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In Re Proshares Trust Securities Litigation

September 10, 2012

IN RE PROSHARES TRUST SECURITIES LITIGATION


The opinion of the court was delivered by: John G. Koeltl, District Judge:

OPINION AND ORDER

This is a putative class action brought by a group of investors (collectively, the "plaintiffs") in forty-four exchange-traded funds ("ETFs") offered by ProShares. The funds have daily investment objectives tied to an underlying benchmark index. The plaintiffs assert securities fraud claims pursuant to Sections 11 and 15 of the Securities Act of 1933, 15 U.S.C. §§ 77k & 77o. Two plaintiffs also assert a breach of contract claim under New York law. The defendants-ProShares Trust, ProShares Trust II, ProShares Advisors LLC, SEI Investments Distribution Co., Michael Sapir, Louis Mayberg, Edward Karpowicz, William Seale, Simon Collier, Charles Todd, Russell Reynolds, and Michael Wachs (collectively, "ProShares")-have moved to dismiss the plaintiffs' Third Amended Complaint pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure.

I.

In deciding a motion to dismiss pursuant to Rule 12(b)(6), the Court accepts the allegations in the complaint as true, and draws all reasonable inferences in the plaintiffs' favor. McCarthy v. Dun & Bradstreet Corp., 482 F.3d 184, 191 (2d Cir. 2007); Arista Records LLC v. Lime Group LLC, 532 F. Supp. 2d 556, 566 (S.D.N.Y. 2007). The Court's function on a motion to dismiss is "not to weigh the evidence that might be presented at a trial but merely to determine whether the complaint itself is legally sufficient." Goldman v. Belden, 754 F.2d 1059, 1067 (2d Cir. 1985). The Court should not dismiss the complaint if plaintiffs have stated "enough facts to state a claim to relief that is plausible on its face." Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007). "A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009). While the Court should construe the factual allegations in the light most favorable to the plaintiff, "the tenet that a court must accept as true all of the allegations contained in a complaint is inapplicable to legal conclusions." Id.

When claims under Section 11 of the Securities Act "are premised on allegations of fraud," they must also satisfy Rule 9(b) of the Federal Rules of Civil Procedure. Rombach v. Chang, 355 F.3d 164, 171 (2d Cir. 2004). Rule 9(b) requires that the complaint "(1) specify the statements that the plaintiff contends were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why the statements were fraudulent." Id. (quoting ATSI Commc'ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 99 (2d Cir. 2007)). If they sound in negligence, however, claims under Section 11 need only satisfy the less rigorous requirements of Federal Rule of Civil Procedure 8(a). See Litwin v. Blackstone Grp., L.P., 634 F.3d 706, 718 (2d Cir. 2011), cert. denied, 132 S. Ct. 242 (2011); see also Panther Partners Inc. v. Ikanos Commc'ns, Inc., 681 F.3d 114, 120 (2d Cir. 2012).

When presented with a motion to dismiss pursuant to Rule 12(b)(6), the Court may consider documents that are referenced in the complaint, documents that the plaintiffs relied on in bringing suit and that are either in the plaintiffs' possession or that the plaintiff knew of when bringing suit, or matters of which judicial notice may be taken. See Chambers v. Time Warner, Inc., 282 F.3d 147, 153 (2d Cir. 2002); City of Roseville Emps.' Ret. Sys. v. EnergySolutions, Inc., 814 F. Supp. 2d 395, 402 (S.D.N.Y. 2011).

II.

The following facts are undisputed unless otherwise noted.

A.

The defendants ProShares Trust and ProShares Trust II (collectively, the "ProShares Trusts") are Delaware Trusts. (Third Am. Compl. ("TAC") ¶ 62.) During the class period, which began on August 6, 2006, and ran through June 23, 2009, ProShares Trust operated as an open-ended investment company under Section 8 of the Investment Company Act, 15 U.S.C. § 80a-8, and was registered with the Securities Exchange Commission ("SEC"). (TAC ¶¶ 2, 62(a), 84.) ProShares Trust II was organized on October 9, 2007 as a publicly-traded commodity pool, and was registered by 2008 with the Commodity Futures Trading Commission ("CFTC"). (TAC ¶¶ 62(b), 85.) The ProShares Trusts offer for sale various ETFs, which are listed on the New York Stock Exchange. (TAC ¶¶ 62(a), (b).) The defendant ProShare Advisors LLC ("ProShare Advisors") serves as an investment advisor to the ETFs, and, among other things, exercises control over the ETFs' management and redemption. (TAC ¶¶ 62(c)-63.)

