BlackRock iShares ETF August 24, 2015 Flash Crash Litigation

CASE NUMBER: CGC-16-552567
COURT: Superior Court State of California, County of San Francisco
PRACTICE AREA: Investor Fraud
STATUS: Active
CLASS PERIOD: Jun. 16, 2013 - Aug. 24, 2015
DATE FILED: 06/16/16

Hagens Berman Sobol Shapiro LLP filed a complaint on behalf of a class of BlackRock ETF investors against BlackRock Inc., iShares Trust and their affiliates. The case is brought on behalf of investors of BlackRock iShares Exchange Traded Funds (“ETFs”) who used market or stop loss orders and suffered losses when the underlying value of the assets in BlackRock ETFs disengaged from the ETF price during the August 24, 2015 ETF Flash Crash. The potential class includes those who purchased iShares ETFs between June 16, 2013 and August 24, 2015 (the “Class Period”) and sold their iShares ETFs on August 24, 2015 pursuant to a market or stop-loss order, and were damaged thereby. Defendant-Respondent iShares Trust is registered with the SEC as an open-end management investment company under the ICA. The iShares Trust, the world’s largest ETF. Defendant BlackRock, Inc. (BlackRock), in turn, controls the iShares Trust. As of 2015, BlackRock had $4.65 trillion assets under management (AUM) – making it the world’s largest asset manager.

While the trial court held the plaintiffs stated a claim for relief, it held a trial on the merits of whether plaintiffs (retail investors) had standing to sue. Each plaintiff investor purchased at least one BlackRock iShares ETF and, due to market or stop-loss orders, each suffered financial losses in the August 2015 flash crash – a gut-wrenching day when ETF trading prices fell dramatically and, due to the nature of their sale orders, caused plaintiffs substantial but avoidable financial losses. Importantly for standing purposes, it was uncontested that iShares ETFs were sold to each plaintiff after, and pursuant to, allegedly defective SEC disclosure documents or amendments thereto issued or filed between 2012 and 2015. The crux on standing is whether this suffices for plaintiffs to invoke the Securities Act. The trial court held plaintiffs did not have standing. The legal issue is of first impression because ETFs are relatively unique and recent security instruments. 

Background Allegations of the Complaint and Proceedings

BlackRock’s failure to disclose the risk of using market, stop-loss or good-until-cancelled orders

Most laypeople are familiar, if only through their jobs, with mutual funds and individual stocks often selected for a 401(k) plan.  But, as an investment vehicle, ETFs are less known and – as even BlackRock freely acknowledged – less understood. This knowledge gap made BlackRock’s pitch to investors highly material in attracting trillions of dollars now invested in BlackRock ETFs under defendants’ management and control.

The Amended Complaint alleges that BlackRock characterizes its ETFs as investment products that “help individuals build a nest egg, prepare for retirement, or save for their children’s education” – a multipurpose investment meant to appeal to a broad audience. To gain an edge on other investment options, BlackRock promoted ETFs for their “versatility and low cost.”

On its website, BlackRock represents to investors that ETFs “trade like a stock but investors will get “a diversified collection of stocks and/or bonds, which can potentially help reduce risk compared to individual securities.” Before the August 2015 flash crash, BlackRock misled investors on the downside risks by proclaiming, for example, that “[m]arket risk is tied to the underlying holdings just like mutual funds” and “[l]ike stocks, you can buy and sell ETFs at the market price whenever the market is open.”

In reassuring investors in ETFs, BlackRock went even further.  It expressly rejected the “belief” that “in a market downturn the frequent trading of ETFs may trigger steeper losses and accelerate shocks.” BlackRock proclaimed that the nature of ETF trading, as to sudden price declines, would act to impose an “emergency brake on an elevator with a broken cable.”  “ETFs can actually serve as a check on volatility during periods of stress,” according to BlackRock, “thanks to their unique structure and the role it plays in balancing supply and demand.”

As plaintiffs discovered to their detriment during the flash crash, the reality was otherwise – as BlackRock knew but did not disclose.  A major risk, unrevealed in BlackRock’s ETF Registration Statements and Prospectuses, is the use of stop-loss and market orders with ETFs, particularly orders placed at the open of markets, or orders that are “good until cancelled.”

