So No One’s Responsible?

That’s the title of this recent op-ed in the NYT, sent to me from an investor in Key West. I believe this is the mutual fund industry’s version of plausible deniability, no?

With Justice Clarence Thomas writing for a 5-to-4 majority, the Supreme Court has made it much harder for private lawsuits to succeed against mutual fund malefactors, even when they have admitted to lying and cheating.

The court ruled that the only entity that can be held liable in a private lawsuit for “any untrue statement of a material fact” is the one whose name the statement is presented under. That’s so even if the entity presenting the statement is a business trust — basically a dummy corporation — with no assets, while its owner has the cash.

The facts of Janus Capital Group v. First Derivative Traders are outrageous. Janus Capital Group created and manages the Janus mutual funds through a business trust. For years, Janus Capital Group, through the Janus funds, worked with at least 10 hedge funds to “market time” — letting them trade rapidly in and out of Janus funds to benefit from delays in updates of asset prices and enjoy guaranteed profits. In 2004, Janus Capital Group admitted its wrongdoing and made a $225 million settlement.

While Janus Capital Group engaged in this improper trading through the Janus funds, the funds’ prospectuses assured that they had policies to prevent market timing. When a complaint from the New York State attorney general became public, the price of Janus Capital Group’s stock dropped by 23 percent. Some shareholders sued Janus Capital Group and Janus Capital Management, which oversees the business trust and funds, for making false statements that led to the drop.

Justice Thomas’s opinion is short and, from the mutual fund industry’s perspective, very sweet: Janus Capital Group and Janus Capital Management were heavily involved in preparing the prospectuses, but they didn’t “make” the statements so they can’t be held liable. Only the business trust set up to hold the funds can be held liable, though it has no assets of its own to compensate plaintiffs in the lawsuit. Which means that there is no one to sue for the misleading prospectuses.

There is no doubt that Janus Capital Group is responsible. It used legal ventriloquism to speak through the business trust and Janus funds. Janus Capital Management does everything for the funds, which have no employees. As Justice Stephen Breyer writes in dissent, “The relationship between Janus Management and the Fund could hardly have been closer.” For the majority, though, it is far enough apart to let the mutual fund industry and possibly others off the hook.

Cale Smith

About Cale Smith

Portfolio Manager at Islamorada Investment Management.
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