The individual defendants in this case were either officers or trustees of one of the entities during the class period, and signed one or more of the registration statements at issue in this case. (TAC ¶¶ 65-74, 90, 92.) The defendant SEI Investments Distribution Co. is the distributor and principal underwriter for the ETFs. (TAC ¶ 64.)

An ETF is similar to an indexed mutual fund. It trades like a stock, and it often tracks a specific index, sector, commodity, or currency. (TAC ¶¶ 81-82.) Unlike mutual funds, ETFs generally sell shares directly to investors, and typically issue shares in large blocks called "creation units." (TAC ¶ 82(a).) Initial investors purchase creation units by exchanging a basket of securities similar to the type of securities being tracked by the ETF, or, less frequently, with cash. (TAC ¶ 82(b).) Investors may then split up the creation unit and sell shares of the ETF on a secondary market or may sell the creation unit back to the ETF at a later date. (TAC ¶ 82(c)-(d).)

ProShares created and operated three types of ETFs: "Inverse ETFs," the goal of which was for the net asset value of the fund to replicate the inverse movement of a specific index over the period of one day; "Ultra Long ETFs," the goal of which was for the fund's value to double the performance of a specified index or benchmark over the period of one day; and "Ultra Short ETFs," the goal of which was for the fund's value to double the inverse of the performance of a specified index or benchmark over the period of one day. (TAC ¶ 93.) All three types of ETFs are leveraged, meaning that the mechanism through which they attempt to achieve their goal involves incurring debt through borrowing. (TAC ¶ 93.)

B.

ProShares Trust filed its first registration statement on June 19, 2006. (See, e.g., Skinner Decl. Ex. 1, at 1.) ProShares Trust II filed its first registration statement on November 17, 2008. (See, e.g., Skinner Decl. Ex. 2, at 1.) The class period in this case begins in August 2006 and runs through 2009. (TAC ¶ 2.) The plaintiffs allege that 21 registration statements filed by ProShares Trust and 5 registration statements filed by ProShares Trust II contained material misstatements or omissions constituting a Section 11 violation. (Am Compl. Exs. A-B.)

The registration statements did include some material that attempted to explain the effects of investing in the ProShares ETFs for a period of greater than one day. (See generally TAC ¶ 102.) For example, the registration statements described, for each individual ETF, the fees associated with selling a $10,000 investment after a period of 1 year, 3 years, 5 years, and 10 years, at a 5% annual rate of return. (See, e.g., Skinner Decl. Ex. 3, at 24.)

However, each registration statement filed by ProShares indicated in its overview, and throughout, that the ETFs' goals were to provide "daily" results matching the "daily" performance of a given index or benchmark. (Skinner Decl. Exs. 1-2; see also TAC ΒΆ 100.) Each registration statement filed by ProShares indicated that the ETFs' returns for a period of greater than one day would not, and could not, match the cumulative returns of the underlying index. For example, it is undisputed that each statement explained that "[t]he Funds do not seek to achieve their stated investment objective over a period of time greater than one day because mathematical compounding prevents the Funds from achieving such results." (Skinner Decl. Ex. 1, at 4; Skinner Decl. Ex. 2, at 2-3.) ProShares's registration statements also explained that "[o]ver time, the cumulative percentage increase or decrease in the net asset value of [a given ETF] may diverge significantly from the cumulative percentage increase or decrease" of the underlying index or benchmark. (Skinner Decl. Ex. 1, at 5-6, 8; Skinner Decl. Ex. 2, at 4.) ProShares's pre-September 2007 registration statements also explained that, "over time, the use of leverage, combined with the effect of compounding, will have a more significant impact on [a given ETF's] performance compared to the index underlying its ...


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