division two. garth jensen et al., plaintiffs-appellants, v. … · 2020-01-27 · garth jensen et...
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Garth JENSEN et al., Plaintiffs-Appellants, v. ISHARES..., 2018 WL 5778127...
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2018 WL 5778127 (Cal.App. 1 Dist.) (Appellate Brief)Court of Appeal, First District, California,
Division Two.
Garth JENSEN et al., Plaintiffs-Appellants,v.
ISHARES TRUST et al., Defendants-Respondents.
No. A153511.October 30, 2018.
On Appeal from the San Francisco County Superior Court No. CGC 16-552567The Honorable Curtis E.A. Karnow, Judge
Respondents' Brief
Eben P. Colby, Skadden, ARPS, Slate, Meagher & Flom, 500 Boylston Street, Boston, Massachusetts 02116, Telephone: (617)573-4800, Facsimile: (617) 573-4822, [email protected].
Jeremy A. Berman, Skadden, ARPS, Slate, Meagher & Flom, Four Times Square, New York, NY 10036, Telephone: (212)735-3000.
Patrick Hammon (SBN 255047), Skadden, ARPS, Slate, Meagher & Flom, 525 University Avenue, Suite 1400, Palo Alto,California 94301, Telephone: (650) 470-4500, Facsimile: (650) 470-4570, [email protected].
Manish Mehta, Mark Weidman, Robert S. Kapito and Jack Gee, Advisors, Blackrock Investments, LLC, Facsimile: (917)777-2032, jeremy.berman @skadden.com, for defendants-respondents Ishares Trust, Blackrock, Inc., Blackrock Fund.
Bruce H. Schneider (pro hac vice), Stroock & Stroock & Lavan LLP, 180 Maiden Lane, New York, New York 10038, Telephone:(212) 806-5636, Facsimile: (212) 806-6006, [email protected], for defendants-respondents John Martinez, Cecilia H.Herbert, Charles A. Hurty, John Kerrigan, Robert H. Silver, Madhav V. Rajan and George G.C. Parker.
John R. Loftus (126841), Stroock & Stroock & Lavan LLP, 2029 Century Park East, Los Angeles, California 90067, Telephone:(310) 556-5800, Facsimile: (310) 556-5959, [email protected], for defendants-respondents John Martinez, Cecilia H.Herbert, Charles A. Hurty, John Kerrigan, Robert H. Silver, Madhav V. Rajan and George G. C. Parker.
*3 CERTIFICATE OF INTERESTED PARTIES
Respondents BlackRock Fund Advisors and BlackRock Investments, LLC are direct or indirect subsidiaries of RespondentBlackRock, Inc., a publicly-held company with stock traded on the New York Stock Exchange. No other respondent is asubsidiary or affiliate of a publicly-owned corporation.
More than ten percent (10%) of the outstanding shares of common stock issued by nonparty BlackRock, Inc., is owned bynonparty PNC Financial Services Group, Inc., a publicly-held corporation with stock traded on the New York Stock Exchange.
Dated: October 30, 2018
PATRICK HAMMON (SBN 255047)
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525 University Avenue, Suite 1400
Palo Alto, California 94301
Telephone: (650) 470-4500
Facsimile: (650) 470-4570
Attorneys for Defendants-Respondents
iShares Trust, BlackRock, Inc.,
BlackRock Fund Advisors, BlackRock Investments, LLC, Manish Mehta, Mark Weidman, Robert S. Kapito and Jack Gee
*4 TABLE OF CONTENTSI. INTRODUCTION ........................................................................................................................................ 11II. FACTUAL BACKGROUND ..................................................................................................................... 16A. How ETFs Work ........................................................................................................................................ 16B. The Flash Crashes ...................................................................................................................................... 21C. Plaintiffs' Funds Issued Millions of Shares Under Registration Statements or Amendments That Are NotAlleged To Be Misleading. .............................................................................................................................
22
D. Plaintiffs Did Not Show Whether the Shares They Purchased Were Issued Under the AllegedlyMisleading Post-2010 Flash Crash Registration Statements or Amendments or Earlier RegistrationStatements or Amendments That Were Not Alleged To Be Misleading. ........................................................
24
III. PROCEDURAL BACKGROUND ........................................................................................................... 24A. The Initial Complaint ................................................................................................................................. 24B. The First Amended Complaint ................................................................................................................... 25C. The Bifurcated Bench Trial ........................................................................................................................ 26IV. STANDARD OF REVIEW ....................................................................................................................... 27V. LEGAL STANDARD ................................................................................................................................. 28A. Section 11 of the 1933 Act Regulates a Corporation's Disclosures Made When New Shares Are FirstPut Into the Market .........................................................................................................................................
28
B. The 1934 Act Generally Regulates an Issuer's Statements and Disclosures After Its Shares Are Tradingin the Secondary Market .................................................................................................................................
29
C. The Investment Company Act of 1940 Governs the Business Practices of Investment Companies .......... 30VI. ARGUMENT ............................................................................................................................................ 31A. The Trial Court's Dismissal of Plaintiffs' Section 11 Claim Should Be Affirmed ..................................... 311. Plaintiffs Were Required To Demonstrate That the Shares They Purchased Were Traceable to aMisleading Registration Statement or Amendment ........................................................................................
