Jensen v. iShares TrustJensen v. iShares Trust
BACKGROUND
Appellants are individual investors who purchased one or more shares of BlackRock iShares Exchange-Traded Funds (ETFs) and thereafter suffered financial losses when their shares were sold pursuant to “market orders” or “stop-loss orders” during a “flash crash” on August 24, 2015, when ETF trading prices fell dramatically. Appellants maintain that BlackRock‘s registration statements, prospectuses and amendments thereto (collectively, “offering documents“) issued or filed between 2012 and 2015, were false or misleading in that they failed to sufficiently disclose the risks associated with flash crashes. Appellants purchased their ETF shares after these allegedly defective offering documents were issued or filed.
Respondent iShares Trust (iShares) is registered with the United States Securities and Exchange Commission (SEC) as an open-end management investment company under the Investment Company Act of 1940 (ICA) (
According to the allegations of the complaint and evidence before the trial court, ETFs, which first came to market in the 1990s, are investment companies that are registered under the ICA as open-end funds or unit investment trusts. (SEC Concept Release: Actively Managed Exchange-Traded Funds,
Appellants alleged that BlackRock portrayed ETFs as safe investments, designed to reduce and protect investors from market volatility, despite being aware of particular risks that it failed to disclose to investors. At issue in the present case is the use of stop-loss orders with ETFs. A stop-loss order requires that an investor‘s security be bought or sold when the stock value hits a certain price; when the stock price drops to the preset price, the order is automatically converted to a market order and the security trade is automatically executed at market price. Stop-loss orders are generally used to limit risk, but in times of high volatility can have the opposite effect. Appellants alleged that the use of stop-loss and market orders to hedge ETF risk “amplifies the disengagement of ETF values from their NAV” due to “lack of liquidity in the ETF market“: “When ETF markets are highly illiquid, market sell orders sweep through available purchase orders, allowing ETF prices to plummet and reflect a sales price completely unrelated to an ETF‘s underlying value.”
On May 6, 2010, equity markets in the United States experienced a “flash crash” in which equities and ETFs holding equities declined “precipitously” for approximately a half hour during afternoon trading. Many ETFs traded 60 percent lower than the value of
Appellants alleged that the offering documents pursuant to which they purchased respondents’ ETFs disclosed that ETFs are subject to volatility but did not disclose “the known inherent risk” of using stop-loss orders with ETFs, despite respondents’ admitted knowledge of the likelihood of disproportionate harm and belief that more flash crashes were inevitable. iShares “continuously issues and redeems ETF shares,” issuing and selling new shares of each series in primary market transactions pursuant to registration statements or amended registration statements filed with the SEC. Accordingly, iShares registration statements are amended at least annually.
On August 24, 2015, another flash crash occurred. BlackRock ETF investors who had placed market or stop-loss orders prior to or at the opening of the market suffered disproportionate losses as their shares were sold below their designated stop prices and below the net asset value of the shares. Price declines of more than 20 percent occurred in 19.2 percent of all ETFs, compared with declines of 4.7 percent in corporate securities. For example, one of BlackRock‘s iShares ETFs dropped more than 35 percent while the underlying investments in the fund dropped only 2 to 4 percent; another ETF dropped over 60 percent.
BlackRock has since admitted that during the crash, ” ‘retail investors who had standing stop-loss orders were especially impacted.’ ” As a result of the August 24, 2015, flash crash, the New York Stock Exchange and other exchanges announced that stop-loss orders and ” ‘good-til-canceled’ ” orders would no longer be accepted.
Appellants’ original class action complaint was filed on June 16, 2016, and alleged claims under sections 11, 12(a)(2) and 15 of the 1933 Act. (
The parties agreed to a bifurcated bench trial on the issue of “standing/tracing.” The trial consisted of the parties’ arguments based on evidence submitted by means of declarations and attached exhibits, the parties having waived objection to the admissibility of the declarations and exhibits thereto and exhibits to the trial briefs and limited their objections to weight or relevancy of the evidence. Appellants argued they were not subject to the tracing requirement under section 11 because iShares is governed by the ICA and, under section 24(e) of the ICA (
DISCUSSION
Appellants’ claims relate to the 1933 Act and the ICA. Among the federal statutes regulating the securities industry, “[t]he 1933 Act regulates initial distributions of securities, and the 1934 [Securities Exchange] Act [1934 Act] for the most part regulates post-distribution trading.” (Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A. (1994) 511 U.S. 164, 171; Blue Chip Stamps v. Manor Drug Stores (1975) 421 U.S. 723, 752 [1934 Act “chiefly concerned with the regulation of post-distribution trading on the Nation‘s stock exchanges and securities trading markets“; 1933 Act “far narrower statute chiefly concerned with disclosure and fraud in connection with offerings of securities—primarily . . . initial distributions of newly issued stock“]; Cyan, Inc. v. Beaver County Employees Retirement Fund (2018) ___ U.S. ___, 138 S.Ct. 1061, 1066 [1934 Act “regulated not the original issuance of securities but instead all their subsequent trading, most commonly on national stock exchanges“].) “The [ICA]
I.
