In re Mutual Funds Investment Litigation

• Decision Date: 07 May 2009
• Docket Number: No. 07-1607.,07-1607.
• Citation: 566 F.3d 111
• Parties: In re MUTUAL FUNDS INVESTMENT LITIGATION. First Derivative Traders, on behalf of itself and all others similarly situated, Plaintiff-Appellant, and Craig Wiggins, individually and on behalf of all others similarly situated, Plaintiff, v. Janus Capital Group, Incorporated, f/k/a Stilwell Securities Laws Financial, Incorporated; Janus Capital Management, Defendants-Appellees, and Mark B. Whiston; Loren M. Starr; Gregory A. Frost, Defendants.
• Court: U.S. Court of Appeals — Fourth Circuit

566 F.3d 111

In re MUTUAL FUNDS INVESTMENT LITIGATION.

First Derivative Traders, on behalf of itself and all others similarly situated, Plaintiff-Appellant, and Craig Wiggins, individually and on behalf of all others similarly situated, Plaintiff, v. Janus Capital Group, Incorporated, f/k/a Stilwell Securities Laws Financial, Incorporated; Janus Capital Management, Defendants-Appellees, and Mark B. Whiston; Loren M. Starr; Gregory A. Frost, Defendants.

No. 07-1607.

United States Court of Appeals, Fourth Circuit.

Argued: October 31, 2008.

Decided: May 7, 2009.

ARGUED: Ira M. Press, Kirby McInerney, L.L.P., New York, New York, for Appellant. Mark Andrew Perry, Gibson, Dunn & Crutcher, L.L.P., Washington, D.C., for Appellees. ON BRIEF: Amanda M. Rose, Gibson, Dunn & Crutcher, L.L.P., Washington, D.C., for Appellees.

Before MICHAEL, SHEDD, and DUNCAN, Circuit Judges.

Reversed and remanded by published opinion. Judge MICHAEL wrote the opinion, in which Judge DUNCAN concurred. Judge SHEDD wrote a separate concurring opinion.

OPINION

MICHAEL, Circuit Judge:

Plaintiff First Derivative Traders (First Derivative) appeals the Rule 12(b)(6) dismissal of its putative class action complaint, which alleges violations of § 10(b) and § 20(a) of the Securities Exchange Act of 1934(Act) and Securities and Exchange Commission (SEC) Rule 10b-5. First Derivative, individually and on behalf of certain shareholders of Janus Capital Group Inc. (JCG), filed the operative complaint against JCG and its wholly-owned subsidiary Janus Capital Management LLC (JCM). JCM is the investment advisor to the Janus mutual funds. The complaint alleges that JCG and JCM were responsible for certain misleading statements appearing in prospectuses for a number of the individual Janus funds during the class period. These statements represented that the funds' managers did not permit, and took active measures to prevent, "market timing" of the funds. First Derivative contends that class members (plaintiffs) bought JCG shares at inflated prices and thereafter lost money when market timing practices authorized by JCG and JCM became known to the public.

The district court concluded that plaintiffs had failed to sufficiently plead certain elements of a § 10(b) securities fraud action against either JCG or JCM. Additionally, the district court determined that plaintiffs' claim of control person liability against JCG under § 20(a) failed because plaintiffs had not pled a viable § 10(b) securities fraud claim against JCM. After reviewing the allegations on our own, we reach a different conclusion. We hold that plaintiffs' § 10(b) primary liability claim against JCM and plaintiffs' § 20(a) control person liability claim against JCG are sufficiently pled to overcome defendants' motion to dismiss. Accordingly, we reverse the district court's order granting defendants' motion to dismiss and remand the case for further proceedings.

I.

Plaintiffs seek to hold JCG and JCM liable for fraud under § 10(b) of the Act, 15 U.S.C. § 78j(b), and SEC Rule 10b-5, 17 C.F.R. § 240.10b-5. In addition, plaintiffs allege that JCG is liable under § 20(a) of the Act, 15 U.S.C. § 78t(a), as a control person of JCM.

The original complaint was filed against JCG in U.S. District Court in Colorado in November 2003 by Craig Wiggins, a purchaser of JCG common stock. On March 26, 2004, the Judicial Panel on Multidistrict Litigation transferred the Wiggins action from the District of Colorado to the District of Maryland for coordination with other actions involving allegations of market timing in the mutual funds industry. After the district court appointed a lead plaintiff (First Derivative) and lead counsel, First Derivative filed an amended complaint in September 2004, which, among other things, added JCM as a defendant. Defendants filed a motion to dismiss this amended complaint in February 2005, and the district court granted dismissal on the narrow ground that plaintiffs' class definition failed to satisfy the loss causation standard articulated in Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 125 S.Ct. 1627, 161 L.Ed.2d 577 (2005).