32
*5 2. Plaintiffs Utterly Failed To Demonstrate That the Shares They Purchased Were Traceable to aMisleading Registration Statement or Amendment ........................................................................................
35
3. To Satisfy the Tracing Requirement, Plaintiffs Must Trace the ETF Shares They Purchased to aMisleading Registration Statement or Amendment and Not Merely to the Latest Amendment Filed BeforeTheir Secondary Market Purchase ..................................................................................................................
38
4. Section 24(e) of the Investment Company Act Left Intact the Tracing Requirement of Section 11 of the1933 Act and Did Not Alter or Weaken It .....................................................................................................
39
(a) Section 24(e)'s Purpose Was To Allow Investment Companies To File Amendments to TheirRegistration Statements Rather than New Registration Statements While Preserving the Status Quo withRespect to Sections 11 and 13 ........................................................................................................................
40
(i) Section 24(e) Eliminated Paperwork and Expense for Investment Companies ......................................... 40(ii) Section 24(e) Does Not - and Did Not - Change the Standing or Tracing Requirements Necessary forBringing Section 11 and 13 Claims ................................................................................................................
42
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(b) Section 24(e)'s Reference to “Securities Sold After Such Amendment” Is to the Sale of Shares by theIssuer, Not to Sales in the Secondary Market By Investors ...........................................................................
46
(c) The Other Statutory Construction Arguments Plaintiffs Advance Do Not Support Their Argument ThatSection 24(e) Eliminates Tracing ....................................................................................................................
48
5. Interpreting the ICA in a Way That Expands Standing Under the Securities Laws for DisclosureViolations Would Contravene the Purpose and History of the ICA ...............................................................
49
(a) The ICA Should Not Be Construed in a Manner That Would Effectively Create a New Private Right ofAction for Alleged Violations of the Federal Securities Laws .......................................................................
49
*6 (b) Plaintiffs' Arguments About the Registration Requirements Do Not Support Their Appeal ............. 51(c) None of the Differences Between the 1933 Act and the ICA Address Tracing ........................................ 526. The SEC's Exemptive Orders Allowing Secondary Trading for ETFs Did Not Eliminate, But RatherAffirmed, Section 11's Tracing Requirements ................................................................................................
54
7. Plaintiffs' Policy Arguments Regarding Sections 11 and 24(e) Are Unavailing ......................................... 55B. The Trial Court's Dismissal of the Section 12(a)(2) Claim Should Be Affirmed ....................................... 581. Plaintiffs' 12(a)(2) Claim Should Be Dismissed Because They Purchased Their ETFs in the SecondaryMarket and Not Directly From an Issuer. .......................................................................................................
58
2. The Absence of a Prospectus Delivery Requirement for ETFs Underscores That Defendants Are NotStatutory Sellers for Purposes of Section 12(a)(2) .........................................................................................
62
VII. CONCLUSION ........................................................................................................................................ 64CERTIFICATE OF WORD COUNT .............................................................................................................. 66CERTIFICATE OF SERVICE ......................................................................................................................... 67
*7 TABLE OF AUTHORITIESCASES
Abbey v. Computer Memories, Inc. (N.D. Cal. 1986) 634 F.Supp. 870.......... 36, 37
Alexander v. Sandoval (2001) 532 U.S. 275.................................................. 50
In re ARIAD Pharmaceuticals Securities Litigation (1st Cir. 2016) 842 F.3d744........................................................................................................................
34, 56
Barnes v. Osofsky (2d Cir. 1967) 373 F.2d 269.............................................. 33, 35
Bellikoff v. Eaton Vance Corp. (2d Cir. 2007) 481 F.3d 110.......................... 50
Blue Chip Stamps v. Manor Drug Stores (1975) 421 U.S. 723...................... 30
Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A.(1994) 511 U.S. 164............................................................................................
30
In re Century Aluminum Co. Securities Litigation (9th Cir. 2013) 729 F.3d 1104passimIn re Countrywide Financial Corp. Mortgage-Backed Securities Litigation(C.D. Cal. 2013) 932 F.Supp.2d 1095.................................................................
58, 59, 60
In re Countrywide Financial Corp. Securities Litigation (C.D. Cal. 2008)588 F.Supp.2d 1132.............................................................................................
56
Cyan, Inc. v. Beaver County Employees Retirement Fund (2018) 138 S.Ct.1061......................................................................................................................
24
Daily Income Fund v. Fox (1984) 464 U.S.523 ................................................. 30
Feiner v. SS & C Technologies, Inc. (D. Conn. 1999) 47 F.Supp.2d 250....... 61
Guenther v. Cooper Life Sciences, Inc. (N.D. Cal. 1990) 759 F.Supp. 1437.. 37, 38
Gustafson v. Alloyd Co. (1995) 513 U.S. 561................................................ 28, 59
Hemmer Group v. Southwest Water Co. (9th Cir. 2016) 663 F.App'x 496...... 36
Hertzberg v. Dignity Partners, Inc. (9th Cir. 1999) 191 F.3d 1076................ 33, 58
Johnson v. CBD Energy Ltd. (S.D. Tex. July 6, 2016, No. H-15-1668) 2016WL 3654657........................................................................................................
