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,
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.
Argued May 2, 2013
BeforeWesley, 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.
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;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 purchased shares in forty-four leveraged ProShares exchange-traded funds ("ETFs") during the August 6, 2006 through June 23, 2009 class period. Third Amended Complaint ("TAC") ¶¶ 1-2. They seek to hold Defendants-Appellees ProShares Trust and ProShares Trust II (collectively, "ProShares") liable for material omissions and misrepresentations in the prospectuses for those ETFs pursuant to sections 11 and 15 of the Securities Act of 1933 ("'33 Act"), 15 U.S.C. §§ 77k & 77o.
A. Exchange-Traded Funds
In a series of press releases, ProShares indicated that their ETFs were for "investors interested in pursuing more sophisticated" trading strategies. See TAC ¶¶ 104-08 (internal quotation marks omitted). With ProShares ETFs, investors could hedge and manage risk without having "'to go through the process of setting up margin accounts or covering margin calls - they [could] simply trade ProShares.'" TAC ¶ 104 (quoting June 21, 2006 Press Release). "'And unlike a margin account, [an investor] can't lose more than [she] invest[s].'" TAC ¶ 106 (quoting Feb. 1, 2007 Press Release). This is because ETFs operate like indexed mutual funds but trade like stocks. TAC ¶ 82.
"ETFs frequently track an index, a sector of stocks, or a commodity or currency." TAC ¶ 81. They are considered to be "indexed mutual funds that trade like stocks, " TAC ¶ 82, but they differ from mutual funds because they are generally sold to institutional investors in large blocks of shares, called Creation Units. These investors generally purchase Creation Units in exchange for "baskets" of securities that mirror the securities in the ETF portfolio. Investors who purchase Creation Units often split up the Units into individual shares and sell them on a secondary market to retail investors who otherwise might not be able to access ETFs because of the cost of Creation Units. These retail investors are then able to sell shares of ETFs on the secondary market, but they generally cannot redeem shares with the ETFs because the ETFs often redeem shares only when they are packaged in Creation Units. TAC ¶ 82.
ProShares offered three types of ETFs: (1) an Inverse ETF, (2) an Ultra Long ETF, and (3) an Ultra Short ETF. TAC ¶ 93(a)-(c). An Inverse ETF aimed to "replicate the inverse movement of the specified index over one day." TAC ¶ 93(a). An Ultra Long ETF tried to "double the performance of the underlying index or benchmark on a daily basis." TAC ¶ 93(b). And an Ultra Short ETF was designed to "double the inverse of the performance of the underlying index or benchmark on a daily basis." TAC ¶ 93(c). Accordingly, if the "specific index, benchmark, sector or commodity on which an ETF [was] based increase[d] by 1% on a given day, then [the Inverse ETF] would decrease by 1%; the [Ultra Long ETF] would increase by 2%; and [the Ultra-Short ETF] would decrease by 2%." TAC ¶ 94. Each one of the ETFs in this case is leveraged.
B. Registration Statements
ProShares I filed its registration statement on SEC Form N-1A. TAC ¶ 89. ProShares II filed its registration statement on Forms S-1 and S-3. TAC ¶ 91. The registration statements consisted of, inter alia, a prospectus and a statement of additional information ("SAI"). Though ProShares I and ProShares II provided investors with several different offering documents relevant to this appeal, ProShares' key disclosures relating to the ETFs at issue here were materially consistent across all of the documents.
All relevant ProShares registration statements disclosed that the ETFs pursued daily investment objectives and daily investment results. See Skinner Decl., App'x A, Item 1; App'x B, Item 1. ProShares I's offering documents make clear that these daily objectives were bets that it could return a stated multiple of an ETF's underlying index each day by investing in different components of the underlying index through various financial instruments. For example, "principal investment strategies include[d i]nvesting in equity securities and/or financial instruments (including derivatives) that ProShare Advisors believe[d], in combination, [w]ould have similar daily price return characteristics" of a stated multiple of the ETF's underlying index. June 19, 2006 ProShares I Reg. Stmt at 7.
To achieve the predicted daily investment results, ProShare Advisors or a Sponsor would determine the type, quantity, and mix of investment positions that an ETF should hold. In addition, ProShares reserved the right to substitute a different index or security for an ETF's underlying index and disclosed that it might over-weight or under-weight certain components contained in the underlying index. See, e.g., id. at 59-60; see also, e.g., Nov. 17, 2008 ProShares II Reg. Stmt. at 33-34. Furthermore, the ETFs never took a defensive position and would remain "fully invested at all times in securities and/or financial instruments that provide exposure to its [u]nderlying [i]ndex without regard to market conditions, trends, or direction." June 19, 2006 ProShares I Reg. Stmt at 60; see also Nov. 17, 2008 ProShares II Reg. Stmt. at 33. The ETFs' views were expressly myopic: long-term objectives were blurred because they were focused only on meeting a benchmark tied to an underlying index one day at a time with a portfolio of different securities.
Moreover, ProShares warned that its decision to invest in a particular stock or financial instrument was not based on the "investment merit of a particular security, instrument, or company" and that it did not use "conventional stock research or analysis, or forecast stock movement or trends" in managing the assets of the funds. June 19, 2006 ProShares I Reg. Stmt at 60; see also Nov. 17, 2008 ProShares II Reg. Stmt. at 34. Instead, ProShares ETFs pursued daily results through aggressive investment techniques. For ProShares I, each registration statement warned that the ETFs used financial instruments and "investment techniques . . . that may be considered aggressive, including the use of futures contracts, options on futures contracts, securities and indices, forward contracts, swap agreements, and similar instruments." See Skinner Decl., App'x A, Item 6. ProShares I also disclosed that use of these techniques and financial instruments exposed the ETFs to "potentially dramatic" losses. Id. Similarly, each relevant ProShares II prospectus warned that the aggressive financial instruments had "volatile [trading prices, and that] even a small movement in market prices could cause large losses" because an ETF investment was "speculative" and involved a high degree of risk. See id., App'x B, Item 6.
ProShares also warned that ETFs could not pursue their stated objectives for beyond-a-day periods because mathematical compounding and leveraging prevented the ETFs from reaching those results. See id., App'x A, Item 2; App'x B, Item 2. In that regard, ProShares disclosed that "[o]ver time, the cumulative percentage increase or decrease in the net asset value of the [ETFs] may diverge significantly from the cumulative percentage increase or decrease in the multiple of the return of the Underlying Index" due to a compounding effect of daily gains and losses. For ProShares II, the warning was even more direct: "[u]sing leverage . . . should be considered . . . speculative and could result in the total loss of an investor's investment." See id., App'x B, Item 6. In its brief, ProShares provided a hypothetical illustration of two investors who invested in an Ultra Long ETF at separate times to illustrate the effect an index's volatility would have on those investments' returns. We have provided that example in Appendix A.
C. Alleged Omissions and Misstatements
Plaintiffs principally complain that ProShares failed to disclose the magnitude and probability of loss for beyond-a-day investments in ProShares ETFs despite investors' correct predictions regarding the overall movement of the indices underlying the ETFs. Furthermore, Plaintiffs allege that the registration statements contained various "contra-indicators" of successful long-term investments which the above omissions made materially misleading. The district court rejected these arguments and dismissed the complaint with prejudice pursuant to Federal Rule of Civil Procedure 12(b)(6). In re ProShares Trust Sec. Litig., 889 F.Supp.2d 644 (S.D.N.Y. 2012). In sum, the district court concluded that ProShares warned of the risks that materialized. For the reasons that follow, we agree.
The standard of review is neither contested nor ...