First Derivative then filed a second amended complaint (the complaint). The basic facts as alleged by the plaintiffs in the complaint are as follows. Defendant JCG is an asset management firm that, directly or through subsidiaries, sponsors and markets mutual funds and provides investment advisory and administrative services to the funds. Defendant JCM, a wholly-owned subsidiary of JCG, is JCG's primary operating company and there is overlap in the executive officers of the two companies. The greater part of JCG's revenue is generated by JCM. JCM serves as the investment advisor and administrator to the Janus funds. As investment advisor to the various Janus funds, JCM "is responsible for the day-to-day management of [the] investment portfolio and other business affairs of the funds." J.A. 206-07. "[A]s a practical matter" JCM runs the Janus family of funds. J.A. 212. First Derivative sues on behalf of persons who bought shares of common stock in JCG between July 21, 2000, and September 2, 2003, and still held shares on September 3, 2003, when their price dropped, allegedly as a result of the public disclosure of defendants' misconduct with respect to market timing.

Shares in the Janus funds were offered for sale by prospectuses that JCG and JCM "caused ... to be issued" and "made ... available to the investing public." J.A. 203. The prospectuses were made available to potential investors on a joint Janus funds-JCG-JCM website, www.janus.com. The prospectuses for a number of the individual Janus funds stated that the funds had policies of discouraging market timing and that the funds engaged in measures to deter such behavior.

Market timing, as it occurred here, refers to the practice of rapidly trading in and out of a mutual fund to take advantage of inefficiencies in the way the fund values its shares. Some funds, including the Janus funds, use stale prices to calculate the value of the securities held in the fund's portfolio (net asset values (NAVs)), which may not reflect the fair value of the securities as of the time the NAV is calculated. The use of stale prices to calculate the NAV makes a fund vulnerable to time zone arbitrage and other similar strategies; repeated use of such strategies is referred to as "timing" the fund. Time zone arbitrage can occur when a fund is invested in foreign securities. As we explained in In re Mutual Funds Investment Litig.:

[T]ime zone differences allow market timers to purchase shares of [mutual] funds [that invest in foreign securities] based on events occurring after foreign market closing prices are established, but before the fund's NAV calculation. Prior to the daily NAV calculation, which in the United States generally occurs at or near the closing time of the major U.S. securities markets, the fund price would not take into account any changes that have affected the value of the foreign security. Therefore, if the foreign security had increased in value, the NAV for the mutual fund would be artificially low. After purchasing the shares at the low price, the market timer would redeem the fund's shares the next day when the fund's share price would reflect the increased prices in foreign markets, for a quick profit at the expense of the long-term fund shareholders.

529 F.3d 207, 211 (4th Cir.2008) (internal citations and quotations omitted). Market timing has the potential to harm other fund investors by diluting the value of shares, increasing transaction costs, reducing investment opportunities for the fund, and producing negative tax consequences.

Plaintiffs charge that statements about market timing appearing in the various Janus fund prospectuses were misleading because they falsely represented that the Janus funds had policies of preventing market timing when, in fact, fund managers explicitly permitted significant market timing and late trading to occur.

Specifically, plaintiffs allege in their complaint that Janus fund prospectuses filed with the SEC and available at the Janus website "included language that said Janus' funds were `not intended for market timing or excessive trading' and said `Janus had measures in place to stop th[is] trading.'" J.A. 212-13. The complaint also cites numerous passages from prospectuses for individual Janus funds condemning the practice of market timing and outlining steps that would be taken to exclude market timers or excessive traders from the funds. For example, the complaint quotes the "Excessive Trading Policy" as set forth in the February 28, 2003, prospectus for the Janus Mercury Fund:

Frequent trades in your account or accounts controlled by you can disrupt portfolio investment strategies and increase Fund expenses for all Fund shareholders. The fund is not intended for market timing or excessive trading. To deter these activities, the Fund or its agent may temporarily or permanently suspend or terminate exchange privileges of any investor who makes more than four exchanges out of the Fund in a calendar year and bar future purchases into the Fund by such investor. In addition, the Fund or its agent also may reject any purchase orders (including exchange purchases) by any investor or group of investors indefinitely for any reason, including, in particular, purchase orders that they believe are attributable to market timers or are otherwise excessive or potentially disruptive to the Fund.

Orders placed by an investor in violation of the exchange limits or the excessive trading policies or by investors that the Fund believes are market timers may be revoked or cancelled by the Fund....

J.A. 213. The complaint repeats this language as it appeared in an earlier Janus Mercury Fund prospectus filed on Form N-1A with the SEC on February 25, 2002, and notes that "[p]rospectuses for the Janus Enterprise Fund, Janus Mercury Fund, Janus...