34
*8 Krim v. pcOrder,com, Inc. (5th Cir. 2005) 402 F.3d 489passim
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Laborers' Local 265 Pension Fund v. iShares Trust (6th Cir. 2014) 769 F.3d399........................................................................................................................
49, 51
Le v. Pham (2010) 180 Cal.App.4th 1201...................................................... 27
Medina v. Clovis Oncology, Inc. (D. Colo. 2017) 215 F.Supp.3d 1094............... 59
In re Merrill Lynch & Co., Inc. Research Reports Securities Litigation(S.D.N.Y. 2003) 272 F.Supp.2d 243....................................................................
60
Morgan Stanley Information Fund Securities Litig. (2d Cir. 2010) 592 F.3d347........................................................................................................................
27
Morse v. Peat, Marwick, Mitchell & Co. (S.D.N.Y. 1977) 445 F.Supp. 619.. 41,44
Northstar Financial Advisors, Inc. v. Schwab Investments (9th Cir. 2010) 615F.3d 1106..............................................................................................................
49
P. Stolz Family Partnership L.P. v. Daum (2d Cir. 2004) 355 F.3d 92........... 41,43
Perrin v. SouthWest Water Co. (C.D. Cal. July 2, 2014, No. CV 08-7844 DMG(AGR)) 2014 WL 10979865...............................................................................
34
Pinter v. Dahl (1988) 486 U.S. 622............................................................... 61
Primo v. Pacific Biosciences of California, Inc. (N.D. Cal. 2013) 940F.Supp.2d 1105.....................................................................................................
59
In re Puda Coal Securities Inc. (S.D.N.Y. Oct. 1, 2013, 11 Civ. 2598 (KEF))2013 U.S. Dist. LEXIS 142081, judg. vacated in part on other grounds,(S.D.N.Y. Apr. 7, 2014) 2014 U.S. Dist. LEXIS 49718 .....................................
36,37
Rubke v. Capitol Bancorp Ltd. (9th Cir. 2009) 551 F.3d 1156....................... 29
Santomenno ex rel. John Hancock Trust v. John Hancock Life InsuranceCo. (3d Cir. 2012) 677 F.3d 178.........................................................................
49
Scott v. ZST Digital Networks, Inc. (C.D. Cal. 2012) 896 F.Supp.2d 877........... 34
Stichting Pensioenfonds ABP v. Countrywide Financial Corp. (C.D. Cal.2011) 802 F.Supp.2d 1125...................................................................................
27
TAAM Associates Inc. v. Housecall Medical Resources, Inc. (N.D. Ga. Mar.30, 1998, No. 1:96CV2214 A JEC) 1998 WL 1745361.....................................
30
*9 TransEnterix Investor Group v. TransEnterix, Inc. (E.D.N.C. 2017) 272F.Supp.3d 740......................................................................................................
34
United States v. Naftalin (1979) 441 U.S. 768............................................... 28
United States v. National Ass'n of Securities Dealers (1975) 422 U.S. 694passimIn re Vocera Communications, Inc. Securities Litigation (N.D. Cal. Feb.11,2015, No. C-13-3567 EMC) 2015 WL 603208..............................................
34
Welgus v. TriNet Group, Inc. (N.D. Cal. Jan. 17, 2017, No. 15-CV-03625-BLF) 2017 WL 167708.....................................................................
59
STATUTES15 U.S.C. § 77a................................................................................................... 1115 U.S.C. § 77h(c)............................................................................................... 2315 U.S.C. § 77j(a)............................................................................................... 4815 U.S.C. § 77kpassim
15 U.S.C. § 77l(a)(2)...................................................................................... 12, 58
15 U.S.C. § 77m.................................................................................................. 4415 U.S.C. § 77o(a)............................................................................................... 2715 U.S.C. § 78a................................................................................................... 12
15 U.S.C. § 78j(b).......................................................................................... 14, 29
15 U.S.C. § 80a-1................................................................................................ 12
15 U.S.C. § 80a-3........................................................................................... 15
15 U.S.C. § 80a-5................................................................................................ 17
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15 U.S.C. § 80a-8........................................................................................... 51
15 U.S.C. § 80a-23.............................................................................................. 1715 U.S.C. § 80a-24 passim15 U.S.C. § 80a-35.............................................................................................. 50
15 U.S.C. § 80a-41......................................................................................... 50
*10 REGULATIONS17 C.F.R. § 229.512............................................................................................. 48
17 C.F.R. § 230.159A..................................................................................... 53
17 C.F.R. § 240.10b-5......................................................................................... 14, 28LEGISLATIVE MATERIALS
H.R.Rep. No. 83-1542 (1954) ............................................................................ 41, 45Sen.Rep. No. 83-1036 (1954) ............................................................................ 41, 45H.R.Rep. No. 104-622 (1996) ............................................................................ 53
OTHER AUTHORITIESAntoniewicz and Heinrichs, Understanding Exchange-Traded Funds: HowETFs Work (Sept. 2014) fn. 14, ICI Research Perspective (Inv. Co. Inst. <;www.ici.org/pdf/per20-05.pdf>;) ........................................................................
18
Frankel & Laby, Regulation of Money Managers: Mutual Funds and Advisers(3d ed. 2015) § 25.01 .........................................................................................
