(The article featured below is a selection from Federal Securities Law Reporter, which is available to subscribers of that publication.)

Fourth Circuit Reverses Dismissal of Fund Fraud Action

A 4th Circuit panel reversed and remanded a district court's grant of a motion to dismiss a putative class action complaint brought against an asset management firm and its investment adviser subsidiary. According to the complaint, the firm and the adviser made misleading statements in prospectuses for certain of the firm's mutual funds. These statements represented that the fund's managers did not allow market timing of the funds and that they took measures to prevent the practice. The shareholders claimed that they suffered losses after it was publicly disclosed that the firm and adviser had secretly authorized several hedge funds to engage in market timing. The district court found that the shareholders failed to plead a viable securities fraud claim.

The panel found that the complaint sufficiently pleaded primary liability for fraud and, consequently, controlling person liability. The panel concluded that the shareholders successfully pleaded reliance based on the fraud-on-the-market presumption. According to the panel, the complaint adequately alleged that the firm and adviser made misleading statements that appeared in funds' prospectuses "by participating in the writing and dissemination of the prospectuses." The statements were sufficiently publicly attributable to the adviser, but not the firm, to hold it responsible. The court explained that it was clear that both disseminated the statements, but it would not be obvious that an investment adviser's parent company would be responsible for drafting a fund's prospectus.

With regard to the reliance requirement, the court stated that "at the complaint stage a plaintiff can plead fraud-on-the-market reliance by alleging facts from which a court could plausibly infer that interested investors would have known that the defendant was responsible for the statement at the time it was made, even if the statement on its face is not directly attributed to the defendant." According to the court, "direct attribution of a public statement, while undoubtedly sufficient to establish fraud-on-the-market reliance, is an inexact proxy for determining whether investors will attribute a publicly available statement to a particular person or entity. We conclude that the attribution determination is properly made on a case-by-case basis by considering whether interested investors would attribute to the defendant a substantial role in preparing or approving the allegedly misleading statement." The appeals panel concluded that "in light of the publicly available material, interested investors would have inferred that if JCM had not itself written the policies in the Janus fund prospectuses regarding market timing, it must at least have approved these statements. This circumstance is sufficient to support the adequacy of plaintiff's pleading of fraud-on-the market reliance as to JCM."

Next, the shareholders successfully pleaded loss causation because the complaint adequately alleged that the false or misleading statements in the prospectuses were a substantial cause of the decrease in the fund's share price when the fraud was publicly revealed. Finally, because the shareholders successfully pleaded a Section 10(b) claim, their allegations were sufficient to plead Exchange Act Section 20(a) controlling person liability. According to the panel, control existed because the firm wholly owned the investment adviser, the two shared a common director, and the firm had authority over the adviser.

� In re Mutual Funds Investment Litigation (4thCir) will be published in a forthcoming REPORT.