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In re Proshares Trust II Securities Litigation

United States District Court, S.D. New York

January 3, 2020

IN RE PROSHARES TRUST II SECURITIES LITIGATION

          For plaintiffs: Samuel H. Rudman, David A. Rosenfeld, Erin W. Boardman, Lindsay La Marca, Magdalene Economou Robbins Geller Rudman & Dowd LLP Steve W. Berman, Karl Barth Hagens Berman Sobol Shapiro LLP Reed R. Kathrein, Lucas E. Gilmore, Hagens Berman Sobol Shapiro LLP

          For defendants ProShares Trust II, ProShare Capital Management LLC, Michael L. Sapir, Louis M. Mayberg, Edward J. Karpowicz, and Todd B. Johnson: Robert A. Skinner Amy D. Roy Jessica M. Bergin Ropes & Gray LLP

          For defendants ABN AMRO Clearing Chicago LLC (f/k/a Fortis Clearing Americas LLC), Deutsche Bank Securities Inc., Goldman, Sachs & Co., J.P. Morgan Securities LLC (f/k/a J.P. Morgan Securities Inc.), Knight Execution & Clearing Services, LLC (n/k/a Virtu Americas LLC), Merrill Lynch Professional Clearing Corp., SG Americas Securities, LLC (on behalf of itself and as successor to Newedge USA, LLC), and Virtu Financial BD LLC: Adam S. Hakki Daniel Lewis Agnès Dunogué Shearman & Sterling LLP

          OPINION AND ORDER

          DENISE COTE, DISTRICT JUDGE.

         SVXY is a derivative financial product that loses value when stock market volatility rises and gains value when the market is calm. On February 6, 2018, the New York Stock Exchange (“NYSE”) halted trading for several hours in SVXY.[1]When trading resumed in the late morning, the SVXY share price had suffered a sharp drop. This putative class action is brought on behalf of investors who purchased or otherwise acquired SVXY shares between May 15, 2017 and February 6, 2018 (the “Class Period”).

         Plaintiffs principally assert that a May 15, 2017 Registration Statement and related filings for the SVXY Fund (collectively the “Registration Statement”)[2] contained material omissions. On September 27, 2019, defendants moved to dismiss plaintiffs' Second Amended Complaint (the “SAC”) pursuant to Rule 12(b)(6), Fed.R.Civ.P. For the reasons that follow, defendants' motion is granted.

         Background

         The following facts are taken from the SAC and documents attached to and incorporated in it by reference, including the Registration Statement. They are taken in the light most favorable to plaintiffs.

         ProShares Trust II (“ProShares”) is a Delaware statutory trust that manages investment funds with combined assets of $29 billion. Among the investment funds managed by ProShares are inverse and leveraged exchange-traded funds (“ETFs”). The SAC alleges that ProShares is one of the world's largest managers of these types of ETFs.

         I. The SVXY Fund

         The SAC contains a detailed description of the securities at issue here. An ETF is a financial product that bundles securities together to offer investors the ability to invest in diversified portfolios. Unlike a mutual fund, shares of which trade at the fund's net asset value (“NAV”), its total assets minus its total liabilities, ETF shares trade on stock exchanges throughout the trading day at varying prices. ETFs are usually designed, however, to keep their market price close to their NAV per share.

         According to the SAC, most ETFs track an index. Inverse ETFs are designed to deliver the opposite of the performance of the index they track.

         This litigation concerns ProShares' inverse ETF called the SVXY Fund (the “Fund”), which ProShares created in 2011. In particular, this litigation concerns SVXY shares that were offered pursuant to the 2017 Registration Statement or that were traded in the period following the filing of the Registration Statement.

         As an inverse ETF, the Fund was designed to deliver the opposite performance of the VIX Short-Term Futures Index. The VIX is an index that seeks to measure the expected (i.e. future) volatility of the S&P 500 Index over the next 30 days.[3]Volatility is the range of price change that a security experiences over a given period of time. The VIX is sometimes referred to as the market's “fear gauge” because it measures expected market swings.

