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Mutual Fund Shareholder Suits Curbed by U.S. Supreme Court

A divided U.S. Supreme Court threw out a suit against Janus Capital Group Inc. in a ruling that will limit the ability of shareholders of mutual fund companies to press securities fraud suits.

The court, voting 5-4 along ideological lines, today said shareholders can’t sue Janus and a subsidiary for helping produce allegedly misleading prospectuses for Janus mutual funds. The majority said that the funds are separate legal entities and that neither the parent company nor the subsidiary were responsible for the prospectuses.

“The mutual funds industry is breathing a big sigh of relief today because the spillover consequences of a broad definition of who makes a prospectus could have been huge,” said Robert Skinner, a Ropes & Gray LLP attorney in Boston specializing in investment management litigation.

The case was a follow-up to a 2008 Supreme Court decision that curbed securities suits against a company’s banks and business partners. In his opinion for the court today, Justice Clarence Thomas said the shareholders were seeking to “create the broad liability that we rejected” in the 2008 case.

“Any reapportionment of liability in the securities industry in light of the close relationship between investment advisers and mutual funds is properly the responsibility of Congress and not the courts,” Thomas wrote.

Beyond Mutual Funds

The ruling may have ramifications well beyond the mutual fund industry, said William Birdthistle, a professor who specializes in investment fund law and securities regulation at Chicago-Kent College of Law.

“It’s a blueprint for operating companies to see what the investment companies are doing and to make themselves as bulletproof as the investment advisers,” said Birdthistle, who filed a brief backing the Janus shareholders.

The fight stemmed from allegations that Janus let preferred clients 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 said 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.

Legally Distinct

The shareholders were 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.

Thomas said those entities were legally distinct from Janus Investment Fund, the investor-owned trust responsible for issuing the prospectuses.

“There is no allegation that JCM in fact filed the prospectuses and falsely attributed them to Janus Investment Fund,” Thomas wrote. “Nor did anything on the face of the prospectuses indicate that any statements therein came from JCM rather than Janus Investment Fund -- a legally independent entity with its own board of directors.”

Janus shares rose 11 cents to $9.22 at 4:01 p.m. in trading on the New York Stock Exchange.

Close Relationship

Justices Stephen Breyer, Ruth Bader Ginsburg, Sonia Sotomayor and Elena Kagan dissented.

“The relationship between Janus Management and the fund could hardly have been closer,” Breyer wrote for the group. “Janus Management’s involvement in preparing and writing the relevant statements could hardly have been greater. And there is a serious suggestion that the board itself knew little or nothing about the falsity of what was said.”

The Obama administration and the Securities and Exchange Commission backed the shareholders at the Supreme Court. Although the case focused on the ability of private shareholders to sue, it may also limit the SEC.

“The ruling affects the SEC’s enforcement authority just as much as it impedes investors’ ability to bring private actions for false statements made through others,” said the Janus shareholders’ lawyer, David Frederick of Kellogg Huber Hansen Todd Evans & Figel PLLC in Washington.

SEC Reaction

John Nester, a spokesman for the commission, said the ruling “makes clear that the SEC has tools to pursue such cases.” Unlike private litigants, the SEC can sue companies and people for aiding and abetting a violation of the securities laws.

Even so, Breyer’s dissent questioned whether the SEC would be able to act in similar cases.

“Under the majority’s rule, it seems unlikely that the SEC itself in such circumstances could exercise the authority Congress has granted it” to pursue both so-called primary violators and those who aid and abet, he said.

Today’s decision limited the scope of Rule 10b-5, the SEC rule that bars companies from making false statements in connection with the purchase or sale of securities.

“We are delighted that the Supreme Court has agreed with our position that only the person ultimately responsible for a statement can be sued for fraud in a private class action under Rule 10b-5,” said Janus’s high court lawyer, Mark Perry of Gibson Dunn & Crutcher LLP in Washington.

The ruling “seems to disregard the importance of integrity in the markets,” Frederick said. “Investors are denied an important remedy if they are deceived by knowingly false statements made through intermediaries.”

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

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