Supreme Court leaves fund investors hanging

[jimmy olsen]

Wretched decision.

http://www.marketwatch.com/story/supreme-court-leaves-fund-investors-hanging-2011-06-19?dist=countdown

Chuck Jaffe

June 19, 2011, 12:01 p.m. EDT
Supreme Court leaves fund investors hanging
Commentary: Janus ruling defies logic, endangers shareholders

By Chuck Jaffe, MarketWatch

BOSTON (MarketWatch) — To be misled by a prospectus into buying a mutual fund, an investor actually would have to read fund documents.

But for people who actually go through a fund's paperwork and use it in making decisions, being misled would seem the fault of the people who put it together — namely the fund's management and its parent company or sponsor.

The U.S. Supreme Court disagrees.

The high court has given investors one more reason to ignore a fund's documents, ruling that a fund's investment adviser may not be sued for securities fraud due to misstatements made in a fund's prospectus.

In a 5-4 decision last week, the high court tossed a lawsuit against Janus Capital Group Inc. /quotes/zigman/316841/quotes/nls/jns JNS +1.84% , the sponsor of Denver-based Janus mutual funds. The court ruled that Janus Capital and a subsidiary that advises the funds could not be sued for supposedly misleading statements in the prospectuses of the Janus funds.

The court reasoned that because the parent company is a separate entity from the funds themselves, only the fund can be held to the Securities & Exchange Commission's standard that "any person, directly or indirectly ... [making] any untrue statement of material fact" in the buying or selling process of a security is breaking the law.
Setback for all investors

While most people saw the decision as a setback for the plaintiff's bar — which has for years been hoping to extend liability up the corporate ladder to find new deep pockets to sue — it is also something of a setback for investors.

To see why, let's look at the case of Janus Capital Group v. First Derivative Traders.

The lawsuit was brought on behalf of people who owned Janus stock from mid-2000 through early September 2003. During that time, Janus had several secret arrangements with hedge funds that allowed those special investors to trade rapidly into and out of some funds, to the detriment of long-term fund holders.

The prospectus of those funds created the impression that Janus had adopted measures to curb such market-timing trades.

In 2003, regulators uncovered the rapid-trading deals at Janus and a number of other fund firms. Ultimately, in 2004, Janus paid $225 million to settle claims that it had failed to disclose the trading arrangements to long-term investors.

But that settlement was for investors in the fund, not in shares of Janus stock. The question in the case was whether the parent company — whose stock price cratered when news of the scandals broke — could be held responsible for making misleading statements in the documents.

Ultimately, the high court's decision boiled down to defining the word "make." Since the prospectus is produced by the fund, it was the fund — and not the parent company — that "made" the misleading statements.

That's a distinction without a difference, at least in the minds of ordinary investors. It's particularly hard to swallow when you consider that the SEC had pursued some Janus corporate executives for their role in this mess as executives of the fund company.

Most of the fund industry's law firms have said the Supreme Court decision was ideal, exactly what the fund industry needed. That alone should make ordinary investors nervous.

And the stock investors do have a beef here, not only in terms of how the scandal hit the sponsor's stock price, but also what happened afterwards. Janus instituted performance fees after the scandal, as a way to show that they were committed to doing right by fund shareholders. The problem with that, from the perspective of stockholders, is that performance fees make it more challenging to operate a public company, as they can alter the revenue stream when times get tough.
Ruling and rule-breaking

Fund companies will not take the court decision for granted. Expect language in a prospectus that indemnifies the parent company from actions tied directly to the fund. They'll bury that detail in the "statement of additional information," the second part of the prospectus that even diligent shareholders rarely read.

If management can "avoid liability," they can also ignore it.

At some point, if fund executives have enough financial incentive, they might even believe they can get away with breaking rules at the corporate level, because they know that only the legal entity of the fund — and not the deeper-pocketed parent — will be on the hook for their actions.

"Funds can have rules to cover just about anything, they could have allowed the market-timing so long as they let everyone do it," said Geoff Bobroff, an industry consultant from East Greenwich, R.I. "But whatever rules they establish must be equally and fairly administered, and that didn't happen with Janus and the others who got in trouble.

"To suggest that the sponsor is not responsible for what happens at the fund is illogical," he added. "If you buy a fund from Janus or Fidelity or Putnam or T. Rowe Price, you're thinking the parent is responsible. If they're not responsible — if they can't be held liable — there's no telling what they might think they can get away with someday."

Chuck Jaffe is a senior MarketWatch columnist. His work appears in many U.S. newspapers.

[Barrister]

Your cheerleading for the plaintiffs bar has been noted.

[Habbaku]

Your cheerleading for the plaintiffs bar has been noted.

To be fair, Tim probably has no idea what the article is even talking about.

[grumbler]

I agree that it is outrageous that the shareholders cannot sue the owners of the company! 

[Admiral Yi]

This article appears to contradict itself.  It first states that this hurts fund investors, then later states that the fund investors got paid off and it was the parent company investors that got shut out.

[alfred russel]

I agree that it is outrageous that the shareholders cannot sue the owners of the company! 

What would be interesting is if the shareholders could immunize themselves against shareholder lawsuits through the annual proxy process. I don't know what the results of a vote would be, but as the shareholder lawsuit process works now it seems to mostly benefit the legal profession.

[HVC]

mostly benefit the legal profession.

that covers basically all litigation

[DGuller]

Supreme Court leaves fund investors hanging

I guess they took the decision really hard.

[The Minsky Moment]

This article appears to contradict itself.  It first states that this hurts fund investors, then later states that the fund investors got paid off and it was the parent company investors that got shut out.

This case had nothing to do with the mutual fund investors; they all got paid out after Spitzer sued the funds and the SEC brought an administrative enforcement action back around 2003.

This case was a private class action lawsuit brought by stockholders in Janus Capital Group, which owns the investment advisor to the Janus Funds.  The individual Janus Funds are all set up as formally independent entities; that is, Janus Capital strictly speaking is not the "parent" of the mutual funds themslelves, just the investment advisor.

These distinctions all came into play in the Court's opinion.

[derspiess]

I first read the title as "Supreme Court fund leaves investors hanging".  I knew you could "invest" in lawmakers, but not the USSC

[The Minsky Moment]

Surprised Timmay didn't post the Wal-Mart class action opinion.

[garbon]

Surprised Timmay didn't post the Wal-Mart class action opinion.

Before I read the article, that's what I thought this was.

[grumbler]

Surprised Timmay didn't post the Wal-Mart class action opinion.

He might have actually tread that story, and so realized it wasn't worth posting about.

[jimmy olsen]

We already had a pretty big thread on that case earlier in the year didn't we? We know where we stand, why revisit the issue?

[The Minsky Moment]

He might have actually tread that story, and so realized it wasn't worth posting about.

I disagree; that opinion is likely to have a bigger impact, b/c it has implications of all kinds of class actions.