“Section 11 of the Securities Act of 1933,
Appellants’ argument focuses on the language of two statutory provisions they view as defining standing to bring their claims. Section 6(a) of the 1933 Act (
” ‘The plaintiff in a § 11 claim must demonstrate (1) that the registration statement contained an omission or misrepresentation, and (2) that the omission or misrepresentation was material, that is, it would have misled a reasonable investor about the nature of his or her investment.’ (In re Stac Elecs. Sec. Litig. [(9th Cir.1996)] 89 F.3d 1399, 1403–1404 (”In re Stac“) (citation and internal quotation marks omitted). ‘No scienter is required for liability under § 11; defendants will be liable for innocent or negligent material misstatements or omissions.’ Id. (citing Herman & MacLean v. Huddleston [(1983)] 459 U.S. 375, 382 . . .).” (In re Daou Systems, Inc. (9th Cir. 2005) 411 F.3d 1006, 1027.)
The distinction is significant because it relates to the tracing requirement that is at the heart of the present case. For a claim under section 11 of the 1933 Act, “[p]laintiffs need not have purchased shares in the offering made under the misleading registration statement; those who purchased shares in the aftermarket have standing to sue provided they can trace their shares back to the relevant offering. Hertzberg v. Dignity Partners, Inc. [(9th Cir. 1999)] 191 F.3d 1076, 1080; Lee v. Ernst & Young, LLP [(8th Cir. 2002)] 294 F.3d 969, 978. When all of a company‘s shares have been issued in a single offering under the same registration statement, this ‘tracing’ requirement generally poses no obstacle. Hertzberg, . . . F.3d at 1082. But when a company has issued shares under more than one registration statement, the plaintiff must prove that her shares were issued under the allegedly false or misleading registration statement, rather than some other registration statement. Id. at 1080 n. 4.” (Century Aluminum, supra, 729 F.3d at p. 1106.)
Thus, “[w]hile Section 11‘s liability provisions are expansive—creating ‘virtually absolute’ liability for corporate issuers for even innocent material misstatements—its standing provisions limit putative plaintiffs to the ‘narrow class of persons’ consisting of ‘those who purchase securities that are the direct subject of the prospectus and registration statement.’ ” (Krim v. pcOrder.com, Inc. (5th Cir. 2005) 402 F.3d 489, 495.) Tracing of the chain of title for shares back to a specific offering “is ‘often impossible,’ because ‘most trading is done through brokers who neither know nor care whether they are getting newly registered or old shares,’ and ‘many brokerage houses do not identify specific shares with particular accounts but instead treat the account as having an undivided interest in the house‘s position.’ ” (Century Aluminum, supra, 729 F.3d at p. 1107, quoting Barnes v. Osofsky (2d Cir.1967) 373 F.2d 269, 271–272.) Nevertheless, “[t]hough difficult to meet in some circumstances, this tracing requirement is the condition Congress has imposed for granting access to the ‘relaxed liability requirements’ section 11 affords.” (Century Aluminum, at p. 1107, quoting Abbey v. Computer Memories, Inc. (N.D.Cal.1986) 634 F.Supp. 870, 875 (Abbey).)
Appellants seek to avoid the tracing requirement by relying upon section 24(e). Although appellants assert claims only under the 1933 Act, not directly under the ICA, they argue that because the investments at issue were sold by an investment company, their standing is governed by the ICA. They see section 24(e) as the relevant standing provision. But the fact that appellants’ claims derive from the 1933 Act is critical. In order to assert such claims, they must have standing under the 1933 Act. The only
As the issue on appeal is solely one of statutory interpretation, our review is de novo. (Bruns v. E-Commerce Exchange, Inc. (2011) 51 Cal.4th 717, 724.) Appellants correctly note that our starting point must be the language of the statutory provisions at issue. (Connecticut Nat. Bank v. Germain (1992) 503 U.S. 249, 253–254; People v. Statum (2002) 28 Cal.4th 682, 689–690.) Appellants argue that the “plain” and “straightforward” language of section 24(e)—“[f]or the purposes of section 11 of the Securities Act of 1933, as amended, the effective date of the latest amendment filed shall be deemed the effective date of the registration statement with respect to securities sold after such amendment shall have become effective“—gives them standing to sue under section 11 because they purchased ETFs “after the latest applicable amendment to the pertinent registration statement for the fund.”
