Securities Law: Private Litigation
The Court decided three cases relating to the legal obligations borne by issuers of securities under the Securities Exchange Act of 1934, and the private right of action that is available to enforce those obligations.
Section 10(b) of the Securities Exchange Act makes it unlawful for any person to use manipulation or deception in connection with the purchase or sale of a security (e.g. a mutual fund share). This statute is implemented by the Securities and Exchange Commission's ("SEC") Rule 10b-5, which makes it unlawful to make misleading statements involving untrue statements of "material facts," or omissions of material facts, in connection with the purchase or sale of a security. The Court has repeatedly upheld a private right of action to enforce these "antifraud" provisions of the securities law.
Erica P. John Fund v. Halliburton (09-1403) concerned the legal standard that must be met by plaintiffs seeking to obtain certification for a class action alleging violation of the antifraud laws. The Court unanimously held that, for purposes of class certification (as opposed to proving their case on the merits) plaintiffs are not required to prove "loss causation" - i.e. to allege specific facts showing that the defendant's material misstatements caused the plaintiff to suffer an economic loss. The Court held that such a requirement has no logical connection to the important question commonly involved in a class certification under Federal Rule of Civil Procedure 23 - i.e. whether the plaintiff relied on the defendant's allegedly material misstatements. The Court held that proof of loss causation is not required in order for a court to presume reliance based on the theory that market prices reflect all information available (the "fraud-on-the-market theory").
Janus Capital Group v. First Derivative Traders (09-525) concerned the allocation of responsibility for making allegedly fraudulent statements. In this case two separate legal entities - Janus Capital Management and Janus Investment Fund - were involved in the decision about how to describe Janus Investment Fund's investment practices for its mutual funds. Although the entities met the standard for legal independence, there was no question about their close relationship in fact: all of Janus Investment Fund's officers were also officers of Janus Capital Management. Nevertheless, the Court held 5-4 that only Janus Investment Fund should be considered to have "made" the allegedly misleading statements for purposes of the antifraud laws. Arguing that prior precedents established the need to carefully limit the private right of action under Rule 10b-5, the narrow majority held that only the person or entity with "ultimate authority" over a statement can be held to have made it. Because Janus Investment Fund was legally a separate entity, and because it was the only entity with a legally-binding disclosure obligation, the Court held that it should be the only entity deemed to have "made" the allegedly false statements. Justice Breyer issued a sharp dissent joined by Justices Ginsburg, Sotomayor, and Kagan. He argued that the majority's arguments exalted form over substance, failed to adhere to precedent, and could potentially create a legal loophole for dishonest managers.
Matrixx Initiatives v. Siracusano (09-1156) addressed the standard for "materiality" and the issue of intent ("scienter") for allegedly misleading statements. In this case, the defendant pharmaceutical company had argued that the plaintiffs' class action couldn't proceed because they hadn't met the standard for stating a legal claim under antifraud law. Matrixx had chosen not to disclose information about reports from scientists and the general public indicating that one of its leading products (Zicam) might be causing loss of smell in some people. Matrixx also chose not to disclose lawsuits that were initiated on the basis of this information, and issued a press release that downplayed concerns about Zicam. Matrixx argued that the information about Zicam wasn't material because no statistically-significant link had been shown between Zicam and loss of smell. The Court unanimously held that statistical significance is not the only indicator of causality, and that even in the absence of studies showing a statistically-significant connection between a product and adverse effects there may be a basis for concluding that information is material and should be disclosed. For this reason, the Court upheld the determination that the plantiffs had established a sufficient legal basis to proceed with their case against Matrixx.