The Supreme Court has today ruled that an investment adviser cannot be held liable under SEC Rule 10b-5 for false statements included in a client mutual fund’s prospectus because the statements were made by the mutual fund and not by its investment adviser. In so doing, the Court correctly upheld the corporate form and the most fundamental principles of contract and securities laws – which are collectively so essential to risk taking and economic development.
In Janus Capital Group, Inc v First Derivative Traders (June 13, 2011), Justice Clarence Thomas, for the majority, equates the relationship of the fund sponsor/ investment adviser to the fund company in preparing a prospectus, to a speechwriter and a speaker. The speaker is ultimately responsible for what is said. In so doing Justice Thomas rejected the plaintiff’s assertion that the correct relationship was more like a playwright (responsible for the words) to an actor (who merely recites them).
During my career in asset management the industry has endlessly debated the risks to an asset manager (and its advisers) of misstatements (or omissions) in a prospectus for securities issued by a special purpose vehicle but sponsored or advised by an investment company. Issuers have been raising capital in a climate of uncertainty given the propensity for judicial and administrative/ regulatory overreach (lifting the corporate veil).
In this climate of uncertainty, law firms have manufactured heavily industrialized, very expensive prospectus production processes (with costs ultimately borne by investors). The current process is burdensome, inefficient and slows the capital formation process. I’m not for a moment suggesting that offering documents should not be 100% accurate, balanced and not-misleading. However, one of the reasons that they are dense, complicated and basically useless to most potential investors is that they are prepared by lawyers in a regulatory environment completely at odds with the needs of investors today – concise, clear, electronic disclosure.
Justice Clarence Thomas’ majority opinion is clear, sensible, and entertaining. Wishful thinking in the era of Regulation but perhaps it will help create a legal and conceptual framework that will ultimately help law makers and regulators to re-imagine and simplify the current disclosure regime. Justice Breyer’s dissent is powerful and the majority is slim (5-4). It will be interesting to see the Court address this issue again with the precedent that Janus sets. Ultimately I’ll leave Justice Thomas with the final word:
“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.”
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