Appellants thus view the language of section 24(e) as unambiguously demonstrating that Congress intended to allow claims under section 11 to be brought by any investor who purchased investment company securities “sold after” an amendment alleged to violate the 1933 Act, including investors who purchased their shares on the
Appellants correctly assert that when a statute‘s words are unambiguous, no further inquiry is necessary or appropriate. (Connecticut Nat‘l Bank v. Germain, supra, 503 U.S. at p. 254; People v. Statum, supra, 28 Cal.4th at p. 690.) “Statutory language, however, ‘cannot be construed in a vacuum. It is a fundamental canon of statutory construction that the words of a statute must be read in their context and with a view to their place in the overall statutory scheme.’ ” (Roberts v. Sea-Land Services, Inc. (2012) 566 U.S. 93, 101; Davis v. Michigan Dept. of Treasury (1989) 489 U.S. 803, 809.) In our view, the meaning of “sold after” in section 24(e) is not without ambiguity.
First, the “plain language” of the statute does not necessarily reflect appellants’ view of it. “For the purposes of section 11 of the Securities Act of 1933” obviously refers to the cause of action created by section 11, which turns on whether “any part of the registration statement” was false or misleading “when such part became effective.” That the “effective date of the latest amendment filed shall be deemed the effective date of the registration statement” can only mean that the latest amendment may be the basis of a section 11 suit. But the critical language of the provision is less clear. The phrase “with respect to securities sold after such amendment shall have become effective” does not clarify what sale was contemplated by use of the term “sold“—the initial sale of ETF shares by the issuer, as respondents maintain and the trial court found, or also subsequent sales on the secondary market.
Appellants assert that “sold” necessarily refers to any sale of the shares, including sales on the secondary market, juxtaposing the language of section 24(e) with that of section 6(a), the provision of the 1933 Act imposing the limitation that a registration statement is “effective” only “as to the securities proposed to be offered under that
But there is no obvious reason to conclude that the references to “effective date” in section 6 of the 1933 Act and in section 24(e) of the ICA were intended to serve the same purposes, so as to make that comparison meaningful with respect to standing under the 1933 Act. Section 11 uses the effective date of the registration statement to define the temporal point at which the validity of a registration statement is to be measured—liability is imposed where “any part of the registration statement” contained a false or misleading statement or omission “when such part became effective.” Section 6(a), in stating that a registration statement is “effective only as to the securities specified therein” uses “effective” in a different sense, to clarify the securities to which a registration statement applies and thereby impose a limitation that speaks to the focus of the 1933 Act on primary market transactions— public offerings by the issuer, not sales on the secondary market. Section 24(e) of the ICA uses “effective date” in the same sense as section 11, to define the point at which the validity of challenged statements or omissions are to be measured for purposes of liability in the context of investment companies utilizing amendments rather than registration statements for their continuous offerings. (See Jacobs, 5 Disclosure & Remedies under the Securities Laws, § 3:72, p. 398 [“securities sold after such amendment shall have become effective . . . [¶] means (1) securities sold pursuant to the registration statement after the effective date of the posteffective amendment, not (2) securities sold in the open market after such effective date“].)
Comparing the language of section 6(a) with that of section 24(e) does not clarify what sale was contemplated by use of the term “sold” in section 24(e)—the initial sale of ETF shares by the issuer, as respondents maintain, or also subsequent sales on the secondary market. The fact that section 24(e) refers to section 11 is a strong indication that Congress was contemplating sales in the primary market. Appellants point to nothing in the legislative history to suggest that Congress intended section 24(e) of the ICA to alter the focus of the 1933 Act on primary market transactions directly involving
Section 24 of the ICA, as its title indicates, is concerned with “Registration of securities under the Securities Act of 1933“; it describes rules applicable to securities issued by registered investment companies that vary from the rules otherwise governing registration of securities under the 1933 Act. In particular, section 80a-24(e) “permits the registration of additional securities of open-end investment companies to be effected by amending an earlier registration statement, instead of filing a new one.” (P. Stolz Family Partnership L.P. v. Daum (2d Cir. 2004) 355 F.3d 92, 105; Morse v. Peat, Marwick, Mitchell & Co. (S.D.N.Y. 1977) 445 F.Supp. 619, 623.) As explained in congressional committee reports concerning the proposed amendment by which it was adopted in 1954, subdivision (e), to section 24 would “afford to those investment companies engaged in continuous offerings (i.e., unit investment trusts, face-amount certificate companies, and open-end management companies) the alternatives of registering additional securities under the Securities Act of 1933 either by filing a new registration statement or, by virtue of this new section 24(e), by filing an appropriate amendment, at intervals of approximately 1 year, to the latest effective registration statement under the Securities Act of 1933 for securities of the same class.” (Sen.Rep. No. 83-1036, 2d Sess. p. 21 (1954); H.R.Rep. No. 83-1542, 2d Sess., p. 30 (1954).) It appears that Congress sought to alleviate administrative burdens on the companies while still ensuring provision of current information about the securities in these continuous offerings. (Ibid.) For example, the congressional reports explain that the “new section 24(e), by appropriate reference to section 10 of the Securities Act [“information required in prospectus“], will require that current information be made a part of the registration statement at approximately yearly intervals. It is not the intent of this paragraph, however, that every change made in a prospectus will involve the filing of such changed prospectus as part of the registration statement. It is intended that only those revised prospectuses which reflect a periodic general revision, to bring up to date the latest prospectus contained in
Given this context, the simplest interpretation of the sentence in section 24(e) referring to section 11 of the 1933 Act is as clarification that a section 11 claim may be based upon false or misleading statements in the most recent amendment despite section 11 itself referring only to registration statements. Read this way, section 24(e) does not confer standing to sue under section 11 but simply confirms that the changes in requirements for registration of securities under the ICA do not affect 1933 Act liability.
