728 F.3d 96
2d Cir.2013Background
- Plaintiffs brought a putative class action under Sections 11 and 15 of the Securities Act of 1933 challenging prospectus disclosures for 44 leveraged ProShares ETFs (Aug 6, 2006–June 23, 2009).
- ProShares offered daily-leveraged ETFs (Inverse, Ultra Long, Ultra Short) that sought to deliver a multiple of an index’s daily return and warned they were designed for one-day objectives using aggressive instruments (futures, swaps, options).
- Registration statements/prospectuses disclosed that compounding and leverage could cause multi-day results to "diverge significantly" from index performance and warned of volatility and potential dramatic losses; some detailed analyses and "wedge graphs" were included in the SAI.
- Plaintiffs alleged ProShares omitted the magnitude and probability of beyond-a-day losses (including an undisclosed formula predicting when ETFs would produce losses despite correct long-term market calls) and that certain tables/graphs misled investors about multi‑day suitability.
- The district court dismissed the TAC with prejudice under Rule 12(b)(6), holding the prospectuses adequately warned of the risks that materialized; the Second Circuit affirmed.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether registration statements unlawfully omitted the magnitude of beyond‑a‑day losses | ProShares failed to disclose that correct long‑term predictions could still produce substantial losses | Prospectuses warned that results may "diverge significantly" and warned of leverage, compounding, volatility, and potential dramatic losses | No omission; disclosures, read holistically, adequately warned investors |
| Whether ProShares omitted the probability that certain market conditions would necessarily cause rapid large losses | ProShares had (and hid) a mathematical formula predicting scenarios where investors "must lose" even with correct market direction | No actionable omission — hypothetical scenarios and inputs are unknowable; prospectuses already warned volatility magnified risk | No omission; plaintiffs’ formula theory implausible and not required disclosure |
| Whether specific prospectus elements (cost tables, line graphs) were misleading about multi‑day suitability | Cost tables and one‑year line graphs implied ETFs suitable/safe for 1,3,5,10 year investments or showed only minimal divergence | Tables/graphs meet SEC Form N‑1A requirements and are accompanied by cautions and context emphasizing daily objectives and volatility | Not misleading when read in context; tables/graphs do not undermine daily‑objective warnings |
| Whether SAI "wedge graphs" and later disclosure amendments cure prior insufficiency or show prior deception | Plaintiffs: burying key risk detail in SAI and later clearer disclosures prove original disclosures were inadequate | ProShares: SAI supplements the streamlined prospectus; later clearer wording does not mean earlier statements were misleading | Revisions do not show prior deception; prospectuses already adequately apprised investors |
Key Cases Cited
- Morgan Stanley Info. Fund Sec. Litig., 592 F.3d 347 (2d Cir. 2010) (materiality and holistic reading of prospectus; omitted facts must be unlawful and material)
- DeMaria v. Andersen, 318 F.3d 170 (2d Cir. 2003) (total‑mix standard for materiality; read prospectus as a whole)
- TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438 (U.S. 1976) (standard for materiality: substantial likelihood disclosure would have altered total mix)
- Basic Inc. v. Levinson, 485 U.S. 224 (U.S. 1988) (materiality standard cautions against trivial disclosures)
- Matrixx Initiatives, Inc. v. Siracusano, 131 S. Ct. 1309 (U.S. 2011) (courts should not set too low a materiality standard)
- Olkey v. Hyperion 1999 Term Trust, Inc., 98 F.3d 2 (2d Cir. 1996) (prospectus violates securities laws if it buries material facts or treats them cavalierly)
- McMahan & Co. v. Wherehouse Entm’t, Inc., 900 F.2d 576 (2d Cir. 1990) (contextual reading of statements in securities litigation)
- Greenapple v. Detroit Edison Co., 618 F.2d 198 (2d Cir. 1980) (adequacy of prospectus judged by whether it apprises reader of essential nature of securities)
- Hunt v. Alliance N. Am. Gov’t Income Trust, Inc., 159 F.3d 723 (2d Cir. 1998) (use of SAI in analyzing disclosures)
- Gerstle v. Gamble‑Skogmo, Inc., 478 F.2d 1281 (2d Cir. 1973) (plaintiff must do more than detect overtones analysts might pick up)
- Hutchinson v. Deutsche Bank Secs. Inc., 647 F.3d 479 (2d Cir. 2011) (Section 15 liability depends on a primary Section 11 violation)
- Litwin v. Blackstone Grp., L.P., 634 F.3d 706 (2d Cir. 2011) (standard of review for Rule 12(b)(6) dismissal)