         The VIX is not tradeable and cannot be invested in directly. Instead, an investor can purchase shares of the VIX Short-Term Futures Index. The VIX Short-Term Futures Index is comprised of VIX futures contracts. A futures contract is an agreement to buy or sell a predetermined amount of a commodity -- here, volatility itself -- at a specific price on a specific date in the future. The VIX Short-Term Futures Index essentially represents the market's expectation as to how the VIX will perform over the next 30 days.

         During the Class Period, the Fund's declared “investment objective” was to achieve results that corresponded to the inverse (-1x) of the daily performance of the VIX Short-Term Futures Index. For example, if the VIX Short-Term Futures Index decreased by 5% on a given day due to low market volatility, the Fund's investment objective was to increase by 5% that same day. Purchasing SVXY shares allowed investors to hedge investment risk and diversify investment portfolios.

         During the Class Period, substantially all of the Fund's assets were invested in VIX futures contracts. Each day, defendant ProShare Capital Management LLC (the “Sponsor”), bought and sold VIX futures contracts to fulfill the Fund's investment objective of replicating the inverse value of the VIX Short-Term Futures Index. When the VIX Short-Term Futures Index increased in value during the trading day, the Fund's value -- as measured by its NAV -- was designed to decrease. This decrease in NAV was accomplished by purchasing VIX futures contracts (i.e. increasing its liabilities). When the VIX Short-Term Futures Index decreased in value during the trading day, the Fund would sell futures contracts in order to increase its NAV (i.e. reducing its liabilities).

         The SAC alleges that this “rebalancing” occurred each day between 4:00 p.m., the time the stock market closes, and 4:15 p.m., the time the VIX futures market closes. This was the same time period in which other volatility-related ETFs rebalanced their portfolios through the purchase and sale of futures contracts. Because the Fund's investment objective was simply to achieve the inverse value of the VIX Short-Term Future Index -- not to achieve the greatest return for investors -- the purchase and sale of VIX futures contracts would occur each day, regardless of the price of the futures contracts. The Fund was thus price insensitive.

         The markets experienced a period of historic low volatility in 2017. As a result, the VIX Short-Term Futures Index dropped to historic lows throughout 2017 and investments in volatility-related ETFs increased. By May 31, 2017, aggregate gross capital subscriptions in the Fund had increased to $7.9 billion.

         As investment poured into inverse-volatility ETFs, the quantity of VIX futures contracts necessary to rebalance each ETF's portfolio grew, too. According to the SAC, however, the growth in demand for VIX futures contracts that was fueled by the volatility-related ETFs' daily rebalancing needs outpaced the growth in the supply of VIX futures contracts, eventually creating a “liquidity gap.”

         On February 5, 2018, the S&P 500 Index fell approximately 4% amid concerns about rising bond yields and higher inflation. At 4:00 p.m., the close of markets, the VIX Short-Term Futures Index had risen 33% from the prior day's close. The SVXY share price fell roughly 32%, from the prior day's close of $105.60 per share to $71.82 per share at 4:00 p.m. on February 5. According to the SAC, the Fund was then rebalanced so that its NAV reflected the 32% decline in the SVXY share price. To rebalance, the Fund purchased hundreds of millions of dollars of VIX futures contracts before 4:15 p.m., the close of the market for VIX futures contracts. During this brief time period, between 4:00 and 4:15 p.m., other volatility-related ETFs also purchased and sold VIX futures contracts in order to rebalance their portfolios. The outsized demand for and limited supply of VIX futures contracts led to a liquidity gap that caused massive investor losses.

         The Fund's NAV was not published at 4:15 p.m. on February 5, and was still not published at 4:00 a.m. on February 6, when pre-market trading began. This led the NYSE to halt trading in SVXY shares. When trading resumed at 11:35 a.m. on February 6, the opening SVXY share price was $11.11, a precipitous drop from the $71.82 trading price at 4:00 p.m. the previous day.

         On February 27, 2018, ProShares announced that the investment objective for the Fund would change. Its new investment objective would be to seek results that correspond to one-half the inverse (-0.5x) of the VIX Short-Term Futures Index for a single day.

         II. The ...


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