Supreme Court Decision Provides Legal Cover to Executives

A slew of recent decisions that address the scope of primary liability under federal securities laws give companies an early glimpse into how lower courts are interpreting the U.S. Supreme Court's decision in Janus Capital Group v. First Derivative Traders.

In Janus the Supreme Court ruled in a 5-4 decision in June that a mutual fund's investment adviser wasn't liable for securities fraud due to mis-statements made in a fund's prospectus, because the fund itself—a separate entity from the investment adviser—ultimately controls the statements. It was a landmark decision on the legal protections that are afforded to separate, but related, companies.

It also sheds light on the legal liability of individuals who make statements on a company's behalf. Rule 10b-5 of the Securities Exchange Act states that it is unlawful for “any person, directly or indirectly … [to] make any untrue statement of a material fact” in connection with the sale or purchase of securities. In Janus, the Court defined the maker of a statement as “the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it. Without control, a person or entity can merely suggest what to say, not ‘make' a statement in its own right.”

Because private plaintiffs frequently sue corporate officers, directors, or employees for statements made on behalf of a corporate issuer, many legal experts and analysts have speculated that the decision could be extended to  such claims.

Now they have plenty of precedents.  In general the courts are applying Janus to extend the protection to individuals who don't have ultimate authority for company statements.

Some lawyers say the Janus decision could be considered problematic in some situations. “There seems to be an undertone in some of these cases where the courts don't say they're looking for ways around Janus, but you get the feeling that they are,” says Tom Gorman, a partner with law firm Dorsey & Whitney.

For example, Gorman cites the recent case, Hawaii Ironworkers Annuity Trust Fund v. Cole, where a Northern District of Ohio court held that the scope of Rule 10b-5 liability defined in Janus protects corporate officers who internally report false financial results at the direction of other executives. Janus does not, however, protect corporate officers from deceptive conduct, the court said.

Prior to Janus the court had denied a motion to dismiss, concluding that the corporate officers could be held primarily liable. The case stemmed from a lawsuit filed by a former shareholder of a bankrupt company, alleging that corporate officers internally reported false financial results that contributed to the company issuing false financial statements. The complaint specifies that the officers falsified the financial results to comply with a “mandatory 6 percent profit margin” imposed by the company's chief executive and chief financial officer.

Accordingly, the court reversed its earlier ruling and held that Janus barred the Rule 10b-5(b) claims because the corporate officers did not have ultimate authority over the alleged false statements. The court declined to dismiss, however, the related Rule 10b-5(a) and (c) claims asserting deceptive conduct for the same actions.

That portion of the court's decision was in response to language in Janus, suggesting that liability for drafting a false statement should be treated the same way as liability for engaging in deceptive conduct, leaving the issue open for further interpretation, explains David Simon, a partner in the litigation department of Wildman Harrold.

Gorman stresses that officers, directors, or employees of companies could still be held primarily liable in damage actions, or even SEC enforcement actions.

For example, in In re Merck, a court held executives liable for false statements despite Janus, and the SEC followed with an enforcement action. The case stems from allegations that pharmaceutical giant Merck and its senior executives misled shareholders by downplaying the heart-attack risks linked to its blockbuster painkiller Vioxx. The New Jersey District Court rejected one executive's argument that the Rule 10b-5 claims against him should be dismissed on the basis of Janus because the complaint failed to allege he had “ultimate authority” over the statements made on Merck's behalf.

“There seems to be an undertone in some of these cases where the courts don't say they're looking for ways around Janus, but you get the feeling that they are.”

—Tom Gorman,

Partner,

Dorsey & Whitney

But the court disagreed. The holding in Janus, the court said, is limited to cases involving a “separate and independent entity” and could not “be read to restrict liability for Rule 10b-5 claims against corporate officers to instances in which a plaintiff can plead, and ultimately prove, that those officers—as opposed to the corporation itself—had ‘ultimate authority' over the statement.”

In Merck, the executive signed official statements and was quoted in articles in his capacity as Merck's executive vice president for science and technology and president of Merck Research Laboratories. For this reason, the court declined to dismiss the claims against him.

In another case, I.B. of T. Grocery and Food Employees Welfare Fund, the Alabama district court decided on June 7 that Janus does not preclude Rule 10b-5 liability for officers who sign false and misleading Sarbanes-Oxley certifications. The district court held that the defendants had ultimate authority over their own statements including the company's financial statements.

More to Come

Janus may have limited the scope of Rule 10b-5 violations in cases involving private rights of action, but it did not deter the Securities and Exchange Commission from bringing aiding and abetting charges against corporate officers and directors.

At least one court has made this point clear. In SEC v. Daifotis, Judge William Alsup of the Northern District of California found that Section 17(a) of the Securities Act claims based on false statements were not limited to claims against the “ultimate authority” for the false statement. 

JANUS DENIED

The following excerpt from I.B. of T. Grocery v. Regions Financial explains why Janus does not apply to this case:

Regions correctly points out that the Supreme Court in Janus instructs that a

Rule 10b-5 action must be applied consistent with the narrow dimensions of this

private cause of action, and thus, can only be brought against a person who

“makes” a statement. See Janus Capital Group, Inc. v. First Derivative Traders,

131 S.Ct. 2296, 2302-2303 (2011). In that case, the Court had to “determine

whether Janus Capital Management LLC (JCM), a mutual fund investment

adviser, can be held liable in a private action under Securities and Exchange

Commission (SEC) Rule 10b-5 for false statements included in its client mutual

funds' prospectuses.” Id., at 2299. Under Rule 10b-5, “the maker of a statement

is the person or entity with ultimate authority over the statement, including its

content and whether and how to communicate it.” Id., at 2302. Relying on that

standard, the Supreme Court found that JCM did not make the statements in the

prospectuses. However, unlike the separate legal entities in Janus, the defendants

here are in ultimate authority over their statements. Plaintiffs allege specifically

that defendants C. Dowd Ritter, Alton E. Yother and Irene

M. Esteves fraudulently signed SOX certifications accompanying

Regions' SEC filings. See Mizzaro v. Home Depot, Inc., 544 F.3d 1230, 1252

(11th Cir. 2008)(“a Sarbanes-Oxley certification is only probative of scienter if

the person signing the certification was severely reckless”). Nothing in Janus

stands for the proposition that CEOs and CFOs can not be liable for false and

misleading statements in their own company's financial statements, for which they

signed Sarbanes-Oxley certifications. Thus, nothing in Janus supports

defendants' motion for reconsideration.

Source: I.B. of T. Grocery v. Regions Financial.

If the “ultimate authority” limitation is not imposed under Section 17(a), Janus “effectively provides scant limitation to the government's regulatory reach,” since the SEC typically charges false statement cases under both Section 10(b) and 17(a), Ethan Brown, a partner of law firm Spillane Weingarten, said in a client alert.

The Daifotis case highlights that Janus offers little relief for defendants in government enforcement actions. “The SEC may still be able to charge participants in the publication of false or misleading statements—even those who don't have ultimate authority over the statements—with primary violations of the securities laws,” wrote Brown.

Because the Janus decision is so new and there have been relatively few decisions concerning executives' interpretations of it, “there are still lots of open issues that haven't been decided,” says Simon.

Analysts have theorized for years, for example, that companies that post analyst reports on their Website might be responsible for those reports, or companies that use analysts as conduits for putting information in statements may be liable, Jordan Eth, a partner at law firm Morrison & Forester, said during a Sept. 7 Webcast. “Certainly,” he said, “I think those will be challenged.”