In Re: ProShares Trust Sec. Litig., No. 12-3981 (2d Cir. 2013)
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Plaintiffs filed a putative class action seeking to hold ProShares liable for material omissions and misrepresentations in the prospectuses for certain exchange-traded funds (ETFs) under the Securities Act of 1933, 15 U.S.C. 77k and 77o. Plaintiffs alleged that registration of statements omitted the risk that the ETFs, when held for a period of greater than one day, could lose substantial value in a relatively brief period of time, particularly in periods of high volatility. The district court concluded that the disclosures at issue accurately conveyed the specific risk that plaintiffs asserted materialized. The court agreed with the district court's conclusion that the relevant prospectuses adequately warned the reasonable investor of the allegedly omitted risks.
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12-3981 In Re ProShares Trust Sec. Litig. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT August Term, 2012 (Argued: May 2, 2013 Decided: July 22, 2013) Docket No. 12-3981 IN RE PROSHARES TRUST SECURITIES LITIGATION MARK KARASICK, STEVEN S. NOVICK, SUSAN ASAI, STEPHEN C. HERMAN, CHARLES SANKOWICH, MICHAEL A. HYMAN, HOWARD SCHWACK, FRANCISCO JAVIER DE LION DIAZ, RENE LACROIX, ANTHONY KOURI, ANTHONY ALEXANDER, JAY BILYEU, JUDY BILYEU, MICHAEL ERIC CODLIN, WENDY ROCKWELL-GOFF, ROBERT SCHUMACHER, JAMES HERSHMAN, DOROTHY HERSHMAN, SCOTT TESSLER, RICHARD RHOADS, MARTIN GARY NORRIS, DOROTHY LOWELL, NANCY HITCHINS, THOMAS TRUONG, EDWARD CISNEROS, CHRIS HONCIK, STEPHEN SHOAP, DMITRI ROUTSKI, ELENA LAVENDER-BOWEN, DAVID BOWMAN, DAVID CHOW, MARK EVERETT BROWN, JONATHAN DEAN, LAWRENCE LEWIS SINSEL, JR., KENNETH L. KRAMER, LAWRENCE I. WEINER, JOHN E. KILLOUGH, ALAN PARKER, SCOTT A. SMELTZ, HOWARD SCHWACK, DOUGLAS JONES, STEPHEN HERMAN, ON BEHALF OF THEMSELVES AND ALL OTHERS SIMILARLY SITUATED, STEVEN SCHNALL, SHERRI SCHNALL, ON BEHALF OF THEMSELVES, Plaintiffs-Appellants, v. PROSHARES TRUST, PROSHARE ADVISORS LLC, SEI INVESTMENTS DISTRIBUTION CO., MICHAEL L. SAPIR, LOUIS M. MAYBERG, RUSSELL S. REYNOLDS, III, MICHAEL WACHS, SIMON D. COLLIER, PROSHARES TRUST II, EDWARD KARPOWICZ, WILLIAM E. SEALE, CHARLES TODD, BARRY PERSHKOW, Defendants-Appellees. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 Before: WESLEY, CARNEY, WALLACE,* Circuit Judges. Appeal from an order of the United States District Court for the Southern District of New York (John G. Koeltl, Judge), entered on September 12, 2012, dismissing Plaintiffs-Appellants third amended complaint, with prejudice, pursuant to Federal Rule of Civil Procedure 12(b)(6). Plaintiffs complain that Defendants offered investments in forty-four leveraged exchange-traded funds ( ETFs ) through prospectuses that failed to warn them about the magnitude and probability of loss in beyond-a-day investments even when investors correctly predicted the overall direction of the ETFs underlying index. Furthermore, Plaintiffs allege that Defendants included various contra-indicators of successful long-term investments in the prospectuses which the alleged omissions made misleading. Accordingly, Plaintiffs seek to hold Defendants liable for the alleged omissions and misleading statements pursuant to sections 11 and 15 of the Securities Act of 1933, 15 U.S.C. §§ 77k & 77o. After a comprehensive review of the relevant prospectuses, the district court concluded that the alleged omissions were immaterial as a matter of law because the prospectuses warned of the risks that materialized and no reasonable investor who read them would have been misled about the risks of leveraged-ETF investments. After our own review of the complaint and of the prospectuses, we agree with that conclusion. AFFIRMED. CHRISTOPHER LOVELL, Lovell Stewart Halebian Jacobson LLP, New York, NY (Jacob H. Zamansky, Zamansky & Associates LLC, New York, NY, on the brief), for Plaintiffs-Appellants. ROBERT A. SKINNER, Ropes & Gray LLP, Boston, MA (Nick W. Rose, Ropes & Gray LLP, Boston, MA; * The Honorable J. Clifford Wallace, of the United States Court of Appeals for the Ninth Circuit, sitting by designation. 2 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 Douglas H. Hallward-Driemeier, Ropes & Gray LLP, Washington, D.C., on the brief), for Defendants-Appellees ProShares Trust, ProShares Trust II, ProShare Advisors LLC, SEI Investments Distribution Co., Michael Sapir, Louis Mayberg, Edward Karpowicz, William Seale, Simon Collier, Charles Todd, and Barry Pershkow. Arthur H. Aufses III, Steven S. Sparling, Kramer Levin Naftalis & Frankel LLP, New York, NY, for Defendants-Appellees Russell Reynolds and Michael Wachs. WESLEY, Circuit Judge: In this putative class action, Plaintiffs collectively 18 purchased shares in forty-four leveraged ProShares exchange- 19 traded funds ( ETFs ) during the August 6, 2006 through June 20 23, 2009 class period. 21 ¶¶ 1-2. 22 Trust and ProShares Trust II (collectively, ProShares ) 23 liable for material omissions and misrepresentations in the 24 prospectuses for those ETFs pursuant to sections 11 and 15 25 of the Securities Act of 1933 ( 33 Act ), 15 U.S.C. §§ 77k 26 & 77o.1 Third Amended Complaint ( TAC ) They seek to hold Defendants-Appellees ProShares 1 Defendant-Appellee ProShares Trust ( ProShares I ) registered with the Securities and Exchange Commission ( SEC ) as an open-end management investment company under the Investment Company Act of 1940. TAC ¶ 62(a). Defendant-Appellee ProShares Trust II ( ProShares II, collectively with ProShares I ProShares ) registered with the Commodity Futures Trading 3 1 2 A. Exchange-Traded Funds In a series of press releases, ProShares indicated 3 that their ETFs were for investors interested in pursuing 4 more sophisticated trading strategies. 