The same congressional reports demonstrate that section 24(e) was meant to maintain companies’ liability under the 1933 Act despite its authorization of amendments in place of registration statements for companies engaged in continuous offerings: “Paragraph (3) also contains references to section 11 and 13 of the Securities Act so that there will be no departure from either the disclosure standards or the liabilities imposed upon sellers. Thus, under the new section 24(e) of the Investment Company Act, the registration statement under the Securities Act of 1933 of an issuer referred to in this subsection must meet the standards of section 11 of the Securities Act not only on the original effective date but also on the effective date of each posteffective amendment to such registration statement, and the periods of limitation on actions provided in section 13 of the Securities Act start anew with respect to securities sold thereafter each time such registration statement is effectively amended either to increase the number or amount of securities registered or to make the above-mentioned revisions of the prospectus a part of the registration statement.” (H.R.Rep. No. 83-1542, 2d. Sess. p. 31 (1954).) “The intention of the legislation was thus to conform the registration procedures of the Securities Act to the special needs of investment companies but, simultaneously, to preserve intact the § 11 liability of investment companies.” (Morse v. Peat, Marwick, Mitchell & Co., supra, 445 F.Supp. at p. 623.) There is no indication that the legislation was intended to expand section 11 liability.
Another point makes it clear that in referring to shares “sold” after the effective date of an amendment, section 24(e) contemplated sales by the issuer. As we have said, when section 24(e) was enacted in 1954, Congress was concerned with open-end mutual funds offering shares on a continuous basis. Open-end companies were described in the congressional reports as “those in which the security holders can at their option compel the company to redeem or repurchase their securities at the actual asset value of such securities.” (H.R.Rep. No. 2639, 76th Cong., 3d Sess., p. 6 (1940).) As appellants acknowledge, redeemable securities were not sold in the secondary market prior to “recent SEC exemptions.” Indeed, the ICA “was designed to restrict most of secondary market trading” in mutual fund shares. (United States. v. National Assn. of Securities Dealers, Inc., supra, 422 U.S. at p. 700.) The United States Supreme Court observed in 1973 that “[p]rivate trading in mutual fund shares is virtually nonexistent.” (United States v. Cartwright (1973) 411 U.S. 546, 547.) There is no reason to believe that Congress, when it enacted section 24(e) in 1954, intended to enable investors who purchased shares in an open end mutual fund to assert a cause of action under section 11 of the 1933 Act.
In sum, the remarks in the congressional reports concerning the references to section 11 and 13 of the 1933 Act in section 24(e) of the ICA explain the need for and purpose of the language appellants rely upon without resort to an interpretation that alters the long-standing requirement that a plaintiff seeking to assert a claim under the 1933 Act must demonstrate that his or her shares were initially offered to the public by the issuer under the allegedly offending registration statement or amendment.
In appellants’ view, the continuous offerings that distinguish ETFs and other investment company offerings from the traditional securities offerings of other corporations require a different view of which investors may bring an action to enforce the disclosure requirements of the 1933 Act, expanding the cause of action from only those investors whose shares derive from the challenged registration statement to any investors who purchase any shares after the challenged amendment, even if those shares were or could have been initially offered to the public under an accurate registration
Appellants take this recognition that amendments to ETF registration statements aim to provide information to secondary market investors as reason to interpret section 24(e) as giving standing to such investors under section 11 of the 1933 Act. This does not follow. As trading of shares on the secondary market is a core feature of ETFs, it is not surprising that the issuer and SEC would recognize the need for accurate disclosure to secondary market investors. But this does not necessarily mean defective disclosure in registration statement amendments must give rise to a cause of action under the 1933 Act where the plaintiffs’ shares were not necessarily offered for sale by the issuer pursuant to
Appellants further argue that it is impossible to trace any individual ETF share to its original issuance. Unlike traditional stock offerings, which entail registration of a specified number of shares (
