Last summer, the Supreme Court held in Janus Capital Group,
Inc. v. First Derivative Traders, Inc. that a defendant may
only be held be liable for securities fraud in a private action
brought under Rule 10b-5(b) of the Securities Exchange Act of 1934
if it was the "maker" of a misstatement.1
Specifically, a defendant may be responsible for a misstatement if
it is the "person or entity with ultimate authority over the
statement, including its content and whether and how to communicate
it."2
In the nine months since Janus was decided,3
the lower courts have applied what is a seemingly simple holding in
divergent ways. Market participants should take an interest in
these post-Janus opinions for two reasons. First, they
suggest potential Janus-based defenses available in ongoing or
future securities-related litigation. Second, they offer a window
into the strategies that the U.S. Securities and Exchange
Commission ("SEC") and the plaintiffs' bar are using
to avoid Janus's strictures.
Among the questions dividing the courts are the following:
1. Does
Janus's "ultimate
authority" limitation apply to actions brought under other
rules or statutes prohibiting false or misleading
statements?
In SEC v. Kelly (S.D.N.Y.), the SEC asserted causes of
action against two non-officer senior managers under Rules 10b-5(a)
and 10b-5(c) of the Exchange Act and Section 17(a) of the
Securities Act of 1933 in connection with alleged fraudulent
transactions intended to artificially inflate revenue figures
reflected in publicly filed financial statements.4
Although the SEC conceded that the defendants lacked the
"ultimate authority" to make the statements at issue and
thus could not be held liable under Rule 10b-5(b),5 it
argued Janus did not preclude it from asserting
"scheme liability" under Rule 10b-5(a) and 10b-5(c) or
claims alleging fraud in the sale of securities under Section
17(a).6 Under the SEC's logic, although Rule
10b-5(a), Rule 10b-5(b), Rule 10b-5(c), and Section 17(a) all
address similar conduct constituting securities fraud, only Rule
10b-5(b) contains the word "make" on which the
Court's decision in Janus turned.
Judge Colleen McMahon disagreed with the SEC's position,
granting defendants' motions for judgment on the pleadings on
all three claims.7 She reasoned that, to hold otherwise
would render Janus "meaningless" because it
would undermine the Supreme Court's stated intention to
preserve a distinction between those who are primarily liable and
those who are secondarily liable under the securities
laws.8 "Where the primary purpose and effect of a
purported scheme is to make a public misrepresentation or
omission," the court stated, "courts have routinely
rejected the SEC's attempt to bypass the elements necessary to
impose 'misstatement' liability under subsection (b) by
labeling the alleged misconduct a 'scheme' rather than a
'misstatement.'"9
In In the Matter of John P. Flannery and James D.
Hopkins, the SEC's Chief Administrative Law Judge Brenda
Murray reached a similar conclusion.10 In a case
involving alleged misstatements by a chief investment officer and a
product engineer, she relied on Kelly in holding that
Janus was appropriately applied not just to claims under
Rule 10b-5(b), but also to claims under Rule 10b-5(a) and (c), as
well as Section 17(a).11 ALJ Murray held that,
"with respect to allegations involving documentary evidence,
the [Enforcement] Division must establish that Respondents had
ultimate authority and control over such
documents."12 She proceeded to analyze whether the
Respondents had "ultimate authority" over each of the
alleged misstatements at issue and concluded, at least with respect
to those that appeared in documents, that neither Respondent
possessed sufficient authority over them to be considered the
"maker" of the statement under Janus. (In the
case of the alleged oral misstatements, the ALJ concluded that,
while the Respondents had "ultimate authority" over
statements that they themselves had made, the statements were not
materially false or misleading).
On March 30, 2012, the SEC denied Respondents' motion for
summary affirmance and granted the Enforcement Division's
petition for review of the ALJ's initial decision, noting the
"important and legal policy issues" raised, including
that this is "a case of first impression regarding the
applicability of the Supreme Court's holding in Janus to claims
other than those brought pursuant to Exchange Act Rule
10b-5(b)."13
In SEC v. Daifotis (N.D. Cal.), however, Judge William
Alsup reached a different conclusion.14 In light of
Janus, the defendants moved for reconsideration of an
order denying their motion to dismiss claims the SEC brought
against them in a civil enforcement action under Rule 10b-5(b),
Section 17(a), and Section 34(b) of the Investment Company
Act.15
The court granted the motion to reconsider as to claims asserted
under Rule 10b-5(b), holding that the defendants did not
"make" a number of the statements at issue within the
meaning of Janus.16
On the other hand, the court also held that Janus does
not apply to claims asserted under Section 17(a) because the word
"make" is "absent from the operative language
of" the statute.17 It reached a similar conclusion
with respect to claims under Section 34(b), which prohibits the
making of untrue statements of material fact in registration
statements, even though that statute does include the word
"make."18 The court reasoned that
Janus's underlying rationale—the need to
construe narrowly the scope of an implied right of private
action—was inapplicable to Section 34(b) because it can
be enforced only by the SEC and has not been interpreted as having
an implied private right of action.19
Since these two cases were decided, other lower courts have
limited Janus's reach to claims brought under Rule
10b-5(b). For example, in Hawaii Ironworkers Annuity Trust Fund
v. Cole, the court reached a similar conclusion to what Judge
Alsup reached in Daifotis, holding that Janus was
inapplicable to claims brought under Rule 10b-5(a) and
10b-5(c).20
And in SEC v. Mercury Interactive, a different district
court in the Northern District of California declined to apply
Janus to scheme liability claims under Rule 10b-5(a) and
(c) or to claims under Section 17(a) or Section 14(a) of the
Exchange Act.21 Other courts have reached similar
conclusions in recent cases.22
2. Does Janus limit liability of corporate officers or does it apply only in situations involving legally separate entities?