40
Loss & Seligman, Securities Regulation p. 538 (4th ed. 2006) ......................... 415 Jacobs, Disclosure and Remedies Under the Securities Laws (2017) § 3:72 ... 44, 47
*11 I. INTRODUCTION
Plaintiffs are purchasers of exchange-traded funds (“ETFs”) who claim to have been misled by registration statements andamendments thereto that Defendant iShares Trust (“iShares”) filed with the Securities and Exchange Commission (“SEC”).The other defendants are BlackRock Fund Advisors (“BFA”) and BlackRock Investments, LLC (“BRIL”), both of which aresubsidiaries of defendant BlackRock, Inc. (“BlackRock”). BFA is the investment adviser to the funds created by iShares, and
BRIL distributes the Creation Units (discussed below) issued by these funds to institutional investors. 1
*12 Plaintiffs sued Defendants for losses they suffered during an unprecedented market event referred to as a “flash crash.”Plaintiffs alleged that certain of Defendants' registration statements and amendments thereto were false or misleading in that theyfailed to disclose the risks associated with flash crashes. Indeed, all of Plaintiffs' claims arose under the Securities Act of 1933(15 U.S.C. § 77a et seq.) (“1933 Act”), a statute primarily concerned with a company's registration statements and amendmentsfor public offerings of new shares by a corporate issuer. This primary market is fundamentally different than the “aftermarket”or “secondary market” - where Plaintiffs purchased their shares - which is the “‘securities market in which previously issued
securities are traded among investors.”' 2 Trading on the secondary market is generally governed by the Securities ExchangeAct of 1934 (15 U.S.C. § 78a et seq.) (“1934 Act”), which is focused on a company's post-issuance statements and disclosures,such as press releases and other public statements.
*13 On September 18, 2017, four months after dismissing Plaintiffs' claims arising under Section 12(a)(2) of the SecuritiesAct of 1933, 15 U.S.C. § 77 (a)(2) (“Section 12(a)(2)”), the Superior Court for the County of San Francisco issued a Statementof Decision that disposed of the remaining claims asserted by Plaintiffs, thereby ending this litigation at the trial court level.In that decision, which was entered after a bench trial, the Superior Court held that Plaintiffs lacked standing to bring a causeof action under Section 11 of the Securities Act of 1933, 15 U.S.C. § 77k (“Section 11”) because they could not prove thatthe ETF shares they purchased were issued (i.e., first put into the market) pursuant to a registration statement that was falseand misleading - and not issued pursuant to a different registration statement that was accurate. Thereafter, Plaintiffs filed the
instant appeal, which endeavors to convince this Court to rely on language from a completely different statute - Section 24(e) 3
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(“Section 24(e)”) of the Investment Company Act of 1940 (15 U.S.C. § 80a-1 et seq.) (“ICA”) - to override the undisputedrequirements for bringing a Section 11 claim.
Plaintiffs' appeal, however, presents no justification for reversing the findings of the Superior Court. Both of the Superior Court'sdecisions should be affirmed for the same reason. First, the rejection of Plaintiffs' Section 11 claim was proper because theyfailed to satisfy the well-settled Section 11 standing requirement to “trace” their shares to an allegedly false or misleadingregistration statement or amendment. Second, the dismissal of Plaintiffs' Section 12(a)(2) claim was appropriate becausePlaintiffs also did not have standing to bring such claims because they purchased in the secondary market rather than in aprimary offering from the Defendants.
*14 First, the dismissal of Plaintiffs' Section 11 claim was proper because Plaintiffs failed to prove that they had standing tobring their claim. The 1933 Act regulates the offer and sale of securities by issuers and Section 11 of the Securities Act “provides
a cause of action to any person who buys a security issued under a materially false or misleading registration statement.” ( In reCentury Aluminum Co. Sec. Litig. (9th Cir. 2013) 729 F.3d 1104, 1106, hereafter Century Aluminum.) Although Section 11 is notlimited to plaintiffs who “purchased shares in the offering made under the misleading registration statement,” and aftermarketpurchasers have standing to sue as well, ibid., Congress imposed an important limitation on potential aftermarket plaintiffs.They must be able to trace their shares back to the relevant offering at issue. Ibid. This is because Section 11 is akin to a strictliability statute and does not require plaintiffs to make an affirmative showing of scienter and reliance like they must for other
securities claims (such as those under Section 10(b) 4 of the Securities Exchange Act of 1934 and SEC Rule 10b-5). 5 Id. atp. 1107. Thus, the “tracing requirement is the condition Congress has imposed for granting access to the ‘relaxed liabilityrequirements' § 11 affords.” Ibid. (emphasis added). There are no exceptions to the requirement that a plaintiff must be ableto trace the shares that he or she purchased to a registration statement or amendment that was false and misleading.