5 (internal quotation marks omitted). 6 investors could hedge and manage risk without having to go 7 through the process of setting up margin accounts or 8 covering margin calls - they [could] simply trade 9 ProShares. See TAC ¶¶ 104-08 With ProShares ETFs, TAC ¶ 104 (quoting June 21, 2006 Press 10 Release). 11 lose more than [she] invest[s]. 12 1, 2007 Press Release). This is because ETFs operate like 13 indexed mutual funds but trade like stocks. 14 And unlike a margin account,[an investor] can t TAC ¶ 106 (quoting Feb. TAC ¶ 82. ETFs frequently track an index, a sector of stocks, or 15 a commodity or currency. TAC ¶ 81. They are considered to 16 be indexed mutual funds that trade like stocks, TAC ¶ 82, 17 but they differ from mutual funds because they are generally 18 sold to institutional investors in large blocks of shares, Commission as a commodity pool. TAC ¶ 62(b). ProShares I offered thirty-eight of the ETFs underlying this action; ProShares II offered six. TAC ¶ 62(a), (b). Plaintiffs have not identified any meaningful distinction between ProShares I s and ProShares II s securities or registration statements such that one of the fund defendants would be subject to liability while the other would not. 4 1 called Creation Units. These investors generally purchase 2 Creation Units in exchange for baskets of securities that 3 mirror the securities in the ETF portfolio. 4 purchase Creation Units often split up the Units into 5 individual shares and sell them on a secondary market to 6 retail investors who otherwise might not be able to access 7 ETFs because of the cost of Creation Units. 8 investors are then able to sell shares of ETFs on the 9 secondary market, but they generally cannot redeem shares Investors who These retail 10 with the ETFs because the ETFs often redeem shares only when 11 they are packaged in Creation Units. 12 TAC ¶ 82. ProShares offered three types of ETFs: (1) an Inverse 13 ETF, (2) an Ultra Long ETF, and (3) an Ultra Short ETF. TAC 14 ¶ 93(a)-(c). 15 movement of the specified index over one day. 16 An Ultra Long ETF tried to double the performance of the 17 underlying index or benchmark on a daily basis. 18 93(b). 19 inverse of the performance of the underlying index or 20 benchmark on a daily basis. 21 the specific index, benchmark, sector or commodity on which 22 an ETF [was] based[] increase[d] by 1% on a given day, then An Inverse ETF aimed to replicate the inverse TAC ¶ 93(a). TAC ¶ And an Ultra Short ETF was designed to double the TAC ¶ 93(c). 5 Accordingly, if 1 [the Inverse ETF] would decrease by 1%; the [Ultra Long ETF] 2 would increase by 2%; and [the Ultra-Short ETF] would 3 decrease by 2%. 4 case is leveraged. TAC ¶ 94. Each one of the ETFs in this 5 B. Registration Statements 6 ProShares I filed its registration statement on SEC 7 Form N-1A. TAC ¶ 89. ProShares II filed its registration 8 statement on Forms S-1 and S-3. 9 statements consisted of, inter alia, a prospectus and a TAC ¶ 91. The registration 10 statement of additional information ( SAI ). 11 ProShares I and ProShares II provided investors with several 12 different offering documents relevant to this appeal, 13 ProShares key disclosures relating to the ETFs at issue 14 here were materially consistent across all of the documents. 15 Though All relevant ProShares registration statements 16 disclosed that the ETFs pursued daily investment objectives 17 and daily investment results. 18 Item 1; App x B, Item 1. 19 make clear that these daily objectives were bets that it 20 could return a stated multiple of an ETF s underlying index 21 each day by investing in different components of the 22 underlying index through various financial instruments. See Skinner Decl., App x A, ProShares I s offering documents 6 For 1 example, principal investment strategies include[d 2 i]nvesting in equity securities and/or financial instruments 3 (including derivatives) that ProShare Advisors believe[d], 4 in combination, [w]ould have similar daily price return 5 characteristics of a stated multiple of the ETF s 6 underlying index. 7 June 19, 2006 ProShares I Reg. Stmt at 7. To achieve the predicted daily investment results, 8 ProShare Advisors or a Sponsor would determine the type, 9 quantity, and mix of investment positions that an ETF should 10 hold. In addition, ProShares reserved the right to 11 substitute a different index or security for an ETF s 12 underlying index and disclosed that it might over-weight or 13 under-weight certain components contained in the underlying 14 index. 15 2008 ProShares II Reg. Stmt. at 33-34. 16 ETFs never took a defensive position and would remain fully 17 invested at all times in securities and/or financial 18 instruments that provide exposure to its [u]nderlying 19 [i]ndex without regard to market conditions, trends, or 20 direction. 21 also Nov. 17, 2008 ProShares II Reg. Stmt. at 33. 22 views were expressly myopic: long-term objectives were See, e.g., id. at 59-60; see also, e.g., Nov. 17, Furthermore, the June 19, 2006 ProShares I Reg. Stmt at 60; see 7 The ETFs 1 blurred because they were focused only on meeting a 2 benchmark tied to an underlying index one day at a time with 3 a portfolio of different securities. 4 Moreover, ProShares warned that its decision to invest 5 in a particular stock or financial instrument was not based 6 on the investment merit of a particular security, 7 instrument, or company and that it did not use 8 conventional stock research or analysis, or forecast stock 9 movement or trends in managing the assets of the funds. 10 June 19, 2006 ProShares I Reg. Stmt at 60; see also Nov. 17, 11 2008 ProShares II Reg. Stmt. at 34. 