The securities industry hopes that the Supreme Court will reverse a lower-court decision that it fears could put all mutual fund companies and financial advisers who sell their funds at a greater risk of being targets of class actions, observers say.
The suit — Janus Capital Group v. First Derivative Traders — stems from the 2003 market-timing lawsuits in which a number of mutual fund companies, including Janus, allowed certain investors to make rapid trades of shares of their funds to the detriment of longer-term investors.
Janus settled the charges with regulators. But in this case, First Derivative, which was a shareholder of Janus, is claiming that the parent company should be held liable for statements made in its fund prospectuses.
A U.S. District Court judge in Maryland dismissed the case in 2005, but the Fourth Circuit Court of Appeals reversed that decision.
The Supreme Court has agreed to hear the case, with oral arguments scheduled to begin Dec. 7.
Janus argues that Congress has made clear that advisers are to be independent of the funds that they advise.
“[Janus Capital Management LLC], as a secondary actor, cannot be held primarily liable for unattributed statements made by another company in that company's prospectus,” the firm argued in a brief filed with the Supreme Court on Sept. 3.
James Aber, a spokesman for Janus, referred calls to Mark A. Perry, a partner at Gibson Dunn & Crutcher LLP and the outside counsel for Janus who drafted the brief. Mr. Perry declined to comment.
On Sept. 10, the Securities Industry and Financial Markets Association and Dechert LLP, which represents several mutual fund companies, filed friend-of-the-court briefs for Janus Capital Group. The U.S. Chamber of Commerce, the Center for Audit Quality, a non-profit organization representing auditors, and the Liability Assurance Society Inc., a mutual insurance company for a number of law firms, also filed friend-of-the-court briefs.
NO CLEAR LINE?
If the Fourth Circuit decision stands, it would cause “crippling uncertainty in the securities markets” by allowing lawsuits to be filed on a case-by-case basis, rather than establishing a clear line that suits must rise above to be brought, SIFMA argued in its filing.
“If they uphold the decision, there will be a flood tide of additional securities litigation taking advantage of this ambiguity,” said Jonathan Cohn, a partner at Sidley Austin LLP, who is the counsel of record for SIFMA. “The costs of these suits are often passed on to investors.”
Industry observers argue that it isn't just the mutual fund companies that would be at greater risk if the case stands. The Fourth Circuit in its decision also indicated that anyone who disseminates prospectuses with false or misleading information could be held liable, said Robert Skinner, a partner at Ropes & Gray LLP.
“This could open the door to [the] plaintiff's bar bringing private class action lawsuits against financial services providers who they allege have touched a prospectus or statement about a stock but haven't actually made these statements in them,” he said. “So if the plaintiff can allege that a broker furthered or disseminated statements made by someone else, you could see them try to sue brokers.”
If the Supreme Court lets the lower court's decision stand, it is likely to have implications only for advisers who actively engage in fraud, said Ira Press, a partner at Kirby McInerney LLP, who is representing First Derivative Traders in the case.
“We are not talking about innocent bystanders,” he said. “We are talking about parties who knowingly participated in some sort of transaction that ultimately caused investor schemes.”
If the Fourth Circuit's decision stands, it could result in much more convoluted fund prospectuses, said Robert W. Helm, a partner at Dechert.
“The purpose of mutual fund disclosure isn't to educate the shareholders of the parent company; it's to educate the shareholders of the fund,” he said. “If the focus of mutual fund disclosure is no longer the mutual fund but the parent of the fund, you have essentially changed the rules of the game in a fairly dramatic way.”
In May, acting U.S. Solicitor General Neal Kumar Katyal filed a brief asking the Supreme Court to let the Fourth Circuit's decision stand.
But with such serious repercussions at stake for all service providers that work on prospectuses, some experts believe that the Supreme Court decided to hear the case just so that it could reverse the Fourth Circuit's decision.
“I think the fact that the Supreme Court took the case against the government's recommendation provides some indication that the court is likely to reverse the lower court's decision,” said Richard Bernstein, lead counsel in the case for the U.S. Chamber of Commerce.
E-mail Jessica Toonkel at firstname.lastname@example.org.