Monday’s Supreme Court ruling in favor of fund manager Janus may well turn out to be a bigger problem than Citizens United. I will address that in the next post, as I think the Janus situation says more than enough about the state of fund management to merit its own post.
According to Reuters, the Court ruled against shareholders of the parent company, who were suing on reasonable grounds:
The lawsuit was brought on behalf of those who bought Janus stock from mid-2000 through early September 2003.
It alleged that the prospectuses of several Janus funds created the false or misleading impression that the company would adopt measures to curb market timing — when in fact secret arrangements with several hedge funds permitted such transactions, to the detriment of long-term investors.
The Court’s ruling hinges on a technicality of the mutual fund structure. Funds in the US (and I believe in the UK and Europe too) are organized as separate corporations, which is why you will often see the word “Trust” or “Company” in the name. It is also why the funds have shareholder reports and prospectuses, just like any publicly traded company does, as well as allegedly independent and accountable boards of directors.
Nonetheless, until Monday, it was generally understood that parent fund companies were entirely liable for any language in fund advertisements, shareholder communications, etc., with much if not all of these materials subject to SEC review, so that each statement and statistic tends to be vetted exhaustively (which is also why those documents can be quite boring – there is no “will,” there is only “may”).
That has now changed.
Janus, in appealing to the Supreme Court, argued that the funds were separate legal entities and that neither the parent company nor its subsidiary was responsible for the prospectuses and could not be held liable.
The high court agreed. It ruled the alleged false statements in the prospectuses were made by an investment fund, not Janus Capital, and that Janus and the subsidiary therefore cannot be held liable in a private securities fraud lawsuit.
The article goes on to point out the ramifications for other types of organizations, which I will address separately. What it doesn’t address is the impact this is likely to have on investors in these funds. Under the current structure, shareholder communications (with some exceptions) are highly regulated, and in the case of annual reports they are subject to the same Sarbox certification requirements – and level of liability – as the annual audited financials of publicly traded companies. But following the Court’s logic, the liability for violations of Sarbox, or of the terms of the prospectus, can only fall on the fund, not the parent company.
That is bad enough until you consider that the funds by design have no assets of their own – the reason the structure of running as a separate company exists is to shield the income from taxes, so funds-as-companies have no cash of their own. They are minimal organizations.
Taken together, this means that fund companies are now able to violate even the terms they choose to present themselves, and to benefit from the average of 40% profit on management fees from running the funds, while now having no liability for wrongdoing beyond what the fund itself is able to pay, which is nothing.
What this will mean for 401k plans is something I can’t even fathom at this point.
I wish I could say the ruling was shocking, but considering the track record of the Roberts Court that would be silly. That said, it is still a bold step into new territory in the dismantling of protections for clients and shareholders, and marks another step away from that quant time when reputational concerns counted for something.
There is at least some poetic justice in the fact that the Janus funds have been in one of their periodic episodes of poor performance. Between bad performance and this clear statement of just what they think of their shareholders, it’s hard to see how the new CEO will be able to “stop the downward slide” he was hired to control.