But courts enforce the tracing requirement for 1933 Act section 11 standing despite express recognition that tracing may be impossible. As stated by the Fifth Circuit Court of Appeals, “[t]hat present market realities, given the fungibility of stock held in street name, may render Section 11 ineffective as a practical matter in some aftermarket scenarios is an issue properly addressed by Congress. It is not within our purview to rewrite the statute to take account of changed conditions.” (Krim v. pcOrder.com, Inc., supra, 402 F.3d at p. 498.) The difficulty of tracing shares held in fungible aggregate is neither unique to ETFs nor a new problem. One federal district court explained, “The cause of action inheres in the faulty registration statement that put the shares in question on the market; it is on the basis of the flaw in the underlying registration that section 11 dispenses with the requirements of scienter, and, for those who purchase soon enough after the registration statement, reliance. Those who purchased in the open market shares that were properly registered in an earlier offering are relegated to the securities fraud remedies that include such requirements. Thus, plaintiffs who purchased securities not issued pursuant to the misleading registration statement lack standing as surely as the purchasers of other securities entirely. [¶] As Judge Friendly noted more than 35 years ago, modern market conditions may have made the tracing requirement obsolete. See
Appellants argue that “[t]hrough the ICA, Congress found it necessary to provide broad standing to investors like plaintiffs who purchase after an amended registration statement because the amended registration statement involves the ‘continuous offering [of] shares of the same class.” They point again to the different language employed in section 24(e) of the ICA and section 6(a) of the 1933 Act, the fact that registration forms under the 1933 Act (SEC Form S-1) require details about the securities offered therein, such as class and amount, that are not called for on registration forms under the ICA (SEC Form N-1A), and the fact SEC rules permitting registration of securities “for the shelf“—securities offered “to the public ‘on a continuous or delayed basis’ ” (Finkel v Stratton Corp. (2d Cir. 1992) 962 F.2d 169, 174;
In effect, appellants’ position is that, pursuant to section 24(e), each amendment to a registration statement becomes the operative registration statement for all shares issued pursuant to the original registration statement, including those shares issued prior to the allegedly defective amendment. A similar argument was rejected in Guenther v. Cooper Life Sciences, Inc. (N.D. Cal. 1990) 759 F.Supp. 1437 (Guenther). Although Guenther did not involve an investment company, it is of interest because it involved a shelf registration and therefore, as with an investment company‘s continuous offering, required the filing of an amended registration statement to update the information provided to investors.16 The allegedly defective documents in Guenther were an amendment to the registration statement for the company‘s first public offering and the registration statement for a second public offering. The plaintiffs argued that because no new securities were offered in the amendment, the securities offered “therein” (in the language of
Appellants, viewing the “sold after” language of section 24(e) as unambiguously referring to any sale of investment companies’ securities after the effective date of an amendment to the registration statement, argue that we have to look at “the words chosen by Congress—not debatable policy considerations.” As we have discussed, the words used in section 24(e), when read in context, do not support the interpretation appellants favor, and it is appellants who resort to “debatable policy considerations” in arguing that their interpretation “advances the ICAs overreaching goals.” As stated by the United States Supreme Court, “[t]his Court has long rejected the notion that ‘whatever furthers the statute‘s primary objective must be the law.’ Rodriguez v. United States [(1987)] 480 U.S. 522, 526, 107 S.Ct. 1391, 94 L.Ed.2d 533 (per curiam). Even if Congress could or should have done more, still it ‘wrote the statute it wrote—meaning, a statute going so far and no further.’ Michigan v. Bay Mills Indian Community [(2014)] 572 U.S. [782, 794] (internal quotation marks omitted).” (Cyan, Inc. v. Beaver County Employees Retirement Fund, supra, 138 S.Ct. at p. 1061.)
In any event, we are convinced that the problems appellants discuss are not ones this court can remedy. Accepting appellants’ interpretation of section 24(e) would require us to depart from established law with regard to both tracing and the distinction between the focus of section 11 on primary market transactions and that of the 1934 Act on secondary market transactions. Appellants’ interpretation of section 24(e)— a provision in separate legislation that does not appear to have been intended to expand standing under the 1933 Act and certainly could not have been enacted with secondary market transactions in mind—is too weak a basis for so great a departure from existing law.17 If, as may well be the case, securities markets and financial products have changed
II.