12 pursued daily results through aggressive investment 13 techniques. 14 warned that the ETFs used financial instruments and 15 investment techniques . . . that may be considered 16 aggressive, including the use of futures contracts, options 17 on futures contracts, securities and indices, forward 18 contracts, swap agreements, and similar instruments. 19 Skinner Decl., App x A, Item 6. 20 that use of these techniques and financial instruments 21 exposed the ETFs to potentially dramatic losses. 22 Similarly, each relevant ProShares II prospectus warned that Instead, ProShares ETFs For ProShares I, each registration statement 8 See ProShares I also disclosed Id. 1 the aggressive financial instruments had volatile [trading 2 prices, and that] even a small movement in market prices 3 could cause large losses because an ETF investment was 4 speculative and involved a high degree of risk. 5 App x B, Item 6. 6 See id., ProShares also warned that ETFs could not pursue their 7 stated objectives for beyond-a-day periods because 8 mathematical compounding and leveraging prevented the ETFs 9 from reaching those results. See id., App x A, Item 2; 10 App x B, Item 2. In that regard, ProShares disclosed that 11 [o]ver time, the cumulative percentage increase or decrease 12 in the net asset value of the [ETFs] may diverge 13 significantly from the cumulative percentage increase or 14 decrease in the multiple of the return of the Underlying 15 Index due to a compounding effect of daily gains and 16 losses.2 17 direct: [u]sing leverage . . . should be considered . . . 18 speculative and could result in the total loss of an 19 investor s investment. 20 brief, ProShares provided a hypothetical illustration of two For ProShares II, the warning was even more See id., App x B, Item 6. 2 In its Beginning with its September 2007 registration statement, this information was moved to the SAI. 9 1 investors who invested in an Ultra Long ETF at separate 2 times to illustrate the effect an index s volatility would 3 have on those investments returns. 4 example in Appendix A. We have provided that 5 C. Alleged Omissions and Misstatements 6 Plaintiffs principally complain that ProShares failed 7 to disclose the magnitude and probability of loss for 8 beyond-a-day investments in ProShares ETFs despite 9 investors correct predictions regarding the overall 10 movement of the indices underlying the ETFs. Furthermore, 11 Plaintiffs allege that the registration statements contained 12 various contra-indicators of successful long-term 13 investments which the above omissions made materially 14 misleading. 15 dismissed the complaint with prejudice pursuant to Federal 16 Rule of Civil Procedure 12(b)(6). 17 Sec. Litig., 889 F. Supp. 2d 644 (S.D.N.Y. 2012). 18 the district court concluded that ProShares warned of the 19 risks that materialized. 20 agree. The district court rejected these arguments and In re ProShares Trust In sum, For the reasons that follow, we 21 22 10 1 2 3 DISCUSSION The standard of review is neither contested nor determinative.3 4 A. Alleged Omissions 5 Liability attaches to a security s issuer, its 6 underwriter, and certain other statutorily enumerated 7 parties pursuant to section 11 of the `33 Act if any part 8 of the operative registration statements omitted to state a 9 material fact required to be stated therein or necessary to 10 make the statements therein not misleading. 11 77k(a); see also In re Morgan Stanley Info. Fund Sec. 12 Litig., 592 F.3d 347, 360 (2d Cir. 2010). 13 plausible section 11 claim based on an alleged omission, a 14 complaint must pass two distinct hurdles: it must identify 15 an omission that is (1) unlawful and (2) material. 16 Morgan Stanley, 592 F.3d at 360. 17 [m]ateriality alone does not demand disclosure, nor does 18 the duty to disclose encompass non-material information. 3 15 U.S.C. § To state a See In other words, We review de novo the dismissal of a complaint under [Federal] Rule [of Civil Procedure] 12(b)(6), accepting all factual allegations as true and drawing all reasonable inferences in favor of the plaintiff. Litwin v. Blackstone Grp., L.P., 634 F.3d 706, 715 (2d Cir. 2011) (internal quotation marks omitted). 11 1 Panther Partners, Inc. v. Ikanos Commc ns, Inc., 538 2 F.Supp.2d 662, 668 (S.D.N.Y. 2008). 3 A plaintiff who plausibly pleads an unlawful omission 4 comes close to stating a section 11 claim because 5 materiality will rarely be dispositive in a motion to 6 dismiss. 7 Nevertheless, the materiality hurdle remains a meaningful 8 pleading obstacle, and we will dismiss a section 11 claim 9 where the alleged omission was so obviously unimportant to 10 a reasonable investor that reasonable minds would agree on 11 that omission s unimportance. 12 omitted). 13 to set too low a standard of materiality, for fear that 14 management would bury the shareholders in an avalanche of 15 trivial information. 16 Siracusano, 131 S.Ct. 1309, 1318 (2011) (quoting Basic 17 Inc. v. Levinson, 485 U.S. 224, 231 (1988)). See Morgan Stanley, 592 F.3d at 360. Id. (internal quotation marks In fact, the Supreme Court has been careful not Matrixx Initiatives, Inc. v. 18 In judging whether an alleged omission was material in 19 light of the information already disclosed to investors, we 20 consider whether there is a substantial likelihood that 21 the disclosure of the [omitted material] would have been 22 viewed by the reasonable investor as having significantly 12 1 altered the total mix of information [already] made 2 available. 3 Cir. 2003) (emphasis added) (quoting TSC Indus., Inc. v. 4 Northway, Inc., 426 U.S. 438, 449 (1976)). 5 sufficient to allege that the investor might have considered 6 the misrepresentation or omission important. 