4th Circuit Lets "Market Timing" Fraud Action Proceed Against Janus
The suit was filed by shareholders of Janus Capital Group, Inc. (JCG) alleging that JCG and its subsidiary violated § 10(b) and § 20(a) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. The complaint alleged that JCG and the subsidiary were responsible for misleading statements appearing in Janus fund prospectuses. These statements represented that the funds’ managers did not permit, and took active measures to prevent, "market timing" of the funds. (Market timing, as it occurred here, refers to the practice of rapidly trading in and out of a mutual fund to take advantage of inefficiencies in the way the fund values its shares--strategies like time-zone arbitrage, which can occur when a fund is invested in foreign securities. Market timing has the potential to harm other fund investors by diluting the value of shares, increasing transaction costs, reducing investment opportunities for the fund, and producing negative tax consequences.) The complaint alleged that statements about market timing appearing in various Janus fund prospectuses were misleading because they falsely represented that the funds had policies of preventing market timing when, in fact, fund managers explicitly permitted significant market timing and late trading to occur. The complaint alleged that the class bought fund shares at inflated prices and thereafter lost money when market timing practices authorized by defendants became known to the public.
The district court concluded that plaintiffs had failed to sufficiently plead certain elements of their claims. The Fourth Circuit disagreed.
As for primary liability under § 10(b) of the Act, the Court offered an extensive analysis about the type of "attribution" required to establish reliance for the "fraud on the market" theory (i.e., before a court will assume that misleading information is reflected in the market price of the security). The attribution issue is whether the publicly disseminated information is attributable to the defendant. The Court held that the complaint's allegations were sufficient to attribute the misleading statements to JCG's subsidiary, but not to JCG itself, based on the subsidiary's role as investment advisor. Thus, the primary liability claim may proceed against the subsidiary, but not against JCG itself.
As for JCG, however, the Court held that the complaint adequately pleaded a claim for "control person liability" under § 20(a) of the Act. This was based on the complaint's allegations of JCG's complete ownership of the subsidiary, overlapping management between the two, control of the subsidiary by JCG executives, and presumptive authority by JCG to regulate market timing activity in the Janus funds.