Section 12(a)(2) of the 1933 Act provides purchasers of securities with “an express cause of action for rescission against sellers who make material misstatements or omissions ‘by means of a prospectus.’ ” (Gustafson v. Alloyd Co., Inc. (1995) 513 U.S. 561, 564 (Gustafson).) The statute provides that “any person” who “offers or sells a security . . . by the use of any means or instruments of transportation or communication in interstate commerce or of the mails, by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in the light of the circumstances under which they were made, not misleading . . . [¶] shall be liable . . . to the person purchasing such security from him, who may sue either at law or in equity in any court of competent jurisdiction, to recover the consideration paid for such security with interest thereon, less
The trial court dismissed appellants’ cause of action under section 12(a)(2) on the pleadings because ” ‘[p]urchasers in private or secondary market offerings do not have standing to bring actions under [Section 12(a)(2) ].’ ” (Rieckborn v. Jefferies LLC (N.D. Cal. 2015) 81 F.Supp.3d 902, 925, quoting In re Ultrafem Inc. Sec. Litig. (S.D.N.Y. 2000) 91 F.Supp.2d 678, 693.) Although there are some cases to the contrary, “[t]he majority of courts who have considered this issue has concluded that purchasers who buy their shares on the secondary market lack standing to assert Section 12(a)(2) claims.” (Local 295/Local 851 IBT Employer Group Pension Trust and Welfare Fund v. Fifth Third Bancorp. (S.D. Ohio 2010) 731 F.Supp.2d 689, 713 (Local 295/Local 851); see, e.g., Medina v. Clovis Oncology, Inc. (D. Colo. 2017) 215 F.Supp.3d 1094, 1135 [section 12(a)(2) liability requires “privity and a direct relationship between buyer and seller“]; Primo v. Pacific Biosciences of California, Inc. (N.D.Cal. 2013) 940 F.Supp.2d 1105, 1124 (Primo) [following cases holding “§ 12(a)(2) liability does not extend to aftermarket transactions“]; In re Century Aluminum Co. Securities Litigation (N.D. Cal. 2010) 749 F.Supp.2d 964, 976 [“Section 12(a)(2) requires a plaintiff to plead and prove that it purchased a security directly from the issuer as part of the initial offering, rather than in the secondary market.“]; In re Levi Strauss & Co. Securities Litigation (N.D. Cal. 2007) 527 F.Supp.2d 965, 983 (Levi Strauss) [“§ 12(a)(2) does not extend to after market transactions]; see In re Sterling Foster & Co., Inc. (E.D.N.Y. 2002) 222 F.Supp.2d 216, 244 (Sterling Foster) [discussing “the predominate conclusion that purchasers in private or secondary market offerings are precluded from bringing actions under Section 12(a)(2).“]; see Hertzberg v. Dignity Partners, Inc., supra, 191 F.3d at p. 1081 (Hertzberg) [section 12 “permits suit against a seller of a security by prospectus only by ‘the person purchasing such security from him,’ thus specifying that a plaintiff must have purchased the security directly from the issuer of the prospectus].)
Many of these cases are based upon Gustafson, which has been interpreted as precluding section 12(a)(2) actions by secondary market purchasers. (E.g., Levi Strauss, supra, 527 F.Supp.2d at p. 983; Local 295/Local 851, supra, 731 F.Supp.2d at p. 713; Primo, supra, 940 F.Supp.2d at p. 1124; In re Century Aluminum Co. Securities Litigation, supra, 749 F.Supp.2d at p. 976; see Sterling Foster, supra, 222 F.Supp.2d at p. 244.) The issue in Gustafson was whether a purchase agreement in a private sale of securities was a prospectus within the meaning of section 12. The court held that “the word ‘prospectus’ is a term of art referring to a document that describes a public offering of securities by an issuer or controlling shareholder.” (Gustafson, supra, 513 U.S. at p. 584.) “[A]lthough Gustafson‘s ‘actual holding was premised upon a public/private distinction rather than the question presented here of the coverage of 12[a](2) for sales direct from an offering versus after-market transaction, . . . the Court‘s dicta provides strong support for finding a clear dividing line on shares purchased pursuant to an offering—either initial or secondary—as cognizable for private remedies under either the 1933 and/or 1934 Act and shares purchased in the aftermarket with a private right of action existing only under the 1934 Act.’ ” (Levi Strauss, at p. 983, quoting Murphy v. Hollywood Entertainment Corp. (D.Or. 1996) 1996 WL 393662, *3.) Levi Strauss observed that Gustafson “held that ‘the term “prospectus” relates to public offerings by issuers and their controlling shareholders’ and ‘was well understood to refer to a document soliciting the public to acquire securities from the issuer.’ 513 U.S. at 575–576, [emphasis in Levi Strauss]. Similarly, the Court has expressed that ‘[t]he 1933 Act regulates initial distributions of securities, and the 1934 Act for the most part regulates post-distribution trading.’ See Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., [supra,] 511 U.S. [at p. 171] (citing Blue Chip Stamps v. Manor Drug Stores, [supra,] 421 U.S. [at p. 752]).” (Levi Strauss, at p. 983.)
In finding that neither the language of section 12 nor its legislative history indicated it was intended to extend beyond public offerings, the Gustafson court contrasted section 12 with what it described as “the one provision of the [1933] Act that extends coverage beyond the regulation of public offerings“—section 17(a) (
As appellants point out, the conclusion that secondary market purchasers lack standing to assert section 12(a)(2) claims is not unanimous. Appellants point to Feiner v. SS & C Techs., Inc. (D.Conn. 1999) 47 F.Supp.2d 250, 253 (Feiner), which held that section 12(a)(2) “extends to aftermarket trading of a publicly offered security, so long as that aftermarket trading occurs ‘by means of a prospectus or oral communication.’ ” Feiner reasoned that under the statutory and regulatory framework, “delivery of a prospectus is required for a fixed number of days after the registration statement becomes effective, even if the initial distribution of shares has already been completed. See
Several of the cases above expressly reject Feiner as inconsistent with the Gustafson dicta and against the weight of authority. (Primo, supra, 940 F.Supp.2d at p. 1124; Levi Strauss, supra, 527 F.Supp.2d at p. 983; Local 295/Local 851, supra, 731 F.Supp.2d at p. 714; Sterling Foster, supra, 222 F.Supp.2d at p. 245.) Moreover, as the Levi Strauss court explained, even Feiner “did not hold that § 12(a)(2) applies to all aftermarket transactions so long as the transaction is traceable to the public offering. . . .
