Janus Capital, the US Supreme Court and Political Decision Making: The Issue of Innocent Intermediaries (Part 6)

We are discussing the recent decision by the Supreme Court in Janus Capital v. First Derivative, a case that involved allegedly false disclosure in a prospectus issued by a mutual fund.

By limiting liability to those with "ultimate authority," the Court created an enormous gap in the protections provided by the antifraud provisions.  Essentially issuers could disclose false information to "innocent" intermediaries such as analysts, the press, and other third parties, without fear of liability.  As long as issuers did not have "ultimate authority" over the disclosure, they could not be sued under Rule 10b-5.  In effect, fraud distributed indirectly through these "innocent" intermediaries would allow issuers to commit fraud but escape liabilty under Rule 10b-5.   

The dissent made considerable hay out of the problem of "innocent" intermediaries.  Justice Breyer noted the unavailability of both Rule 10b-5 and Section 20(a). 

• And there is at least one significant category of cases that §10(b) may address that derivative forms of liability, such as under §20(a), cannot, namely, cases in which one actor exploits another as an innocent intermediary for its misstatements. Here, it may well be that the Fund’s board of trustees knew nothing   about the falsity of the prospectuses. See, e.g., In re Lammert, Release No. 348, 93 S. E. C. Docket 5676, 5700 (2008) (Janus Management was aware of market timing in the Janus Fund no later than 2002, but “[t]his knowledge was never shared with the Board”).  And if so, §20(a) would not apply.

Section 20(a) extends liability to "controlling persons".  15 USC 78t(a) ("Every person who, directly or indirectly, controls any person liable under any provision of this title or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable, unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action.").

Apparently stung by the criticism, the conservative majority left open the possibility that there was some recourse in the case of "innocent" intermediaries, at least under Section 20(b).  See Id. at n. 10 ("We do not address whether Congress created liability for entities that act through innocent intermediaries in 15 U.S.C.A 78t(b).").").  Section 20(b) extends liability to unlawful acts "through or by means of any other person."

Yet the reference is inconsistent with the analysis employed by the conservative majority and reflects an attempt to fill an analytical hole created by the faulty reasoning used by the conservative majority.  Nonetheless, it provides lower courts with a glimmer of authority that can be employed when issuers deliberately use innocent intermediaries to funnel fraudulent information to the market.