In the same decision rejecting Janus's applicability to claims under Rule 10b-5(a) and (c), the district court in Hawaii Ironworkers dismissed the Rule 10b-5(b) claims that had been brought against two corporate officers by a former shareholder. The shareholder alleged that those officers internally reported false financial results that had contributed to the corporation's issuing false financial statements.23 The officers contended that they could not be held liable under Janus because they had acted at the direction of other executives and therefore had not possessed "ultimate authority" over the allegedly false financial statements. In dismissing the 10b-5(b) claims against them, the court agreed, noting that "nothing in the Court's decision in Janus limits the key holding... to legally separate entities."24
The ruling in Hawaii Ironworkers departed from the approach taken earlier by a district court in the District of New Jersey in In re Merck & Co., Inc. Securities, Derivative & "ERISA" Litigation.25 In that case, the court held that Janus is limited to claims against "separate and independent" entities and "certainly cannot be read to restrict liability for Rule 10b-5 claims against corporate officers[.]"26
3. Can a parent company have "ultimate authority" within the meaning of Janus over statements made by a wholly owned subsidiary?
Even if Janus can fairly be read as being limited to situations involving legally separate entities, there is further disagreement about Janus's scope. Specifically, can a corporate parent have "ultimate authority" over claims made by a wholly owned subsidiary?
In City of Roseville Employees Retirement System v. EnergySolutions, Inc. (S.D.N.Y.), Judge John Koeltl held that the holding company defendant had "ultimate authority" over and therefore was the maker of the allegedly misleading statements issued by its wholly owned subsidiary.27 In support of this ruling, the court noted that the parent company had "direct control over all corporate transactions" of the subsidiary and, accordingly, a reasonable jury could find it had control over the content of the subsidiary's registration statement (which contained the alleged misstatement), the underlying subject matter of that statement, and the ultimate decision of whether to make that statement.28
Two weeks later in In re Optimal U.S. Litigation
(S.D.N.Y.), Judge Shira Scheindlin reached the opposite conclusion.
She dismissed claims brought by a putative class of investors
against the investment manager and corporate parent of the Optimal
Strategic U.S. Equity Fund under Rule 10b-5 for allegedly false and
misleading statements made in connection with the sale of the
fund's shares. The defendants argued that they were not the
makers of the allegedly false statements because they had appeared
in Explanatory Memoranda (the Bahamian equivalent of a prospectus)
issued by Optimal Multiadvisors, Ltd., a separate entity of which
the investment manager owned 100% of the voting shares.
The court agreed, holding "it follows from Janus
that Rule 10b-5 liability for a one-hundred percent shareholder of
an entity 'making' a misleading statement is inappropriate;
rather, [S]ection 20(a) [control person liability] is the
appropriate source of liability."29 The court distinguished
Roseville on the basis that, "unlike
Roseville," Optimal Multiadvisors' board
"expressly retained the ability to amend the [prospectuses]
without consulting its shareholders in numerous
situations."30
Key Takeaways For Participants in the Securities Markets
1. Janus
limits the universe of those who may be held liable for
alleged misleading statements under Rule 10b-5(b) to those with
"ultimate authority" over the statements. After
Janus, it is evident that plaintiffs, including the SEC,
must allege that entities have "ultimate authority" to
make the allegedly 31 Some courts have extended this
rule to claims brought under Rule 10b-5(b) against an entity's
individual officers32 and controlling
shareholders.33
2. Some courts have been reluctant to extend
Janus to securities fraud claims
other than those brought under Rule 10b-5(b). With the
exception of Kelly,34 several courts to
consider the issue have limited Janus's reach to
claims under Rule 10b-5(b). Both the SEC and private plaintiffs
have successfully argued that the absence of the word
"make" means that Janus does not apply to claims
alleging scheme liability brought under Rule 10b-5(a) and
(c).35 And in one case, the SEC succeeded in arguing
that Janus does not apply to claims the Commission brings
under Section 17(a) and Section 34(b) (neither of which are
available to private plaintiffs).36 The chief counsel
for the SEC's Division of Enforcement recently acknowledged
that Janus has caused the agency to shift its emphasis
toward aiding-and-abetting and control person liability claims
under Rules 10b-5(a) and (c) and Section 20(a),
respectively.37
Footnotes
1 131 S.Ct. 2296, 2299 (2011).
