broad potential liability for “help[ing]” or “participating” in a misstatement generally to the specific facts of the case before the Court.  “We would submit this case is not about service providers, but it is about Janus Capital Management being the primary violator.”  In a further exchange with Justice Scalia, Frederick asserted that it was possible for a party to “make” a statement that is attributed to that party.  He continued, “we address the definition of ‘make’ under the SEC’s interpretation, which is entitled to deference, as being to create or to compose or to accept as one’s own.”  In response, Justice Scalia emphasized that “[t]he representation was made in the prospectus issued by the Fund, not by [the advisor],” and he described the fund advisor’s role as “just like writing a speech for somebody.”

Responding to further questions from Justice Scalia and Chief Justice Roberts, Frederick returned to the mutual fund industry and the specific allegations of the complaint, “They [Janus] created the fund, Justice Scalia.  That’s how mutual funds work.  Managers create them, they lure investors to them, they get money by having a percentage of assets under management.”  The argument then turned from the mutual fund industry to situations of broader application.  Justice Alito asked Frederick to distinguish between the case at issue and one with misstatements in a prospectus issued by “a corporation with thousands of employees and the prospectus is drafted by outside counsel.”  Frederick responded that outside lawyers “are distinguishable in a number of different ways.”  While outside lawyers might face, at most, an aiding and abetting action from the SEC, Frederick argued that the fund advisor remained analogous to the hypothetical oil executive described previously by Justice Breyer based on its ongoing control over the day-to-day operations of the mutual fund.  Frederick concluded by emphasizing that under the interpretation of the federal securities laws advanced by Janus no primary violator would exist under the facts alleged notwithstanding the presence of material misstatements.  He labeled that potential outcome a “road map to commit fraud.”

Assistant to the Solicitor General Curtis Gannon argued on behalf of the United States as an amicus supporting First Derivative.  He repeated the U.S.’s view that a party “makes” a statement “if they create the statement.”  Under questioning from the Chief Justice, Gannon confirmed that if the Court were to adopt Janus’s interpretation of the law, under the facts as pled there would be no primary violator and neither the SEC, nor any other party, would have a claim against Janus for secondary liability.   In response to questions regarding whether outside counsel could potentially face primary liability for drafting misstatements in clients’ prospectuses, Gannon indicated that potential primary liability would be limited by whether such counsel or service provider were “sufficiently involved” as to justify primary liability.  Gannon also confirmed that “attribution to the actor is not necessary for the actor’s liability for his statement.”  Finally, in response to a question from Justice Kagan regarding the possibility of limiting any ruling by the Court to the mutual fund context, Gannon suggested that this case could be analogized to those in which a corporate employee drafts a misstatement issued by an employer because, “ [i]n this instance the investment advisor is management for the company, and the fact that they happen to be management by virtue of contract rather than just the internal arrangements of the corporation shouldn’t change that arrangement.”

In his rebuttal, Perry argued for a “bright line” test for primary liability and asserted that neither First Derivative nor the United States had set forth an appropriate rule: “[t]hey can’t articulate the difference between primary and secondary, between principal and agent, between aiders and abettors and anything else.  This is an area that needs bright lines, it needs to be resolved on motions to dismiss.”