Here, the ETF funds whose shares Plaintiffs purchased had issued hundreds of millions of shares between 2000 and 2010.On May 6, 2010, what is known as a “flash crash” occurred, causing market prices for ordinary stock and ETF shares todrop precipitously. After that crash, the ETF funds whose disclosures are the subject of this lawsuit issued additional sharespursuant to subsequent registration statements and *15 amendments. Plaintiffs concede that only the post-2010 statementswere allegedly misleading because they purportedly did not disclose the risks associated with a potential future flash crash. In2015, a second flash crash occurred, as a result of which Plaintiffs allegedly suffered damages when they sold their ETF sharesat significant losses. Plaintiffs, however, did not - and cannot - show whether the shares they purchased were issued under theallegedly misleading post-2010 flash crash registration statements or amendments, or whether their shares were issued underearlier registration statements or amendments that are not alleged to be misleading. The Superior Court correctly found thatPlaintiffs' failure to trace their shares to any of the allegedly defective registration statements or amendments was fatal to theirSection 11 claim.
*16 Plaintiffs want this Court to override Congress's intent - and undo decades of Section 11 jurisprudence in the process - by
finding that plaintiffs who sue investment companies 6 such as ETFs do not need to satisfy Section 11's longstanding tracingrequirement. Plaintiffs base their argument on an incorrect reading of ICA Section 24(e) - a statute from a different set of laws,serving different purposes. Plaintiffs' argument is simply not supported by the language, history, or purpose of either Section11 or Section 24(e), let alone by any cases interpreting those statutes. Literally, no court in the country has endorsed or adoptedPlaintiffs' interpretation of Section 24(e).
Second, the Superior Court's dismissal of Plaintiffs' Section 12(a)(2) claim should also be affirmed because Plaintiffs did nothave standing to assert such claim. Section 12(a)(2) only confers standing on those who purchased directly from an issuer;
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purchasers in the secondary market cannot bring such claims. Because none of Plaintiffs alleged that they made any purchasesdirectly from the funds at issue, and, instead, the brokerage records attached to their declarations confirm that they purchasedETFs in the secondary market, Plaintiffs' Section 12(a)(2) claim was properly dismissed.
II. FACTUAL BACKGROUND
A. How ETFs Work.
*17 Investment companies - such as open-end mutual funds, closed-end funds, and ETFs - are vehicles in which investors'assets are pooled to invest in stocks, bonds, and other securities. These investment companies offer shares to the investingpublic; each share representing a proportional interest of the pool of investments that are held by the investment company.That proportional interest's value is known as its net asset value per share, or NAV, and represents the investment company'sassets (i.e., the value of the securities held by the investment company) minus its liabilities (i.e., the costs of operating theinvestment company) divided by the number of shares outstanding. Investment companies calculate the NAV of their shares
every trading day. 7
Open-end funds continuously offer and redeem shares at NAV directly to shareholders in exchange for cash. (See 15 U.S.C.§ 80a-5(a)(1).) Closed-end funds, on the other hand, typically conduct offerings of a set number of shares to the market atNAV, and thereafter those shares are traded among shareholders on an exchange at prevailing market prices. (See 15 U.S.C.§ 80a-5(a)(2); 15 U.S.C. § 80a-23.)
*18 An ETF is a hybrid of an open-end and a closed-end fund, although they are registered with the SEC as open-end funds.(See 1AA0409 [“SEC Concept Release: Actively Managed Exchange-Traded Funds,” modified May 18, 2004, explaining“What Are ETFs”].) Like a closed-end fund, ETF shares are primarily traded on secondary markets, such as stock exchanges.(1AA0143 ¶¶ 57-59.) Like an open-end fund, however, ETFs continuously offer shares, issuing more shares as shareholdersinvest more money and buying back shares when shareholders redeem their investment. (See 1AA0409.) ETFs, however, do nottransact directly with retail investors, but only offer and redeem shares through financial intermediaries - certain broker-dealersknown as “Authorized Participants.” (4AA1452.) ETFs issue and redeem large blocks of shares at NAV, typically 50,000 sharesor multiples thereof called “Creation Units,” to and from Authorized Participants in so-called primary market transactions. TheAuthorized Participants then split up Creation Units into individual shares and sell them on a secondary market to end investors
such as Plaintiffs. (1AA0144 ¶¶ 61-63; see also AA0409.) 8
*19 The creation and redemption activity between iShares and Authorized Participants is part of the primary or “new issue”market and is “analogous to an operating firm issuing new shares to raise additional capital for investment or retiring shares by
buying them back.” 9 On occasion, this activity is initiated by Authorized Participants to capture arbitrage opportunities thatmay arise when there are disparities between the market prices of ETF shares and their NAV. For example, when the marketprice of a particular ETF share exceeds its NAV - i.e., the share trades at a premium to NAV - Authorized Participants maypurchase newly issued Creation Units at NAV and sell shares to retail investors at market prices above NAV. Conversely, whenETF shares trade in the secondary market at a discount to NAV, Authorized Participants may purchase discounted shares in themarket, and then sell Creation Units back to the ETFs at NAV, enabling Authorized Participants to receive a premium over theprevailing market price. Under normal market conditions, these arbitrage transactions operate to minimize the trading of ETFshares at a premium or discount to NAV. In periods of high market volatility, market prices and NAVs can diverge, sometimessignificantly, as iShares itself disclosed in its filings with the SEC. (See 3AA0958.)