The SEC in 2002 granted iShares an exemption from the ICA‘s requirement that dealers must provide a prospectus to investors purchasing securities of an open end investment company (unlike those of a closed end investment company), apparently in recognition that, because shares are exchange-listed, investors have access to “several types of market information about iShares” as described in the application for the exemption, and investors would receive a “Product Description” that “while not intended as a substitute for a prospectus, . . . will contain information about iShares that is tailored to meet the needs of investors purchasing iShares in the secondary market.”18 iShares did not seek relief from the prospectus delivery requirement “for non-secondary market transactions, including purchases of creation units or those involving an underwriter.”
Respondents assert that because they are not required to deliver a prospectus to secondary market investors, they cannot be held liable by such investors under section 12(a)(2). Appellants, however, point out that in granting the exemption, the SEC order
In light of the SEC‘s obvious focus on the needs of secondary market investors, as well as its qualification regarding 1933 Act liability in the order granting relief from the prospectus delivery requirement, we are hesitant to accept respondents’ view that this exemption immunizes them from liability under section 12(a)(2). Nevertheless, in addition to the fact that the majority of federal cases, unlike Feiner, view secondary market investors as lacking standing to assert claims under section 12(a)(2), another consideration causes us to agree that appellants lack standing here.
Liability under section 12(a)(2) “extends only to the ‘immediate sellers’ of securities and ‘those who solicit purchasers to serve their own financial interests or those of the securities owner.’ ” (In re Countrywide Financial Corp. Mortgage-Backed Securities Litigation (C.D. Cal. 2013) 932 F.Supp.2d 1095, 1118 (Countrywide), quoting Maine State Retirement System v. Countrywide Financial Corporation (C.D.Cal. May 5, 2011) 2011 WL 4389689, *9 (Maine State Retirement System).) As indicated above, section 12 “permits suit against a seller of a security by prospectus only by ‘the person purchasing such security from him,’ thus specifying that a plaintiff must have purchased the security directly from the issuer of the prospectus.” (Hertzberg, supra, 191 F.3d at p. 1081, quoting
The parameters of a statutory “seller” under section 1219 were established in Pinter v. Dahl (1988) 486 U.S. 622, 642, 647 (Pinter). Pinter held that liability under section 12 “is not limited to persons who pass title” but also extends to one who “successfully solicits the purchase, motivated at least in part by a desire to serve his own financial interests or those of the securities owner.”20 But the court limited its holding, noting that
Shaw involved a “firm commitment” underwriting, in which “the issuer of the securities sells all of the shares to be offered to one or more underwriters, at some discount from the offering price” and investors “purchase shares in the offering directly from the underwriters (or broker-dealers who purchase from the underwriters), not directly from the issuer.” (Shaw, supra, 82 F.3d at p. 1215.) Because the issuer did not pass title to the securities to investors, it could be liable under section 12(a)(2) only if it “actively ‘solicited’ the plaintiffs’ purchase of securities to further their own financial
Lone Star Ladies Inv. Club v. Schlotzsky‘s Inc. (5th Cir. 2001) 238 F.3d 363, 369, similarly held that in a firm commitment underwriting, “the public cannot ordinarily hold the issuers liable under section 12, because the public does not purchase from the issuers.” The court stated, “It is true that there are unusual cases in which the issuer is sufficiently active in promoting the securities as to essentially become the vendor‘s agent. But that possibility does not weaken this basic principle. Virtually all issuers routinely promote a new issue, if only in the form of preparing a prospectus and conducting a road show. That said, Pinter holds that a plaintiff invoking section 12 may show that an issuer‘s role was not the usual one; that it went farther and became a vendor‘s agent.” (Lone Star, at p. 370.)