A stop-loss order mandates that an investor’s security be bought or sold once the stock value hits a certain price; it is intended to limit an investor’s loss.  Once a security’s price drops to the targeted lower price, the stop-loss converts to a market order – meaning the trade is automatically executed at market price.  But during the August 2015 flash crash, stop-loss orders had the opposite effect.  Instead of reducing risk, many ETF investors were surprised and damaged as a result.

Before the August 2015 flash crash, BlackRock observed that during high volatility, ETF values were impacted much more than mutual funds and regular securities.  On May 6, 2010, U.S. equity markets experienced a flash crash when U.S. equities, and ETFs holding them, declined precipitously for one-half hour.  Numerous ETFs traded 60% lower than the value of their underlying assets.  BlackRock later observed that this was similar to a 2008 crash where ETFs traded 5-8% lower than the underlying asset values.

As detailed in the operative complaint, BlackRock was on ample notice of the volatility risk for investors in iShares ETFs.  But because of BlackRock’s failure to warn investors, including plaintiffs, of potential consequences from a flash crash, many investors and investment advisors remain ignorant of the risks of using stop-loss orders with ETFs.  Although the Offering Documents disclosed that ETFs are subject to volatility, investors were not advised of the known inherent risk of using stop-loss or market orders with ETFs – the very selling methods that caused plaintiffs’ losses here.

The August 2015 flash crash and plaintiffs’ federal securities claims against defendants

On August 24, 2015, BlackRock ETF investors who had placed market orders or protective stop-loss orders before or at market opening suffered drastic losses.  Of all ETFs, 19.2% experienced price declines of more than 20% (compared to only 4.7% of corporate securities). For example, BlackRock’s iShares Select Dividend ETF dropped more than 35% by 9:42 a.m. EST when the underlying investments within the fund dropped only 2-4% – a disengagement of over 30%.

BlackRock knew, and in fact explicitly acknowledged, the risk that the August 2015 flash crash would occur and that it would disproportionately harm ETF investors who entered market or protective stop-loss orders.  BlackRock omitted this risk despite amending its Offering Documents at least annually starting in 2002 and through the Class Period.  Frequent and periodic registration amendments flow from, and reflect, the nature of ETFs.  In defendants’ words, iShares “continuously issues and redeems ETF shares.”

Since the crash at issue in this case, the leading stock exchanges – including NASDAQ and the New York Stock Exchange – announced their intent to eliminate “stop-loss orders” and “good-til-canceled” orders.  So, when BlackRock failed to protect its investors from sharp single-day declines, the major exchanges stepped in.

Against this backdrop, plaintiffs assert causes of action under Sections 11, 12 and 15 of the Securities Act, 15 U.S.C. §§77k, 77l, 77o. They seek to represent the following class:

  • “all persons who purchased shares of BlackRock iShares” ETFs “beginning three years before the filing of the original complaint (June 16, 2013) to August 24, 2015”;
  • who did so “pursuant and/or traceable to continuous offering Registration Statements, and the Prospectuses identified herein” and “amendments thereto and incorporated therein” (collectively, Offering Documents); and
  • who sold On August 24, 2015 pursuant to a market order or stop-loss order” and were damaged thereby.

Relevant to standing, the last amended registration statements preceding plaintiffs’ ETF purchases were admitted at trial.  Several named plaintiffs received an Offering Document, such as a prospectus, in connection with their iShares ETF purchase.

Holding that plaintiffs state viable claims for relief, the trial court twice rejected defendants’ attempt to terminate this action at the pleading stage.

Although defendants sought dismissal on the pleadings three times, their standing argument was virtually an afterthought.

First, defendants demurred to the original complaint. 

But defendants did not challenge standing and their demurrer was “taken off calendar.” Defendants then filed separate answers.  Neither alleged standing as an affirmative defense.

After the trial court stayed all discovery, defendants moved for judgment on the pleadings.

Again, standing to sue was not disputed.  The trial court granted dismissal with leave to amend so plaintiffs could plead facts “‘to demonstrate conformity with the statute of limitations.’” Although not at issue now, plaintiffs later cured.

More significantly for present purposes, the trial court also ruled that plaintiffs stated viable Securities Act claims. 