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*20 The relevant terms of these primary market transactions - the sale of Creation Units of a particular ETF to AuthorizedParticipants - are spelled out in a registration statement, which is a required disclosure under the 1933 Act. These registrationstatements are publicly filed with the SEC, and are available for inspection and review by the investing public on the SEC's
website, called EDGAR. (See 4AA1452 ¶ 5; 4AA1476 ¶ 3; see also Pl. Br. 10 at p.48, fn. 28.)
Once the individual shares are trading on a securities exchange, such as the New York Stock Exchange Arca, retail investorsmay buy and sell individual shares in that secondary market through retail securities brokers, just like they do with commoncompany stock. (4AA1452-53.) Like ordinary common stock, an ETF's price per share fluctuates according to market forces,based on supply and demand for the shares. (1AA0144 ¶¶64-65.) ETFs trade at prevailing market prices. (See ibid.)
Both primary market transactions in Creation Units and secondary market transactions in ETF shares are executed withoutthe physical transfer of share certificates. (4AA1476.) All Creation Units and ETF shares are held in fungible bulk by TheDepository Trust Company (“DTC”), and registered in the name of its nominee, Cede & Co., the sole record owner of thoseshares. (4AA1476-77.) Through use of an electronic book-entry system, DTC transfers ETF shares by debiting and creditingthe accounts of participating members of DTC, the so-called DTC Participants, who typically are broker-dealers, banks, andother institutions. (4AA1477.) Because all ETF shares are held in fungible bulk in DTC's vault, “in most instances, it is notpossible to link specific ETF shares to specific investors.” (Ibid.)
*21 B. The Flash Crashes.
On May 6, 2010, publicly traded security prices on the New York Stock Exchange dropped at a dramatic and unprecedentedrate in what is referred to as a “flash crash” (“2010 flash crash”). During the crash, prices declined precipitously in about 30minutes, and did not return to their precrash price levels until the end of the trading day. (1AA0145.) Plaintiffs claim that ETFinvestors that had pending “stop loss” orders were the most severely impacted by this flash crash. A stop loss order is a standinginstruction by an investor to their broker to try to sell a security if the market price of that security falls below a specified price.(1AA0115.) The 2010 flash crash caused market prices of ETF shares sponsored by various fund companies (including iShares)to decline rapidly, which, in turn, automatically converted outstanding stop loss orders on those shares to sell orders to beexecuted in the secondary market. (See 1AA0116.) Given the precipitous market drop, ETF shareholders with pending stop lossorders ultimately were only able to sell their securities at prices below the NAV and their designated stop price. (1AA0116-17.)The 2010 flash crash was unanticipated and unprecedented, considered to be “one of the most unusual - and puzzling - eventsin U.S. stock market history.” (4AA1455, citation omitted.)
A second flash crash occurred approximately five years later, on August 24, 2015 (“2015 flash crash”). Plaintiffs had stop lossorders *22 pending on that date, which triggered the sale of their fund shares at market prices below both their designatedstop prices and below the NAV of the shares. (See 1AA0120, 0123-28.)
Plaintiffs claim they suffered losses in the 2015 flash crash because, after the 2010 flash crash, subsequent iShares offeringdocuments did not adequately disclose the risk of loss from a potential future flash crash to ETF investors who utilized stoploss orders. Plaintiffs contend that iShares should have disclosed that risk because of its experience with the flash crash thatoccurred five years earlier, in 2010.
C. Plaintiffs' Funds Issued Millions of Shares Under Registration Statements or Amendments That Are Not AllegedTo Be Misleading.
*23 The ETF funds at issue - i.e., funds whose shares Plaintiffs had purchased (“Plaintiffs' Funds”) - had issued millionsof shares prior to the 2010 flash crash, the point in time at which Plaintiffs allege the relevant offering documents becamemisleading. Beginning a decade earlier, on July 10, 2000, iShares began issuing shares of the Plaintiffs' Funds. The effective
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dates for their initial registration statements were as follows: IWF and IVV (July 10, 2000); IJR (October 15, 2000); IWS(January 21, 2001); IWP and IWR (February 5, 2001); DVY (November 1, 2003); JKG and JKD (May 19, 2004); ITA (February
28, 2006); and PFF (September 18, 2006). (1AA0278.) 11 Between 2000 and May 6, 2010, Plaintiffs' Funds collectively issuedand sold Creation Units comprised of hundreds of millions of shares in a series of primary market transactions pursuant toregistration statements and amendments filed with the SEC. (See IAA 0260-76, 0278, 0280-281.) The cumulative effect ofthese issuances in primary offerings (and redemptions) was that Plaintiffs' Funds, respectively, had between 1,600,000 and220,950,000 shares outstanding as of the 2010 flash crash. (1AA0280-81.)
It is undisputed that these shares were issued pursuant to offering documents that were not false or misleading. Plaintiffsstipulated at trial that “[t]here [wa]s no material misrepresentation or omission in any part of any registration statement or anyamendment thereto... before May 6, 2010.” (4AA1448 ¶ 1.) The Plaintiffs' Funds continued to issue shares after May 6, 2010.
(1AA0260-76.) 12
*24 D. Plaintiffs Did Not Show Whether the Shares They Purchased Were Issued Under the Allegedly MisleadingPost-2010 Flash Crash Registration Statements or Amendments or Earlier Registration Statements or AmendmentsThat Were Not Alleged To Be Misleading.