Here, respondents assert that appellants did not allege them to have been directly or indirectly involved in selling shares on the secondary market, or to satisfy any of the factors Pinter noted in discussing what might make a person who did not pass title to the investor a “seller.” In Pinter, the question was whether an individual investor who told others about the venture, in which they subsequently invested, could be considered a seller by virtue of receiving financial benefit such as a share of the profits from the sale or commission, or soliciting the sale to “serve the financial interests of the owner,” as opposed to having urged the purchase only to assist or benefit the buyer. (Pinter, supra, 486 U.S at pp. 654–655, 647.) The necessary inquiry, the court explained, “focuses on
Appellants maintain that they sufficiently alleged both motive and solicitation. As to the former, they cite allegations that BlackRock is the world‘s largest asset manager ($4.5 trillion) and iShares the world‘s largest ETF provider (“700 ETFs globally with more than $1 trillion under management as of December 31, 2014“), and that BlackRock ” ‘earns its fees from the Funds based on the Fund‘s allocable portion of the aggregate of the average daily net assets’ of the iShares Funds.” As to solicitation, appellants argue that “BlackRock maintains a website encouraging investors to buy its ETFs“; that respondents “filed, issued and distributed Offering Documents to investors,” “published misinformation about their funds in guides, brochures, and websites directed to investors and their advisors,” “sent letters to shareholders to calm investors and keep them from fleeing the funds,” and “gave interviews to the financial press promoting their funds.” Appellants assert that respondents “were not earning their money from the sales to the intermediary Authorized Participants who slipped in and out of the shares to facilitate trading for retail investors such as plaintiffs” and that respondents acknowledged “retail investors are the ‘intended recipients of ETF prospectus disclosure.’ ”
With respect to solicitation, reading the allegations of the first amended complaint, rather than appellants’ description of them, the complaint alleges that respondents’ website describes its ETF funds as safe long term investment vehicles, acting as an “emergency brake” against volatility in the market, that respondents, on the BlackRock website and in the media, responded to criticisms that investors are given insufficient information to understand the risks of ETFs, and “glossed over” the risks, published misinformation about their funds in guides and brochures, including an “Adviser Guide to ETFs” that failed to mention specific risks and promoted the “benefits of ETFs for advisers,” “encourage[d] investors to use market and stop-loss orders in conjunction with ETF purchases” “published and mailed” to owners of ETF shares an ” ‘Open Letter to Our Investors’ ” that inaccurately responded to concerns about volatility in the market,
Most of these allegations appear to reflect general advertising and promotions of the product to the public rather than direct or immediate solicitation of appellants’ purchases. As such, the factual allegations fail to demonstrate ” ’ “a direct relationship between the defendant and the plaintiff purchaser. [Citation.]” ’ ” (In re Municipal Mortg. & Equity, LLC (D. Md. 2012) 876 F.Supp.2d 616, 661–662, quoting In re Constellation Energy Group, Inc. (D.Md. 2010) 738 F.Supp.2d 614, 632.) “To count as ‘solicitation,’ the seller must, at a minimum, directly communicate with the buyer.” (Rosenzweig v. Azurix Corp. (5th Cir. 2003) 332 F.3d 854; Maine State Retirement System, supra, 2011 WL 4389689, at *10 [“Plaintiffs must include very specific allegations of solicitation, including direct communication with plaintiffs.“].) Appellants have not alleged any direct contact with them by respondents, and to the extent they allege direct contact by respondents with investors generally, it is in connection with attempts to prevent ETF shareholders from divesting themselves of the securities, not solicitation of new purchases of shares. The complaint thus fails to allege the necessary “direct and active participation in the solicitation of the immediate sale to hold the issuer liable as a § 12(2) seller” (Shaw, supra, 82 F.3d at pp. 1214–1215), given that appellants purchased their ETF shares on the secondary market, not directly from respondents.21
DISPOSITION
The judgment is affirmed.
Costs on appeal to respondents.
Kline, P.J.
We concur:
Richman, J.
Stewart, J.
Trial Judge: Hon. Curtis E.A. Karnow
Attorneys for Plaintiffs and Appellants: Hagens Berman Sobol Shapiro
Reed R. Kathrein
Peter E. Borkon
Danielle Smith
Kevin K. Green
Attorneys for Defendants and Respondents: Skadden, Arps, Slate, Meagher & Flom
Jeremy A. Berman
Eben P. Colby
Patrick M. Hammon
Stroock & Stroock & Lavan
John R. Loftus
Notes
Section 10b provides: “It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange . . . [¶] . . . [¶] (b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities-based swap agreement[,] any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.” (
SEC rule 10b-5 provides: “It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, [¶] in connection with the purchase or sale of any security.” (
Furthermore, several courts have held that because an SEC regulation “cannot countermand a contrary Supreme Court holding,” SEC rule 159A cannot prevail over Pinter‘s holding that a defendant who did not directly sell the security to the purchaser can be liable under section 12 only if ” ‘directly involved in the actual solicitation of a securities purchase.’ ” (Massachusetts Mut. Life Ins. Co. v. Residential Funding Co., LLC (D. Mass. 2012) 843 F.Supp.2d 191, 207, quoting Shaw, supra, 82 F.3d at 1215; Federal Home Loan Bank of Boston v. Ally Financial, Inc. (D.Mass. Sept. 30, 2013) 2013 WL 5466631, *4; In re Kosmos Energy Ltd. Secs. Litig. (N.D.Tex. 2013) 955 F.Supp.2d 658, 672; Maine State Retirement System, supra, 2011 WL 4389689, *10.) At least one court has held that the SEC exceeded its authority in adopting the rule. (Countrywide, supra, 932 F.Supp.2d at p. 1118; but see National Credit Union Administration Board v. RBS Securities, Inc. (C.D.Cal. Dec. 19, 2013) 2013 WL 12320069, *5 [disagreeing with Countrywide].)