2 Id. at 2302.
3 For our initial update concerning Janus, see Lori A. Martin, Thomas W. White, Douglas J. Davison, Christopher Davies, Michael Mugmon, and Jaclyn Moyer, UPDATE: Supreme Court Curtails Ability of Plaintiffs to Hold Secondary Actors Liable in Private Securities Fraud Actions (June 29, 2011). Available at: www.wilmerhale.com/publications/whPubsDetail.aspx?publication=9874 .
4 No. 08-CV-4612 (CM), 2011 WL 4431161, at *1 (S.D.N.Y. Sept. 22, 2011).
5 Id. at *2.
6 Id. at *2, *4. Section 17(a) applies only to the "offer and sale" of securities whereas Rule 10b-5(b) applies to either purchase or sale. Id. at *4.
7 Id. at *6.
8 Id. at *4-*5 (citing Janus, 131 S. Ct. at 2302 n.6).
9 Id. at *3.
10 See Initial Decision Release No. 438, Administrative Proceeding, File No. 3-14081 (SEC Administrative Decision, Oct. 28, 2011).
11 Id. at 42-43 ("This case involves allegations of materially false or misleading statements or omissions, and I find the Janus test to be the appropriate standard to apply in evaluating the extent of Respondents' conduct.").
12 Id.
13 See Order Denying Motions for Summary Affirmance, Granting Petition for Review, and Scheduling Briefs, Administrative Proceeding, File No. 14081 (Securities and Exchange Commission, Mar. 30, 2012).
14 See No. C 11-00137 WHA, 2011 WL 3295139, at *5 (N.D. Cal. Aug. 1, 2011). ALJ Murray cited Daifoitis, but declined to follow it.
15 Id. at *1.
16 Id. at *3.
17 Id. at *5-6.
18 Id. at *6.
19 Id.
20 See No. 3:10CV371, 2011 WL 3862206, at *5-6 (N.D. Ohio Sept. 1, 2011).
21 See 5:07-cv-02822, 2011 WL 5871020, at *2-3 (N.D. Cal. Nov. 22, 2011).
22 See, e.g., SEC v. Pentagon Capital Mgmt. PLC, 08 CIV. 3324, 2012 WL 479576, at *41-42 (S.D.N.Y. Feb. 14, 2012) (declining to apply Janus to claims brought by the SEC under Rule 10b-5(a) and (c) and Section 17(a)).
23 2011 WL 3862206, at *3.
24 Id.
25 MDL No. 1658 (SRC), 2011 WL 3444199 (D. N.J. Aug. 8, 2011).
26 Id. at 26. Other courts have also held individual officers to be "makers" under Janus. See, e.g., SEC v. Carter, No. 10 C 6145, 2011 WL 5980966, at *2-3 (N.D. Ill. Nov. 28, 2011); SEC v. Das, No. 8:10CV102, 2011 WL 4375787, at *6 (D. Neb. Sep. 20, 2011); SEC v. Landberg, No. 11 Civ. 0404, 2011 WL 5116512, at *4 (S.D.N.Y. Oct. 26, 2011).
27 See City of Roseville Employees' Ret. Sys. v. EnergySolutions, Inc., 814 F. Supp. 2d 395, 418 (S.D.N.Y. 2011).
28 Id.
29 No. 10 Civ. 4095(SAS), 2011 WL 4908745, at *5-*6 (S.D.N.Y. Oct. 14, 2011).
30 Id. at *6 n.50.
31 See, e.g., Reese v. BP Exploration (Alaska) Inc., 643 F.3d 681, 694 (9th Cir. 2011) ("The insufficiency of Reese's pleadings are reinforced by the Supreme Court's recent opinion in Janus ... which sets the pleading bar even higher in private securities fraud actions seeking to hold defendants primarily liable for the misstatements of others."); S.E.C. v. Radius Capital Corp., 2:11-CV-116-FTM-29, 2012 WL 695668, at *7 (M.D. Fla. Mar. 1, 2012) (dismissing complaint for failure to state a claim where the SEC failed to allege facts demonstrating that the defendant exercised "ultimate authority" over alleged misstatements).
32 See, e.g., Hawaii Ironworkers, 2011 WL 3862206, at *3. But see Merck, 2011 WL 3444199.
33 See, e.g., Optimal, 2011 WL 4908745, at *5. But see City of Roseville, 2011 WL 4527328, at *17-18.
34 2011 WL 4431161.
35 See Mercury Interactive, LLC, 2011 WL 5871020 (holding Janus does not apply to scheme liability claims brought by SEC); Hawaii Ironworkers, 2011 WL 3862206 (holding Janus does not apply to scheme liability claims brought by private plaintiffs).
36 See Daifoitis, 2011 WL 3295139, at *5-6.
37 See Yin Wilczek, SEC Looking to Aiding/Abetting Claims In Wake of Janus Decision, Official Says, Securities Law Daily (Feb. 27, 2012).
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