The order agreed with plaintiffs that “prospectuses must state risk peculiar to the securities” at issue. “There are allegations that the omitted risks are specifically tied to the security (ETFs), that they specifically have to do with flash crashes and market and stop loss orders, and that these risks are not general to any and every fund because they disproportionately affect ETFs.”  On all three causes of action – Sections 11, 12(a)(2) and 15 of the Securities Act – plaintiffs’ allegations were “sufficient to state a claim.”

After plaintiffs filed their First Amended Complaint (FAC), defendants once more sought judgment on the pleadings. Concurrently, they again filed separate answers.  Eight months after suit was initiated – and facing the prospect of litigating the action on the merits – the individual defendants added standing to their affirmative defenses. 

The BlackRock defendants did not.

Nonetheless, claiming “space limitations” impeded raising the contention earlier, defendants’ second motion for judgment on the pleadings targeted plaintiffs’ standing.  Defendants’ newfound theory was that “Section 11 and 12(a)(2) liability only applies to initial offerings, not aftermarket trading.  Because plaintiffs purchased all of their ETF shares on the secondary market, they assertedly lack standing.”

As to Section 11 standing, the trial court advised that plaintiffs’ allegations “might be enough” and that, due to insufficient information, defendants’ motion could not be sustained “on this basis now.” To decide standing, the order suggested a further “motion or (perhaps better) a bifurcated bench trial.” (1AA223.)  Despite ruling earlier that plaintiffs had pled a Section 12 cause of action, the court dismissed this claim on the rationale that, as a matter of law, “[p]urchasers in the secondary market don’t have standing.”

Despite defendants’ failure to raise standing earlier, the trial court ruled that plaintiffs lack Section 11 standing and entered judgment.

Taking the trial court’s cue, plaintiffs urged a bench trial to determine Section 11 standing.  As plaintiffs explained in a joint case management statement, standing involved “very few contested facts” and, decided by way of bench trial, “should take not more than a few hours to complete.” For their part, defendants agreed with “resolution of the threshold issue of tracing/standing through a bench trial.”

At the case management conference to determine next steps, the parties made “a joint proposal to the Court for a bench trial.”

Ordering further briefing and “limited” discovery on the standing, the court set a trial date.  With evidence to present but no material facts in dispute, the trial mode was the most efficient vehicle, more streamlined than summary judgment, to resolve the standing issue.  In the weeks prior, the parties supplied nearly all their evidence in advance through declarations and attached exhibits. (4AA1606-1609.)

The “trial” was two hours of oral argument.  No witnesses testified; there were no credibility determinations.  The parties stipulated “to the admissibility of the trial declarations and exhibits thereto” already on file.

To simplify the evidence presented, the parties waived any objection to “admissibility” with objections limited to “weight or relevancy.”

The trial court found:  “There are no disagreements on the facts.  It is clear that if defendants are right on the law, plaintiffs have no standing, and contrariwise if plaintiffs are right on the law, they do have standing.”  The judge and counsel spent most of the hearing discussing the law governing standing.  As the judge stated at the outset, “this is really purely a matter of law.  This looks like it is a legal problem.”

In its statement of decision, the trial court concluded that “plaintiffs have no standing to bring their § 11 or dependent § 15 claims in this case.” After the final judgment entered for defendants, plaintiffs timely appealed.

On appeal plaintiffs assert the fundamental error permeating the trial court’s decision is reading the ICA’s plain language, in a case involving an investment company security, out of the standing inquiry. 
When the ICA is restored to its proper place in the analysis, plaintiffs necessarily have standing to assert their claims.

The United States Supreme Court instructs:  “The starting point for interpretation of a statute ‘is the language of the statute itself.  Absent a clearly expressed legislative intention to the contrary, that language must ordinarily be regarded as conclusive.’” (Kaiser Aluminum & Chemical Corp. v. Bonjorno (1990) 494 U.S. 827, 835; accord, Jarrow Formulas, Inc. v. LaMarche (2003) 31 Cal.4th 728, 735.)  Put another way, when statutory language is applied, “the statutory language controls its construction.” (Ford Motor Credit Co. v. Cenance (1981) 452 U.S. 155, 158, fn. 3; accord, Griffin v. Oceanic Contractors, Inc. (1982) 458 U.S. 564, 571.)  “When the words of a statute are unambiguous, then, this first canon is also the last:  ‘judicial inquiry is complete.’” (Conn. Nat. Bank v. Germain (1992) 503 U.S. 249, 254, citation omitted; accord, People v. Statum (2002) 28 Cal.4th 682, 689-690.)