7 Citizens Utils. Co., 228 F.3d 154, 162 (2d Cir. 2000). 8 While the objective of a prospectus is to solicit 9 investment by the general public and the intended audience DeMaria v. Andersen, 318 F.3d 170, 180 (2d It is not Ganino v. 10 . . . encompasse[s] both sophisticated financial analysts 11 and untutored lay persons, Greenapple v. Detroit Edison 12 Co., 618 F.2d 198, 210 (2d Cir. 1980), the prospectuses are 13 not required to address [reasonable investors] as if they 14 were children in kindergarten, id. (quoting Richland v. 15 Crandall, 262 F. Supp. 538, 554 (S.D.N.Y. 1967)). 16 words of the district court below, [w]hen a registration 17 statement warns of the exact risk that later materialized, a 18 [s]ection 11 claim will not lie as a matter of law. 19 ProShares, 889 F. Supp. 2d at 653. 20 In the Here, the district court concisely summarized 21 Plaintiffs allegations: the thrust of the [P]laintiffs 22 [s]ection 11 claim is that the registration statements 13 1 omitted the risk that the ETFs, when held for a period of 2 greater than one day, could lose substantial value in a 3 relatively brief period of time, particularly in periods of 4 high volatility. 5 that claim in equally concise language: the disclosures in 6 the registration statements accurately conveyed the specific 7 risk that the [P]laintiffs assert materialized: when 8 investors held the ETFs for periods longer than one day the 9 funds performance widely diverged from the performance of Id. at 654. The district court dismissed 10 the underlying indices sometimes resulting in losses despite 11 the overall direction of the underlying indices. 12 656. 13 warned the reasonable investor of the allegedly omitted 14 risks. We agree that the relevant prospectuses adequately 15 16 Id. at 1. The Magnitude of Beyond-A-Day Losses Plaintiffs allege that the registration statements 17 omitted the risk that correctly predicting the long-term 18 movement in an ETF s underlying index could result in a 19 substantial loss in their investment over that same period 20 of time. 21 warned that the value of long-term ETF investments may 22 diverge significantly from that ETF s underlying index. Plaintiffs acknowledge that the prospectuses 14 1 Pls. Br. at 42. 2 ProShares ETFs did not seek to achieve long[-]term 3 cumulative investment returns in their ETFs and that they 4 could not seek such returns. 5 assert, however, that the diverge significantly disclosure 6 does not speak to a divergence that results in actual, 7 substantial loss. 8 9 The complaint even recognizes that the TAC ¶ 100. Plaintiffs In evaluating a prospectus, we read it as a whole. DeMaria, 318 F.3d at 180 (internal quotation omitted). As 10 we read the prospectus cover-to-cover, we consider whether 11 the disclosures and representations, taken together and in 12 context, would have misl[ed] a reasonable investor about the 13 nature of the [securities]. 14 Wherehouse Entm t, Inc., 900 F.2d 576, 579 (2d Cir. 1990)). 15 As we have explained, [a] prospectus will violate federal 16 securities laws if it does not disclose material objective 17 factual matters, or buries those matters beneath 18 information, or treats them cavalierly. 19 at 180 (quoting Olkey v. Hyperion 1999 Term Trust, Inc., 98 20 F.3d 2, 5 (2d Cir. 1996) (internal quotation marks 21 omitted)). Id. (quoting McMahan & Co. v. 22 15 DeMaria, 318 F.3d 1 Here, the district court concluded that it was not 2 possible to read the registration statements . . . without 3 understanding that the ETFs were particularly risky and 4 speculative and were intended to meet their stated goal only 5 over the course of a single day. 6 2d at 656. 7 [P]laintiffs lost money while guessing correctly on the 8 direction of the underlying index, this possibility is 9 plainly consistent with the significant divergence that was ProShares, 889 F. Supp. The district court reasoned that while some 10 disclosed in the registration statements. Id. On appeal, 11 Plaintiffs maintain that the district court overvalued the 12 diverge significantly disclosure because [d]iverge 13 significantly is not a synonym for loss and refers only 14 to [an ETFs ] outperforming or underperforming a perfect 15 long-term correlation with its index. 16 they argue, diverge significantly does not include large, 17 rapid losses. At the very least, Pls. Br. at 42-43. 18 We are unpersuaded by this argument, and Plaintiffs 19 efforts to find a meaningful distinction between diverge 20 significantly and actual loss strains the plain meaning 21 of the former phrase. 22 term value of an ETF to correlate with the long-term value Because one might expect the long- 16 1 of its underlying index, ProShares warned that the actual 2 results might diverge significantly from that prediction. 3 Significant means large or important; in the context of 4 the offering documents, divergence means the opposite from 5 one s expectation. 6 disclosures, fairly read, put investors on notice that an 7 ETF s value might move in a direction quite different from 8 and even contrary to what an investor might otherwise 9 expect. 10 ProShares significant divergence Plaintiffs use a linguistic preference to read out of 11 the prospectuses a scenario which the ProShares disclosures 12 clearly contemplate. 13 disclosure is not a rite of confession or exercise in 14 common law pleading. 15 (internal quotation marks omitted). 16 the materiality requirement is not to attribute to investors 17 a child-like simplicity, we presume that a reasonable 18 investor can comprehend the basic meaning of plain-English 19 disclosures and will not credit Plaintiffs narrow reading 20 of diverge significantly. 