Plaintiffs purchased their ETF shares on secondary securities exchanges via their retail brokers. (See 2AA0511-722.) Butbecause all these shares were held in fungible bulk at the DTC, Plaintiffs were unable to prove at trial whether these shareswere issued pursuant to registration statements and amendments that pre-dated or post-dated May 6, 2010.
III. PROCEDURAL BACKGROUND
A. The Initial Complaint.
*25 Plaintiffs' initial and amended complaints were both brought under the 1933 Act. Plaintiffs filed their initial complaint
against Defendants on June 16, 2016, and alleged three claims under the 1933 Act. 13 Those claims were: (1) violation of Section11 for allegedly causing material misstatements and/or omissions to be made in the registration statements, (2) violation ofSection 12(a)(2) for offering or selling a security by means of prospectuses that allegedly contained untrue statements of materialfact or omissions of material facts that defendants knew (or should have known) were untrue or omitted, and (3) violation ofSection 15 of the 1933 Act (15 U.S.C. § 77o) by controlling persons and/or those who aided and abetted alleged violations ofthe 1933 Act. (1A0025-68.) On December 21, 2016, the trial court dismissed the initial complaint without prejudice on statuteof limitations grounds because Plaintiffs had not adequately alleged that they purchased their ETF shares within one year oftheir discovery of the alleged misstatements. (1AA0101-08.)
B. The First Amended Complaint.
After the trial court dismissed their initial complaint, Plaintiffs filed their “First Amended Complaint for Violation of the U.S.Securities Act of 1933,” which also suffered from fatal legal defects. Plaintiffs' First Amended Complaint contained the samethree causes of action as their initial complaint. (1AA0109-191.) By Order dated April 27, 2017, the trial court partially grantedDefendants' motion for judgment on the pleadings by dismissing Plaintiffs' claim under Section 12(a)(2) for lack of standing,on the ground that none of Plaintiffs alleged they purchased ETF shares in an initial offering. (1AA0217-25.) The trial courtreasoned:
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“[P]urchasers in private or secondary market offerings do not have standing to bring 12(a)(2) actions.”
There are no allegations in the FAC that plaintiffs purchased their ETF shares in an initial offering. In fact, the complaint suggest[sic] just the opposite. ETFs are not sold directly to individuals from retail investors, but sold in large blocks to an “AuthorizedParticipant” who then splits up the shares “and sell[s] them to individuals or on a secondary market such as the NASDAQArca.” FAC ¶¶ 61-63. Ninety percent of ETFs are traded on a secondary market (the New York Stock Exchange Arca). Id. ¶ 59.
(1AA0222-23, second alteration in original, citations omitted.)
*26 In that same order, the trial court held there was an issue of fact as to whether Plaintiffs satisfied the tracing requirementneeded to establish standing on their Section 11 claim. Citing supporting case law, the Superior Court explained that if thereare some registration statements that are alleged to be false and misleading and some that are not, a plaintiff will have to tracehis or her shares to a specific registration statement:
Where all the potentially pertinent registration statements contain the same allegedly false or misleading language and each wasat the time false and misleading, there may not be much reason to insist on traceability to any one of them. If the fact is thatsome of potentially pertinent registration statements do, and some do not, contain the false and misleading statementsalleged in the operative complaint, then plaintiff will indeed have to shoulder the burden of tracing title to a specificregistration statement, a burden which they likely cannot sustain.
On this record, I do not know if we have a standing problem or not, because I do not know if we have more than one offeringunder multiple registration statements with materially differing representations...
(1AA0221-22, emphasis added, citations omitted.)
C. The Bifurcated Bench Trial.
On June 25, 2017, the parties agreed to a bifurcated bench trial on the issue of whether Plaintiffs had standing to bring a claimunder Section 11. (1AA0239.) The trial was conducted on September 11, 2017. At trial, the parties provided opening statements,presented arguments, and delivered closing arguments before the Court, all regarding Plaintiffs' standing. The parties introducedevidence in the form of sworn affidavits and stipulated facts, including the stipulation that “[t]here [wa]s no material *27misrepresentation or omission in any part of any registration statement or any amendment thereto... before May 6, 2010,” whenthe 2010 flash crash occurred. (4AA1448 ¶ 1.)
At trial, no Plaintiff offered any evidence as to whether any of the shares he or she purchased were issued before or after May 6,2010. Instead, each Plaintiff submitted evidence that it purchased its ETF shares in the secondary market through a brokeragefirm. (2AA0511-722.)
One week after trial, on September 18, 2017, the Superior Court issued a Statement of Decision that disposed of Plaintiffs'
remaining Section 11 and Section 15 claims. 14 The trial court held that because Plaintiffs could not trace their shares to adefective registration statement, their claims failed for failure to prove standing. Plaintiffs appealed.
IV. STANDARD OF REVIEW
The question presented on appeal - namely, whether Section 24(e) eliminates Section 11's standing and tracing requirement -
should be evaluated under the “independent review” standard. ( Le v. Pham (2010) 180 Cal.App.4th 1201, 1206.) Under thisstandard of review, Plaintiffs' *28 appeal must be rejected for the reasons described below.