As noted, the pertinent text here is the following:

Section 24(e) of the ICA (1954 Amendments):

“For the purposes of section 11 of the Securities Act of
1933, as amended [15 U.S.C. § 77k], 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

15 U.S.C. § 80a-24(e)
Section 6(a) of the Securities Act:

A registration statement shall be deemed effective only as
to the securities specified therein as proposed to be offered. 15
U.S.C. § 77j(a), 6(a)

17 C.F.R. § 229.512

(2) That, for the purpose of determining any
liability under the Securities Act of 1933, each such post-effective amendment
shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at
that time shall be deemed to be the initial bona fide offering thereof.”

The contrasting nature of the language is readily apparent.  ICA standing is afforded to those “sold” a security, without limitation.  The Securities Act’s more restrictive language, enacted before the ICA, only underscores that Congress intended broader standing for Securities Act claims involving investment companies.

The trial court thus gave “sold” in the ICA an unduly grudging application to negate the very standing provided by Section 24(e).  The trial court’s interpretation cannot be squared with the plain language.  The Securities Act focuses on specific offerings of specific securities; ICA standing turns simply on the sale of a security governed by the statute. There is no dispute that iShares ETFs were sold to plaintiffs, and the proposed class, after the latest applicable amendment to the pertinent registration statement for the fund.  This gives them standing.  There is no other interpretation of standing faithful to the straightforward language used by Congress in Section 24(e).

Indeed, the trial court’s ruling that plaintiffs nonetheless needed to trace their shares, evidently through chain of title, erroneously renders the standing inquiry the same for two statutes that are written very differently. (4AA1546-1547.)  Under the trial court’s reading, the broader ICA standing language is rendered surplusage. 

Together, the Securities Act as supplemented by the ICA create a uniform set of rules to protect investors in investment company transactions.

These statutes demand full disclosure. (SEC v. Capital Gains Research Bureau, Inc. (1963) 375 U.S. 180, 186.) 
The Securities Act “was drafted with an eye to the disadvantages under which buyers labor” in public offerings. (Wilko v. Swan (1953) 346 U.S. 427, 435.)  “Section 11 creates ‘correspondingly heavier legal liability’ in line with responsibility to the public[.]” (Herman & MacLean v. Huddleston (1983) 459 U.S. 375, 381, fn. 12.)  And, contrary to the trial court’s assumption, the Securities Act’s protections are not restricted to initial offerings but, more expansively, “public offerings.” (Gustafson v. Alloyd Co. (1995) 513 U.S. 561, 571 (Gustafson).)  There was no dispute that investment companies, as in this case, continuously offer their shares to the public.

Section 11 imposes “virtually absolute liability” where a registration statement contains “an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading.” 15 U.S.C. § 77k(a); In re Direxion ETF Tr. (S.D.N.Y. 2012) 279 F.R.D. 221, 232.)  Section 11 and 12 claims do not require a plaintiff to prove causation, reliance or scienter. Id.  Stating a Securities Act claims places “a relatively minimal burden on a plaintiff.” (Litwin v. Blackstone Grp., L.P. (2d Cir. 2011) 634 F.3d 706, 716.)  It would be inconsistent to give Section 11 in the Securities Act a robust application but investor rights under the ICA a toothless one.

Broader standing under the ICA reflects the two statutes’ different but complementary roles in securities regulation:

Investment Company Act of 1940

Distribution and redemption is continuous. 15 U.S.C. §

Issuer must redeem shares of all investors. 15 U.S.C. §
80a-2(a)(32),§5(a)(l) and §22(e).
Redemption by issuer at NAV required. §22(d) and § 270.22c-1
[secondary market transactions not contemplated]

Indefinite amount of shares registered. 15 U.S.C. §

Annual amendments to registration statement and
pospectus are required. 15 U.S.C. § 80a-§24(e)(third
sentence);17 C.F.R. § 270.8b-16(a).

Dealers must use a prospectus continually “if any other
security of the same class is currently being offered or sold by the issuer or
by or through an underwriter in a distribution.” 15 U.S.C. § 80a-
Securities Act of 1933

Distribution is not continuous.