21 (citations omitted). 22 23 Time and again, we have said that Morgan Stanley, 592 F.3d at 365 Because the role of See Basic, 485 U.S. at 234 Perhaps more importantly, the diverge significantly disclosure takes on additional meaning within the context of 17 1 the prospectus as a whole. 2 prospectuses make absolutely clear that the ETFs operated 3 pursuant to daily investment objectives, that they utilized 4 leveraged investment techniques to achieve those objectives, 5 and that mathematical compounding combined with leveraging 6 prevented the ETFs from achieving their stated objectives 7 over a period of time greater than one day. 8 ProShares I prospectuses make clear that ETFs used 9 aggressive financial instruments and investment techniques 10 that exposed the ETFs to potentially dramatic losses in 11 the value of its portfolio holdings and imperfect 12 correlation to the index underlying ; ProShares II warned 13 that volatility could result in a total loss of an 14 investor s investment. 15 App x B, Item 6. 16 The earliest relevant All the See Skinner Decl., App x A, Item 6; Accordingly, we conclude that it is implausible that 17 substituting actual loss for diverge significantly is a 18 change substantially likely to be viewed by a reasonable 19 investor as having significantly altered the import of the 20 total mix of information ProShares made available. 21 See Basic, 485 U.S. at 232. 22 23 2. The Probability of Long-Term Loss Plaintiffs also complain that ProShares omitted that 18 1 certain market circumstances would necessarily [cause] 2 quick and potentially large losses despite an investor s 3 correct prediction of the overall, beyond-a-day direction of 4 an ETF s underlying index. 5 see also id. at 24-25; TAC ¶¶ 12-26. 6 asserts that ProShares possessed an undisclosed 7 mathematical formula which very accurately predicted and 8 described the relationship between the movements in each 9 type of ETF s price and the movements in the index Pls. Br. at 1 (emphasis added); The complaint further 10 underlying the ETF in any market scenario. 11 Based on this formula, Plaintiffs allege that ProShares knew 12 and omitted that certain market conditions could materialize 13 that would put investors who held ProShares products for 14 extended periods of more than a day in a must lose 15 position. 16 Plaintiffs maintain, when the volatility (i.e., the day-to- 17 day changes in prices) of the underlying index significantly 18 exceeded its performance over time. 19 TAC ¶ 15. See TAC ¶ 13. These market conditions existed, TAC ¶ 16. The district court concluded that the existence of the 20 undisclosed mathematical formula was implausible on its 21 face. ProShares, 889 F. Supp. 2d at 656. 22 alternative, the district court concluded that such a 23 formula would rely on inputs from the underlying index or 19 In the 1 benchmark, that those inputs could not be known in advance, 2 and that failure to predict future market performance was an 3 immaterial omission. Id. 4 Here, Plaintiffs continue to pursue the argument and 5 allege that ProShares knew and could simulate from their 6 mathematical formula exactly what was going to happen to 7 investors for each market scenario, including the 8 continuation of the actual, existing current daily 9 volatility circumstances. Pls. Br. at 11 (emphasis in 10 original) (complaint citations omitted). 11 Plaintiffs, ProShares knew to the day when, if current 12 actual volatility circumstances continued, their ETFs would 13 become dysfunctional and an investor necessarily would lose 14 from a correct judgment about the market. 15 25 (complaint citations omitted). 16 We remain unpersuaded. According to Pls. Br. at 24- Assuming, arguendo, that 17 ProShares possessed an undisclosed mathematical formula that 18 accurately predicted potential market conditions and the 19 effect market volatility would have on ETF shares, 20 Plaintiffs argument amounts to nothing more than an 21 allegation that ProShares failed to disclose that the more 22 an ETF s underlying index changed value day-to-day for a 23 particular investor, the more likely it became that the 20 1 investor would experience long-term losses depending on when 2 she invested. 3 omission of an objective fact, but rather a general omission 4 regarding the risks associated with (1) hypothetical 5 investments over (2) hypothetical periods of time during (3) 6 hypothetically volatile market conditions. 7 be expected to predict and disclose all possible negative 8 results across any market scenario. 9 this point. 10 That does not constitute an actionable ProShares cannot Appendix A illustrates In tandem with this argument, Plaintiffs assert that 11 ProShares failed to disclose the risks of excess daily 12 index volatility which its mathematical formula predicted 13 and that eventually materialized.4 14 consistently disclosed the effect market volatility had on 15 ETFs. 16 under Principal Risk Considerations, that the equity 17 markets are volatile, and the value of securities, futures, 18 options, contracts and other instruments correlated with the 19 equity markets may fluctuate dramatically from day-to-day. ProShares, however, The first relevant ProShares I prospectus warned, 4 Plaintiffs make a distinction between inherent facts and materialization facts. For example, Plaintiffs argue that ETFs were subject to an inherent risk of excess market volatility which ProShares omitted and that once the markets became excessively volatile those inherent risks became materialized risks. For the purpose of our analysis, this distinction is without a difference. 21 1 June 19, 2006 ProShares I Prospectus at 8, 64. 2 volatility may cause the value of an investment in a[n ETF] 3 to decrease. 