Another Face Of Janus: Judge Scheindlin Holds Investment Manager Is Not Primarily Liable For Statements Made By Equity Fund

Originally published in V&E Securities Litigation and Enforcement Update E-communication, October 21, 2011
Only weeks after Judge Koeltl of the United States District Court for the Southern District of New York (S.D.N.Y.) opined on the meaning of "ultimate authority"¹ as used by the U.S. Supreme Court in Janus Capital Group, Inc. v. First Derivative Traders,² Judge Scheindlin of the S.D.N.Y. issued a decision reaching a different conclusion on similar facts. In the recent case In re Optimal U.S. Litigation,³ Judge Scheindlin's interpretation of Janus creates further uncertainty in the S.D.N.Y. regarding the scope of Section 10(b)/Rule 10b-5 liability in private securities-fraud actions.

As explained in our June 13, 2011, Securities Litigation and Enforcement Update E-communication, Janus set forth a seemingly straightforward rule: A defendant can only be primarily liable for "making" a false statement if the defendant is "the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it. . . . One who prepares or publishes a statement on behalf of another is not its maker."⁴ In the September 2011 S.D.N.Y. decision City of Roseville Employees Retirement System v. EnergySolutions, Inc., discussed in our October 5, 2011, E-communication, Judge Koeltl interpreted Janus to still impose securities-fraud liability when a defendant wholly owns the company issuing the allegedly fraudulent registration statements and maintains other "indicia of control," such as owning all outstanding stock of the issuer and selling the issuer's stock in the IPO.⁵ Judge Scheindlin's Optimal opinion distinguishes Roseville and holds that a similarly situated defendant does not have "ultimate authority" under Janus.

In Optimal, a putative class of investors sued the investment manager and corporate parent of the Optimal Strategic U.S. Equity Fund for investing 100 percent of its assets with Bernard L. Madoff's firm. The investors alleged that defendants failed to conduct adequate diligence regarding the investment and made misstatements and omissions in Explanatory Memoranda (EMs) (the Bahamian equivalent of a prospectus) in connection with the sale of the fund's shares.⁶ The defendants moved to dismiss under Janus, arguing that the issuer of the EMs — Optimal Multiadvisors, Ltd. — was the maker of the statement, rather than Optimal Investment Management Services, S.A. (OIS), the fund's investment manager.⁷ The putative plaintiff class disagreed, arguing that (1) OIS owned 100 percent of the voting shares of Multiadvisors; (2) OIS could appoint and remove Multiadvisors' directors at will; and (3) OIS's CEO was a director of Multiadvisors.⁸

The court sided with the defendants. Stressing that "Janus emphasizes the narrow scope of the private right of action under Rule 10b-5 and a formalistic approach to Rule 10b-5 liability," the court concluded that "it was the board of directors of Multiadvisors, not the shareholders, which had 'ultimate authority' to issue the EMs."⁹ The court also rejected the plaintiffs' argument that OIS's 100 percent ownership of Multiadvisors gives rise to liability under Janus because "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, section 20(a) [control-person liability] is the appropriate source of liability."¹⁰ Judge Scheindlin acknowledged that this conclusion was at odds with the decision in Roseville, but distinguished Roseville on the grounds that the facts of that case involved "explicit statements in registration statements indicating that the defendant had direct control over all corporate transactions," whereas "here Multiadvisors' board expressly retained the ability to amend the EMs without consulting its shareholders (OIS) in numerous situations." Judge Scheindlin also noted that Roseville failed to address Janus's concern for broadening Rule 10b-5 liability when control-person liability is more appropriate.¹¹

Optimal is an important counterpoint to the S.D.N.Y.'s earlier interpretations of Janus — and proof that the meaning of Janus remains unclear in the S.D.N.Y. Until more district court and courts of appeals confront the issue, the precise scope of "ultimate authority" under Janus has yet to be determined.

Footnotes

1 City of Roseville Emps. Ret. Sys. v. EnergySolutions, Inc., 2011 WL 4527328 (S.D.N.Y. Sept. 30, 2011).
2 131 S. Ct. 2296 (2011).
3 2011 WL 4908745 (S.D.N.Y. Oct. 14, 2011).
4 131 S. Ct. at 2302.
5 2011 WL 4527328, at *16-*18. The Roseville Court also noted that the defendant would retain a controlling interest in the issuer after the IPO, and that certain individuals who wholly owned the defendant company could cause the issuance of additional shares of common stock. Id.
6 2011 WL 4908745, at *1.
7 Id.
8 Id. at *4.
9 Id.at *5.
10 Id. at *6.
11 Id. at *6 n.50.

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