Shares are not redeemable.
[Secondary market contemplated. 15 U.S.C. §

Offering must specify amount of shares offered. 15 U.S.C. §
77f(a) (§6(a) of the 1933 Act).

No annual amendments.

Dealers generally exempt from delivery
requirements forty days after the effective date of the registration statement.
15 U.S.C. § 77d(a)(3)(§4(3) of the 1933 Act)

Defendants’ ETFs are registered under the ICA. [stating on first page of each: “Registration Statement Under the Investment Company Act of 1940”].)  Every Prospectus and Statements of Additional Information filed by the defendants acknowledges the ICA as the applicable law. By contrast, the Securities Act mandates registration of specific securities in each statement and not an indefinite amount of a class of shares on a continuous basis.

Through 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.” Investment management companies are “deemed to have registered “an indefinite amount of securities.” (15 U.S.C. § 80a-24(f)(1).)

Thus, in the ICA standing provision, Congress soundly provided that for Securities Act claims, “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.” (15 U.S.C. § 80a-24(e), emphasis added.)  The ICA does not say, like the Securities Act, that Offering Documents “shall be deemed effective only as to the securities specified therein as proposed to be offered.” (15 U.S.C. § 77f(a), emphasis added.)

Defendants’ ETF amendments to their own registration statements filed under the ICA illustrate the distinction. [Compare S-1 Registration Statement, filed solely under Securities Act] with Form N-1A Registration Statements for ETFs, filed under both Securities Act and ICA].)  As legally required, the form S-1 registration statements explicitly list details about the securities offered therein, including the “Title of Each Class of Securities to be Registered” and the “Amount to be Registered.” By contrast, defendants’ Form N-1A registration statements for ETFs, registered pursuant to the ICA, do not contain these specifics.

When Congress added Section 24(e) of the ICA, it rejected calls to similarly amend Section 6(a) of the Securities Act. 

Unlike the ICA, Section 6(a) of the 1933 Act “does not permit ‘registration for the shelf.’”  The SEC did not mirror the 1954 ICA language (“securities sold after”) in 1981 when it adopted 15 C.F.R. § 230.415 and 17 C.F.R. § 229.512 to allow registration of shelf offerings of a specified amount of securities for a limited time under the Securities Act.  Rather, the SEC maintained the limiting language “the securities offered therein.” (17 C.F.R. § 229.512 (1990).)

The trial court thus erroneously ignored not just the differing statutory language but its manifestations in defendants’ Offering Documents – along with subsequent indications that the Securities Act and ICA are written differently because they serve different salutary goals in protecting investors.

The SEC did not exempt defendants from Section 11 or 12 liability to ETF investors who purchased their shares in the secondary market.

In assessing plaintiffs’ standing, it is also significant that the SEC must affirmatively exempt an investment company from the Securities Act. To allow trading on an open market, the SEC has granted exemptions under its narrow authority within the ICA.

As investors are the very persons the statutes and regulations were designed to protect the SEC cannot grant exemptions from the statute to diminish the rights and protections of investors.

Like mutual funds, ETFs register an “indefinite amount” of shares which they continuously offered and in a constant process of redemption and reissue. (15 U.S.C. § 80a-24(f).)  Unlike Securities Act-regulated companies, which register to issue a set number of shares, investment companies must file annual amendments to their registration statements. (17 C.F.R. § 270.8b-16(a).)  The prospectus must be updated annually. (15 U.S.C. § 80a-24(e).) The prospectus also must be made available to any investor. (15 U.S.C. § 80a-24(d); 15 U.S.C. § 77d(3).)  BlackRock itself, in commenting on enhanced prospectus disclosure, agreed with the SEC that investors in the secondary market are the intended primary recipients of each prospectus.

The SEC adheres to the ICA statutory structure that the disclosure requirements in the registration statements and prospectuses of ETFs are intended for investors in the secondary market.  For example, in adopting a final rule revising ETF prospectus disclosure in 2009, the SEC reiterated that the rule revisions were “intended to result in the disclosure of more useful information to investors who purchase shares of exchange-traded funds on national securities exchanges.”  In no uncertain terms the SEC stated: “The proposed amendments for ETF prospectuses were designed to meet the needs of investors (including retail investors) who purchase ETF shares in secondary market transactions rather than financial institutions that purchase creation units directly from the ETF.

