Mutual Fund Company Shareholder Suits May Split Court

U.S. Supreme Court justices, hearing arguments in a case involving Janus Capital Group Inc., signaled they are divided about restricting securities fraud suits by shareholders of mutual fund companies.

The court today reviewed a ruling that let shareholders sue Janus and a subsidiary for helping produce allegedly misleading prospectuses for Janus mutual funds. Janus contends the funds are separate legal entities and that neither the parent company nor the subsidiary were responsible for the prospectuses.

The case is a follow-up to a 2008 Supreme Court decision that curbed securities suits against a company’s banks and business partners. That decision divided the court along ideological lines, and today’s hour-long argument in Washington suggested the likelihood of a similar split, possibly leaving Justice Anthony Kennedy as the deciding vote.

Kennedy hinted that he is uncomfortable with the prospect of absolving parent companies when they exercise total control over a unit that misleads the public. He asked whether a mutual fund company could be sued if it “did 100 percent of the prospectus work.”

At the same time, Kennedy suggested that shareholders must show that misleading statements were openly attributed to the parent -- something he said the Janus investors hadn’t done.

Job Discrimination Case

The court today also heard arguments in a job bias case, considering whether an employer can be sued for unlawful retaliation for firing the fiancé of a worker who complained about discrimination. The justices are scheduled to resolve both cases by early July.

The mutual fund fight stems from allegations that Janus allowed preferred clients to engage in market timing, a practice of making frequent, short-term trades at the expense of other investors.

The prospectuses said the funds had taken steps to deter market timing. In the lawsuit, Janus shareholders say those assurances were revealed to be false in 2003 when New York state officials filed a complaint against the company, causing its share price to fall. Denver-based Janus later agreed to pay $201 million and cut fees by $125 million to settle claims by state and federal regulators.

The shareholders are seeking to sue both Janus Capital Group and Janus Capital Management LLC, which serves as the investment adviser to the funds and has day-to-day responsibility for their management. The Obama administration is backing the shareholders at the Supreme Court, arguing that the suit should be allowed to go forward.

Bearing Responsibility

The justices spent much of today’s session trying to determine who at Janus bore responsibility for the allegedly misleading nature of the prospectuses.

“Somebody deviated from what was the announced policy -- that there was to be no market-timers investing in these Janus funds,” Justice Ruth Bader Ginsburg said to Janus’s lawyer. “Somebody made the decision that certain hedge funds would be allowed to engage in that activity. Who was that somebody?”

Chief Justice John Roberts and Justice Antonin Scalia signaled they viewed the Janus funds as independent entities. Roberts said outside lawyers representing the fund had reviewed the prospectuses.

Control Over Prospectus

“Couldn’t the fund have stopped this statement from being placed in its prospectus?” Scalia asked. “How can you say that they didn’t have control?”

The lawyer for the shareholders, David Frederick, urged the court to view the Janus entities as part of the same operation.

“What we’re talking about here is a company with a product, and they lie about the product,” he said.

Janus’s attorney, Mark Perry, told the justices that the lower court ruling allowing the suit to go forward “would authorize private securities fraud class actions against every service provider that participates in the drafting of a public company’s prospectus.”

Justice Elena Kagan, however, suggested that any ruling favoring the shareholders might be limited. She asked a government lawyer how the court could “confine our holding just to the mutual fund situation.”

Justice Sonia Sotomayor likened the allegations to a situation in which a company deceives outside analysts who then pass on the misinformation to the public.

“We don’t talk about the market analyst’s falsity,” Sotomayor said. “We talk about the company’s falsity.”

The case is Janus Capital Group v. First Derivative Traders, 09-525.

To contact the reporter on this story: Greg Stohr in Washington at gstohr@bloomberg.net.

To contact the editor responsible for this story: Mark Silva at msilva34@bloomberg.net.

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