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Cardozo Law Review

Abstract

On June 13, 2011, in a 5-4 ruling that has generated much criticism, the Supreme Court decided Janus Capital Group, Inc. v. First Derivative Traders, a landmark case establishing the limits of secondary actor liability under section 10(b) of the Securities Exchange Act of 1934 (Exchange Act). Following Janus, investment managers who deceive and manipulate their shareholders no longer face the prospect of liability under section 10(b) as long as those managers perpetrate their fraud through the mutual fund itself which is, in essence, a business trust. More importantly, the decision holds that liability under section 10(b) may only be imposed upon issuers or any person or entity that ultimately has control over a false statement that is issued to the market. Janus will thus act as a bar to private lawsuits brought by investors under section 10(b) against secondary actors (such as attorneys, accountants, investment bankers, and counterparties). In effect, the blurry line between primary and secondary misconduct that investors had attempted to invoke in the aftermath of the Supreme Court's decisions in Central Bank and Stoneridge to seek broader redress for securities fraud has now been clarified to eviscerate secondary actor liability.

In an editorial entitled So No One's Responsible?, the New York Times commented that the decision was wrong because "[t]here is no doubt that [the fund adviser] is responsible" given that "[i]t used legal ventriloquism to speak through the business trust and [the] funds." Days later, Senate Judiciary Committee Chairman Patrick Leahy lamented that "the decision allows Wall Street companies to design new ways to evade accountability from the harm inflicted on hardworking Americans who have seen their life savings ravaged over the past few years by fraudulent investment schemes and corporate misconduct."

Not surprisingly, as the Supreme Court has limited the scope of private securities fraud liability since its decision over fifteen years ago in Central Bank, fraud in the financial markets has become increasingly prevalent. In light of this inverse relationship, this Article proposes that Congress amend section 20 of the Exchange Act (the control person provision) to include a private right of action against "any person [who] knowingly provides substantial assistance to another person in violation of" the Exchange Act. The proposed substantial participation standard would effectuate the remedial purpose of the federal securities laws, restore investor confidence in the United States's financial markets, and promote outside advisers' traditional role as gatekeepers of the securities market. In rejecting the formalistic approach adopted by the Supreme Court in Janus, the proposed standard also properly balances the need to permit investors to recover against outside advisers for securities fraud, and to limit frivolous claims at an early stage of the litigation. Furthermore, the SEC should enact a regulation mandating that investment advisers sign their funds' filings to ensure that investment advisers are treated as primary violators under section 10(b). Whatever the merits of creating categorical restrictions on primary liability for secondary actors, such restrictions should not apply to those who play a substantial role in assisting fraud, regardless of the "legal ventriloquism" involved in making false statements to the market.

Private securities litigation is a valuable and necessary part of the overall anti-fraud enforcement regime that compensates defrauded investors, deters fraud, promotes investor confidence in the financial markets, and facilitates the fair and efficient functioning of our capital markets. To restrict it in the manner the Supreme Court did in Janus is improvident and provides a blueprint for widespread immunity from securities violations.

Disciplines

Law | Securities Law

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