Thus, the SEC has expressed the clear position that the annual disclosure obligations under the ICA in the amendments to the registration statements are targeted to the investor trading in the secondary market.  Accordingly, the secondary market investor has standing under the governing provisions of the ICA to make the claim for defective disclosure under Sections 11 and 12(a)(2) of the Securities Act.

Section 24(e)’s legislative history confirms that purchases after a defective amendment to a registration statement suffice for standing.

The text of the ICA, unambiguously, gives plaintiffs standing.  Even if the statute allowed for “more than one reasonable construction” and this Court looked to legislative history, Wells v. One2One Learning Foundation (2006) 39 Cal.4th 1164, 1190, the ICA’s backdrop only underscores that plaintiffs have standing. (See also Hertzberg v. Dignity Partners, Inc. (9th Cir. 1999) 191 F.3d 1076, 1081 (Hertzberg) [aftermarket purchasers have standing to pursue a Section 11 claim].)

The trial court acknowledged that the “legislative background and other evidence plaintiffs have offered does plainly show that secondary market purchasers were to be protected.” (4AA1547.)  The ICA was the product of congressional concern that the Securities Act of 1933, 15 U.S.C. § 77a et seq., and the Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq., “were inadequate to protect the purchasers of investment company securities.” (United States v. Nat. Assn. of Secs. Dealers (1975) 422 U.S. 694, 704.)  The ICA was directed at unregistered securities of investment management companies “in which securities holders can at their option compel the company to redeem or repurchase their securities at the actual asset value of such securities.” Hence, unlike 1933 Act securities, ETFs are “redeemable securities.”  Other “unique characteristics” including the need to “continuously issue and sell new shares” in order to “avoid liquidation” have been noted by the United States Supreme Court. (Id. at pp. 697-698.)

Indeed, under the ICA and until recent SEC exemptions, redeemable securities such as ETFs were not sold on a national exchange or secondary market. (U.S. v. Cartwright (1973) 411 U.S. 546, 547-549.)  BlackRock’s ability to do so, to the tune of trillions of dollars under management, is thus a legally unique privilege granted by the SEC.

In 1954, Congress perceived inadequacies with the protection of investors in investment companies when purchasing securities in the continuous offerings allowed under the ICA.  Rather than change the Securities Act, for which liability runs from the first offered date, Congress added provisions to the ICA.  At the same time, attempts to make the similar changes for continuous offerings under the Securities Act failed. (P. Stolz Fam. Partn. L.P. v. Daum (2d Cir. 2004) 355 F.3d 92, 105-106 [discussing this history].)

The Senate Report on the 1954 ICA amendments is instructive.  First, the 1954 ICA bill, through a new Section 24(d), required all dealers, including those who are not participants in the distribution of ICA shares to use a prospectus “as long as the issuer is offering any securities of the same class as the security which is the subject matter of the dealers transactions”—not just during the first year.  The Senate Report found that “[t]he continuous offering practices of these investment companies justifies a requirement that all dealers be compelled to use the statutory prospectus so long as shares of the same class are being offered.”

The bill added a new §24(e) mandating annual amendments to the registration statement by requiring “current information be made part of the registration statements at approximately yearly intervals.” (1AA382.)  The Senate report continues that:

“[T]he 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.”

Thus, because of the unique nature of investment companies and their “continuous offering practices” of “the same class of shares,”  Congress dictated that the registration statements and prospectuses would be “updated annually . . . regardless of the need to offer new shares.”  Congress also dictated that the prospectus be used by dealers (regardless of their participation in a distribution) and that liability under Section 11 for defective registration statements would be extended to each investor sold shares after the amendment, with the statute of limitation running anew for such investors.

The 1954 House and Senate Reports stated that Section 24(e) aimed to require the entire registration statement to meet the standards of Section 11 “not only on the original effective date but also on the effective date of each post-effective amendment.”  Congress added 24(e) to the Investment Company Act of 1940 to ensure that Section 11 liability would not dissipate simply because a new amendment was filed.

In sum, the plain language and legislative history are more than ample to show that that plaintiffs have standing.  Resisting this conclusion, the trial court reasoned that if “plaintiffs need only show they bought in the secondary market after an infirm registration statement, then all securities, including those sold in an initial offering pursuant to a perfectly innocent registration statement, could be the subject of a § 11 suit if the securities ended up in the hands of someone – anyone – after a much later infirm registration statement.”