4 net asset value of an ETF and its market price would be made 5 more volatile than its underlying index on account of 6 leveraged investment techniques that magnify exposure to the 7 underlying index. 8 bullet-pointed the risk: Volatility Risk [Leveraged ETFs] 9 seek to achieve a multiple of an index and therefore will Id. at 65. This ProShares also warned that the Finally, ProShares highlighted and 10 experience greater volatility than the index underlying its 11 benchmark and consequently ha[ve] the potential for greater 12 losses. Id. at 9. 13 prospectus warned that price volatility, which is 14 exacerbated by the use of leverage, may possibly cause the 15 total loss of an investor s investment. 16 ProShares II Reg. Stmt. at 4. 17 In addition, the earliest ProShares II Nov. 17, 2008 While it is not sufficient that overtones might have 18 been picked up by the sensitive antennae of investment 19 analysts, Gerstle v. Gamble-Skogmo, Inc., 478 F.2d 1281, 20 1297 (2d Cir. 1973) (Friendly, Judge), no reasonable 21 investor could read these prospectuses without realizing 22 that volatility, combined with leveraging, subjected that 23 22 1 investment to a great risk of long-term loss as market 2 volatility increased. 3 B. Misleading Statements 4 Our conclusion that the [`33 Act] did not directly 5 require defendants to disclose the allegedly omitted 6 information does not mark the end of our inquiry. 7 Stanley, 592 F.3d at 365. 8 the disclosure of information that is necessary to avoid 9 rendering misleading the representations in prospectuses. Morgan Section 11 [also] call[s] for 10 Id. (citing 15 U.S.C. § 77k(a)). 11 same as it was above: we review documents holistically and 12 in their entirety. 13 literal truth of an isolated statement is insufficient; the 14 proper inquiry requires an examination of defendants 15 representations, taken together and in context. 16 (quotation marks and citation omitted). 17 Our inquiry here is the Id. (citing Olkey, 98 F.3d at 5). The Id. Plaintiffs complain that ProShares prospectuses 18 included numerous misleading statements about the positive 19 results of 1, 3, 5, and 10 year investments in ProShares 20 ETFs. 21 Indeed, Plaintiffs provide us with a string citation to the 22 complaint outlining at least eight categories of misleading 23 statements across various prospectuses. See, e.g., TAC ¶ See Pl. Br. at 38 (complaint citations omitted). 23 1 102(a)-(h). 2 three specific alleged misrepresentations. 3 Queens College, 242 F.3d 58, 75 (2d Cir. 2001) ( [I]ssues 4 adverted to in a perfunctory manner, unaccompanied by some 5 effort at developed argumentation, are deemed waived. 6 (internal quotation omitted)). 7 1. Plaintiffs appeal, however, focuses on only See Tolbert v. 1, 3, 5, and 10 Year Cost Projections 8 Plaintiffs contend that ProShares provided tables which 9 illustrated the hypothetical costs of investing in ProShares 10 I ETFs for 1, 3, 5, and 10 year periods, which misleadingly 11 implied that ProShares ETFs were suitable 1, 3, 5, and 10 12 year investments. 13 dismissed the argument for two reasons. 14 that the various projections . . . fall far short of 15 undercutting the emphasis on the daily nature of the ETFs. 16 ProShares, 889 F. Supp. 2d at 655. 17 that because Form N-1A required disclosure of that exact 18 information, ProShares could not expect that the SEC would 19 require that information be specifically identified, 20 qualified, or tempered. 21 of the district court s analysis and affirm its conclusion. 22 23 See TAC ¶ 102(a). Id. The district court First, it reasoned Second, it concluded We agree with the first half The contested tables are presented as an example of the costs of investing in ProShares I ETFs assuming a $10,000 24 1 investment for time periods spanning 1, 3, 5, and 10 years - 2 assuming a 5% return each year. 3 assumptions. 4 intended to help investors compare the cost of investing in 5 ProShares with the cost of investing in other funds. 6 would be difficult to cross-compare the costs of investing 7 in different funds were prospectuses to use different time 8 periods, different assumptions about annual returns, and 9 different assumptions about the amount invested. Form N-1A requires those This makes sense because the example is It The 10 ProShares I prospectuses also tie cautionary language to the 11 tables, which Form N-1A does not expressly require: the 12 table was for illustration purposes only and was not 13 meant to suggest actual or expected fees and expenses or 14 returns, all of which may vary. 15 Reg. Stmt. at 20. 16 See, e.g., Sept. 28, 2007 We conclude that the cost tables, placed in context, 17 would not lead a reasonable investor into thinking that 18 ProShares I ETFs were safe 1, 3, 5, and 10 year investments. 19 We also agree with the district court that the tables do not 20 undercut the disclosures regarding the ETFs daily 21 objectives with all the attendant warnings already described 22 in this opinion. 23 Plaintiffs attempt to isolate and construe a single element Accordingly, we are unpersuaded by 25 1 of ProShares I s prospectuses. 2 180. 3 would have been misled by the cost tables.5 It is therefore implausible that a reasonable investor 4 5 See DeMaria, 318 F.3d at 2. Correlation Risks and Line Graphs Beginning with the September 28, 2007 ProShares I 6 prospectus, Plaintiffs assert that ProShares I included 7 correlation-risk disclosures which included line-graph 8 examples that misled them into thinking that an ETF s 9 divergence from its underlying index would be somewhere in 10 11 the ballpark of 0.6%-2.2%. TAC ¶¶ 29-43, 102, 203-220. The correlation-risk disclosure expressly warns that 12 there is no guarantee that an ETF will achieve a high degree 13 of correlation with its benchmark and lists factors that 14 prevent perfect correlation. 