This article originally appeared in Bloomberg View on June 24th, 2011.
The hundreds of thousands of Americans who own shares in publicly traded mutual-fund companies — not to mention fans of corporate accountability — should be feeling a little unsettled by a recent U.S. Supreme Court ruling.
Janus Capital Management LLC, a mutual-fund adviser, was sued for fraud in 2003 by shareholders who said Janus and its publicly traded parent company, Janus Capital Group Inc., had lied in mutual-fund prospectuses, and that those lies had cost them a lot of money. On June 13, the Supreme Court threw out their case.
Here’s why they sued: Investors dumped shares of Janus, the parent company, in September 2003 after the New York State Attorney General’s Office accused the Denver-based group of entering into secret agreements to help hedge funds and other favored customers engage in market timing. This is a controversial — but legal — practice in which select investors trade in and out of funds to take advantage of pricing inefficiencies. As far as Janus investors knew, it wasn’t happening at Janus, which said in several of its prospectuses that it deterred market timing.
The firm wound up settling various regulatory complaints for $226 million. The settlements may have addressed the alleged wrongs to buyers of the mutual funds. But investors who were stuck with sunken shares of the parent company were never made whole. Now, the Supreme Court has said they never will be, either.
Copycat Suit
Mark Perry, a lawyer for Janus, said it “paid a significant amount of money” to resolve cases with New York and the Securities and Exchange Commission, and that the “copycat suit” was properly dismissed.
To understand why the decision is a slap in the face for Janus shareholders, and potentially those of other mutual-fund companies, you need to know a little about the strange corporate structure that most mutual funds use. There are the mutual funds that investors actually purchase, such as Janus’s Mercury Fund. Investors own the funds, which generally have no employees but “retain” a separate investment adviser to run the business and decide what the funds will invest in. In this case, Janus Capital Management played the adviser role. If the fund is publicly traded, there can also be another entity, a parent corporation like Janus Capital Group.
Suing Yourself
If something goes awry, this nifty arrangement makes it impractical to sue the fund — what’s the point of suing yourself? — and with the new Supreme Court ruling, it has now become exceedingly difficult for a shareholder to take action against the company that runs the fund, too. Thus, you purchase shares of companies in the mutual-fund business at your own risk because managements are no longer answerable to shareholders if the investment vehicles they “advise” get caught in a fib. (I garnish the words “advise” and “retain” with quotation marks because mutual funds have about as much control in choosing their advisers as most of us do when picking a cable-television provider.)
In Janus’s case, the fund and the adviser shared the same business address and the funds’ officers were also officers of the adviser. “The funds are inert, on life support, dominated by Janus Capital Group,” says William A. Birdthistle, an associate professor of law at Chicago-Kent College of Law and the co-author of a Supreme Court brief supporting the investors who sued Janus.
Clintonesque Opinion
The Supreme Court, though, said that both Janus, the publicly held company, and Janus, the investment adviser, were off the hook because neither was the entity that stated in a prospectus that market timing was discouraged. In a Clintonesque “it depends on what the meaning of the word ‘is’ is” opinion, Justice Clarence Thomas wrote that the defendants didn’t “make” the misstatements in the prospectuses — the mutual fund did.
Rule 10(b) 5 of the Securities Exchange Act of 1934 says it’s unlawful for a public company “to make any untrue statement of material fact,” and if you’re going to win a lawsuit based on that rule, you need to show that someone lied. The court says only the mutual fund could have “made” any untrue statements in this case.
Big Win
So Janus is acquitted with the aid of a dictionary, and public companies have a lot less to worry about when they shade the truth to shareholders. The decision is such a big win, in fact, that Birdthistle expects corporations outside of the investment-management business to alter their legal structures to gain the same protection that funds now enjoy. “In Delaware, with 30 minutes and $50, you can create a legal entity,” he says.
In its Corporate Code of Business Conduct, Janus Capital Group counsels employees that the letter of the law isn’t always enough. “While we monitor laws and regulations that apply to our business worldwide, we trust you to do the right, ethical thing even when the law is unclear,” it says.
When it comes to shareholders, though, the letter of the law, not to mention the general vocabulary, seems not to include the word “accountability.”