Respectfully, these floodgates are illusory.  Plaintiffs allege, and the trial court held a claim was stated, that the Offering Documents failed to disclose risks specific to ETFs before the August 2015 flash crash.  This typifies the sort of case that will be brought if Section 24(e) of the ICA is given a plain-language interpretation.  Moreover, ETFs can be sold only by Authorized Participants who have purchased them from issuers such as defendants, who, in turn, can sell them only to broker-dealers.  They are then limited to being sold on a national exchange or by broker-dealers. (4AA1452-1453, 1476.)  Therefore, secondary market investors cannot, among themselves, sell and purchase ETFs.

Belying the trial court’s policy objection, the band of cases affected is slender at most (more than 50 years after the ICA amendments, the central issue on appeal here is of first impression).  Although the court viewed “sold” in the ICA standing provision as “arguably creating ambiguity,” even if that were so, the interpretation favoring investor protection controls.  Congress admonished that the ICA “shall be interpreted” to “eliminate the conditions enumerated in this section which adversely affect the national public interest and the interest of investors.” (15 U.S.C. § 80a-1.)

Indeed, the Securities Act has been routinely enforced in state court. (See, e.g., Luther v. Countrywide Fin. Corp. (2011) 195 Cal.App.4th 789; Lakewood Bank & Trust Co. v. Super. Ct. (1982) 129 Cal.App.3d 463.)  The trial court also overlooked that “California also has a legitimate and compelling interest in preserving a business climate free of fraud and deceptive practices.  California business depends on a national investment market to support our industry.” (Diamond Multimedia Systems, Inc. v. Super. Ct. (1999) 19 Cal.4th 1036, 1064.)

Relying on Section 11 “tracing” decisions, the trial court mistakenly extrapolated Securities Act standing to the ICA.

The trial court’s leap of logic to require Section 11-type tracing for ICA standing flowed from erroneous reliance on decisions not involving the ICA, investment companies, or amendments to registration statements that are the statutory hook for standing in this case.  To the extent the trial court deferred to (inapposite) federal case law, it overlooked that California courts may “render binding judicial decisions that rest on their own interpretations of federal law.” (ASARCO Inc. v. Kadish (1989) 490 U.S. 605, 617.)

The trial court took its analytical cue from In re Century Aluminum Co. Sec. Litig. (9th Cir. 2013) 729 F.3d 1104. (4AA1545-1546.)  But Century Aluminum did not involve investment companies or the ICA.  The Second Circuit decisions do not speak to the standing issue here, either.  Barnes v. Osofsky (2d Cir. 1967) 373 F.2d 269, 272, involved separate complete registration statements, not amendments.  DeMaria v. Andersen (2d Cir. 2003) 318 F.3d 170, 178, held there is standing in the aftermarket where securities are issued under a single registration statement.  And Rosenzweig v. Azurix Corp. (5th Cir. 2003) 332 F.3d 854, 873, holds that plaintiffs have standing where there is only “one offering.”

Here, similarly, there is only one continuous offering, and one registration statement, it is undisputed, with amendments.  Under the ICA, again, no individual shares are registered or specified.  Rather an “indefinite amount” of shares are registered under §24(f) in a continuous offering and redemption cycle. (15 U.S.C. § 80a-24(f).)  By relying on chain-of-title tracing decisions applying Section 11 of the Securities Act, the trial court committed legal error.

Current Status

The case is on appeal to the Court of Appeal of California, First Appellate District, Division Two, No. A153511. Plaintiff/Appellant has filed it’s opening brief linked above.

Hagens Berman purchases advertisements on search engines, social media sites and other websites. Transmission of the information contained or available through this website is not intended to create, and receipt does not constitute, an attorney-client relationship. If you seek legal advice or representation by Hagens Berman, you must first enter a formal agreement. All information contained in any transmission is confidential and Hagens Berman agrees to protect information against unauthorized use, publication or disclosure. This site is regulated by the Washington Rules of Professional Conduct.

Back to all cases


Please fill out the form below and we will get back to you as soon as we can.
*Required Field
Please list the date, quantity and share price of your purchases/sales during the Class Period so that we can calculate your losses. *
Upload your trade information. *

Case videos

Case Gallery

Case Timeline