15 funds there [was] a special form of correlation risk[:] for 16 periods greater than one day, the use of leverage tends to For Plaintiffs leveraged 5 The district court also commented that the tables did not create liability because the plaintiffs point[ed] to no case that holds that information that the SEC requires must be specifically identified, qualified, or tempered. ProShares, 889 F. Supp. 2d at 655. While Form N-1A requires the allegedly misleading table, it also requires this information to be in plain English under rule 421(d) under the Securities Act. See Skinner Decl. Ex. 5 at 11 (SEC Form N-1A). Rule 421(d) requires that financial data be presented in an understandable manner and that any information provided must not be misleading. 17 C.F.R. § 230.421(d)(3). Accordingly, there remains a possibility that an issuer might present required information in a misleading manner. That, however, is not this case. 26 1 cause the performance of an [ETF] to be either greater than 2 or less than the index performance. See Sept. 28, 2007 3 ProShares I Reg. Stmt at 8. 4 To illustrate how leveraging increases correlation 5 risk, the prospectus included three line graphs that 6 simulated [a] hypothetical one year performance of an index 7 compared with the performance of a fund that perfectly 8 achieved its investment objective of twice (200%) the daily 9 index return. Id. Each of the graphs [assumed] a 10 volatility rate of 15%, which [was] an approximate average 11 of the five-year historical volatility rate of certain 12 indices. 13 benchmarked ha[d] different historical volatility rates; 14 certain of the [ETFs] historical volatility rates [were] 15 substantially in excess of 15%. Id. But, [o]ther indexes to which the [ETFs] are Id. 16 The line graphs show that where a leveraged ETF meets 17 its daily objectives each day, with the above assumptions, 18 its value could diverge from the index s performance by 2.2% 19 in a flat market, 0.7% in an upward-trending market, and 20 0.6% in a downward-trending market. 21 of the graphs, the prospectus referred potential investors 22 to the SAI for a further discussion of how both index 23 volatility and index performance can impact ETF 24 performance. After the presentation The SAI includes a wedge graph that 27 1 represents the effect market volatility would have on a 2 leveraged ETFs annual correlation with index volatility 3 ranging from 0%-40% at 5% intervals. 4 clearly demonstrate that at high levels of volatility an 5 ETF s value could move in the opposite direction from its 6 underlying benchmark. 7 graph in Appendix B. 8 9 The wedge graphs We have included an example wedge Plaintiffs complain that the line graphs misled them into believing that annual ETF returns ran the risk of only 10 a slight disconnection (.6% - 2.2%) from an index s 11 performance. 12 prospectuses, absent the wedge graphs, clearly described the 13 daily investment objectives, the nature of ETFs, and, in 14 plain English, warned that leveraging, volatility, and 15 compounding could cause an ETF s performance to 16 significantly diverge from its underlying index. 17 also already concluded that the relevant prospectuses 18 disclosed that aggressive investment techniques exposed the 19 ETFs to dramatic losses and an imperfect correlation with 20 its index. 21 We have already concluded that the ProShares We have The addition of the line graphs does not alter those 22 conclusions, and we agree with the district court that this 23 one-year representation does not undercut the 24 representations throughout the rest of the prospectuses. 28 1 This is especially true because the disclosure introducing 2 the line graphs clearly explained that the line graphs 3 assumed 15% volatility and that many of the ETF indices have 4 historically experienced volatility substantially in excess 5 of 15%. 6 investor would expect that an ETF s divergence from its 7 underlying index would be only minimal. 8 It is therefore implausible that a reasonable 3. SAIs and Wedge Graphs 9 Plaintiffs argue that the district court impermissibly 10 relied upon the wedge graphs to dilute their cost-table and 11 line-graphs arguments and to bolster ProShares disclosures. 12 See Pls. Br. at 46-47. 13 because the district court concluded, as we do here, that it 14 was not possible to read the registration statements - even 15 those issued before the wedge graphs were added in September 16 2007 - without understanding that the ETFs were particularly 17 risky and speculative and were intended to meet their stated 18 goal only over the course of a single day. 19 F. Supp. 2d at 655. 20 concluded that the diverge significantly disclosures 21 plainly contemplated the possibility that certain investors 22 would lose money despite correctly predicting the direction 23 of an underlying index. That argument is misplaced, however, ProShares, 889 Moreover, the district court also Accordingly, the district court did 24 29 1 not rely on the wedge graphs to reach its conclusions; nor 2 do we. 3 Plaintiffs also contend that the wedge graphs 4 constitute a unique principal-risk disclosure that ProShares 5 impermissibly buried in the SAI. 6 however, merely repackages what they argued earlier: 7 ProShares failed to disclose the effect of excess daily 8 volatility in the principal-risk portion of the 9 prospectuses. Plaintiffs argument, Because we concluded that ProShares 10 volatility disclosures and prospectuses sufficiently warned 11 of the effects excess market volatility would have on an 12 ETF, spelling out the details of those disclosures in the 13 SAI does not violate the securities laws. 14 recognized: to avoid prospectus disclosures that are too 15 long and complex, Form [N-1A] calls for a streamlined, 16 simplified prospectus and an SAI which offer[s] issuers 17 the opportunity to provide more detailed discussions of 18 matters required to be in the prospectus. 19 592 F.3d at 352 n.2 (quotation marks and citations 20 omitted).6 6 As we have Morgan Stanley, ProShares asserts that the law of this Circuit permits reliance on information contained in the SAI in evaluating section 11 claims. See ProShares Br. at 53 (citing Hunt v. Alliance N. Am. Gov t Income Trust, Inc., 159 F.3d 723, 730-31 (2d Cir. 1998)). Hunt, however, only looked at an SAI to 30 1 Finally, Plaintiffs allege that the wedge graphs 2 themselves were materially misleading for not contemplating 3 the effects of volatility above 40% and the effect 4 volatility would have on short-term investments.7 5 the district court concluded, no reasonable investor could 6 read the prospectuses without understanding beyond-a-day 7 risk exposure or that risks increased as volatility 8 increased above 40%. 9 acknowledges that ProShares could not meet its objectives But, as In fact, the complaint itself 10 beyond a day, TAC ¶ 100, and all of the ProShares 11 prospectuses made clear that leveraging, compounding, 12 volatility, and aggressive investment techniques subject the 13 ETFs to high degrees of risk.8 Accordingly, it is contextualize a prospectus disclosures. Id. Accordingly, Hunt does not permit relegating to the SAI material risk disclosures that Form N-1A requires to be in the prospectus; nor could it. 7 We note a bit of an internal inconsistency in Plaintiffs theories of liability: Plaintiffs argue that the district court impermissibly relied upon the wedge graphs buried in the SAI in analyzing the complaint while simultaneously maintaining that this same buried information misled them about ETF risks. Plaintiffs complaint actually presents the point heading Additional Misleading Statements in the SAI. TAC ¶¶ 44-47. It s curious that Plaintiffs could not find this information to get a more in-depth understanding of the funds but have no trouble using that same information to shoulder ProShares with liability. 8 Plaintiffs argue that In re Direxion Shares ETF Trust counsels against reliance on the daily objective disclosures. 279 F.R.D. 221 (S.D.N.Y. 2012). The district court here, 31 1 implausible that a reasonable investor would read these 2 offering documents without understanding the potential for 3 rapid, substantial loss. 4 C. Corrective Disclosures 5 Plaintiffs allege that ProShares made new disclosures 6 beginning on the last day of the class period, thereby 7 tacitly conceding that the class-period disclosures failed 8 to reveal critical facts. 9 inter alia, (1) acknowledging that volatility could cause an 10 ETF to move in [the] opposite direction as the index, TAC 11 ¶ 181 (quoting July 31, 2009 Am. No. 16 of Reg. Stmt. at 12 410); (2) stating that an investor s views on the future 13 direction and volatility of the markets can be useful tools 14 for investors, TAC ¶ 185-186 (quoting July 31, 2009 15 Amendment No. 16 of Reg. Stmt. at 410); and (3) advising 16 that investors should be willing to monitor and/or 17 periodically rebalance their portfolios, id. 18 These new disclosures include, We have previously noted that where the quality of [a] 19 disclosure could have been improved[,] the advisability of 20 revision does not render what was done deceptive or however, relied on the total mix of ProShares disclosures and correctly identified significant differences between Direxion s offering documents and ProShares offering documents. Without commenting on Direxion s merits, Plaintiffs have not persuaded us that the district court erred in parsing these differences. 32 1 misleading. Greenapple, 618 F.2d at 211. 2 always remains whether the prospectuses, as written, 3 adequately apprise the reader of the essential nature of 4 the securities. 5 not alter our conclusion that the earlier ProShares 6 prospectuses adequately warned of volatility s effect on the 7 magnitude and probability of loss. 8 ProShares came to use different, arguably clearer language. 9 To hold an issuer who alters disclosures deemed adequate in 10 the first instance suddenly liable because it found a better 11 way to say what has already been said would perversely 12 incentivize issuers not to strive for better, clearer 13 disclosure language. 14 disclosures do not alter our conclusions. See id. The question Accordingly, these revisions do It is of no matter that Accordingly, the corrective 15 D. Section 15 16 Plaintiffs also brought claims under section 15 of the 17 `33 Act against the individual defendants. 18 [section] 15 liability, a plaintiff must [first] show a 19 primary violation of [section] 11 . . . . 20 Deutsche Bank Secs. Inc., 647 F.3d 479, 490 (2d Cir. 2011) 21 (internal quotation marks omitted). 22 dismissal of Plaintiffs section 11 claims, we also affirm 23 the dismissal of their section 15 claims. 33 To establish Hutchinson v. Having affirmed the See id. 1 2 CONCLUSION The order of the United States District Court for the 3 Southern District of New York (John G. Koeltl, Judge.), 4 entered on September 12, 2012, dismissing Plaintiffs- 5 Appellants third amended complaint, with prejudice, 6 pursuant to Federal Rule of Civil Procedure 12(b)(6), is 7 hereby AFFIRMED. 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 34 1 APPENDIX A 2 Hypothetical ETF Investments Seeking to Double the Daily Return of its Underlying Index 3 4 5 6 35 1 APPENDIX B 2 Example Wedge Graph 3 36
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