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V. LEGAL STANDARD
The nature, purpose, and background of the 1933 Act, the 1934 Act, and the ICA demonstrate that Plaintiffs' argument thatSection 24(e) of the ICA supersedes the tracing requirement of the 1933 Act is meritless.
A. Section 11 of the 1933 Act Regulates a Corporation's DisclosuresMade When New Shares Are First Put Into the Market.
The 1933 Act, of which Section 11 is a part, regulates the offer and sale of securities by issuers and seeks to prevent fraud in
public offerings by imposing disclosure and registration requirements. (See Gustafson v. Alloyd Co. (1995) 513 U.S. 561,571-572 [“primary innovation” of the 1933 Act “was the creation of federal duties - [principally,] registration and disclosure
obligations - in connection with public offerings”]; United States v. Naftalin (1979) 441 U.S. 768, 777-778 [“T]he 1933 Actwas primarily concerned with the regulation of new offerings.”].)
Section 11 provides a private right of action for purchasers of a security if the issuer of new shares files a registration statementfor those shares that “contain[s] an untrue statement of a material fact or omit[s] to state a material fact required to be statedtherein or necessary to make the statements therein not misleading.” (15 U.S.C. § 77k(a).) Plaintiffs seeking to assert such aclaim must prove (1) that the registration statement contained an omission or misrepresentation, and (2) that the omission or
*29 misrepresentation was material. ( Rubke v. Capitol Bancorp Ltd. (9th Cir. 2009) 551 F.3d 1156, 1161.)
A Section 11 plaintiff generally need not prove scienter or causation. Furthermore, a Section 11 plaintiff ordinarily does nothave to prove reliance on the misstatement (although there is an exception where the issuer's financial statements have been onfile for over a year). (See 15 U.S.C. § 77k(a).) As discussed below, however, in order to avail themselves of Section 11 as aremedy, plaintiffs must trace their shares to the allegedly defective registration statement.
B. The 1934 Act Generally Regulates an Issuer's Statements andDisclosures After Its Shares Are Trading in the Secondary Market.
Plaintiffs in this case purchased their shares in the secondary market. The 1934 Act generally regulates an issuer's statementsand disclosures after its shares begin trading on the secondary market. Section 10(b) of the 1934 Act, along with SEC Rule10b-5, prohibits “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.” (17 C.F.R. § 240.10b-5(c); accord 15 U.S.C. § 78j(b).) 15
*30 Courts have long recognized that Section 10(b) generally deals with trading in the secondary market. (See CentralBank of Denver, N.A. v. First Interstate Bank of Denver, N.A., (1994) 511 U.S. 164, 170-71 [“The 1933 Act regulates initialdistributions of securities, and the 1934 Act for the most part regulates post-distribution trading.”].) While the “purpose behind§ 11 of the 1933 Act is relatively limited in scope,” § 10(b) of the 1934 Act imposes “a broad proscription against fraud.” (SeeTAAM Assocs. Inc. v. Housecall Med. Res., Inc. (N.D. Ga. Mar. 30, 1998, No. 1:96CV2214 A JEC) 1998 WL 1745361, at
*4-5.) 16
C. The Investment Company Act of 1940 Governs the Business Practices of Investment Companies.
*31 The ICA, which Plaintiffs argue gives them standing in this case, regulates investment companies, including ETFs, and
was adopted principally to police the potential conflicts between an investment company and its advisor. (See Daily Income
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Fund v. Fox (1984) 464 U.S. 523, 536 [“Congress adopted the [ICA] because of its concern with ‘the potential for abuse inherentin the structure of investment companies.”’] (citation omitted).) To reduce the risk these conflicts pose, the ICA (i) regulatedtransactions between investment companies and their advisors; (ii) limited the number of persons affiliated with the advisorwho may serve on the investment company's board; and (iii) required that advisory fees be set forth in written agreements. (See
ibid. at pp. 536-37.) The remedies prescribed by the ICA concern the business practices of investment companies. ( Nat'lAss'n. of Sec. Dealers, supra, 422 U.S. at pp. 704-705 [“The [ICA] vests in the SEC broad regulatory authority over the business
practices of investment companies.”].) 17 The ICA does not have a private right of action for fraud (as noted above, that iscovered by the 1933 Act and the 1934 Act).
VI. ARGUMENT
A. The Trial Court's Dismissal of Plaintiffs' Section 11 Claim Should Be Affirmed.
Plaintiffs' entire argument that their Section 11 claims were improperly dismissed rests on their incorrect view that they are notrequired to trace their shares to a primary offering that had an allegedly defective registration statement. Instead, Plaintiffsargue that they only need to show that the registration statement that was effective at the time they purchased shares onthe secondary market contained materially misleading information. In other words, Plaintiffs essentially read the tracingrequirement completely out of Section 11.
Plaintiffs raise a number of arguments - some more intelligible *32 than others - as to why this Court should ignore black-letter law that, in order to have standing to bring a Section 11 claim against an issuer, a plaintiff must trace his or her sharesto a defective registration statement. All of Plaintiffs' arguments hinge on their apparent view that the securities at issue here- shares of ETFs - are so unique as to require special treatment under the 1933 Act. Of course, there are no cases that supporttheir radical proposition, so Plaintiffs attempt to obfuscate by pointing to other, unrelated securities laws, strained statutoryconstruction, irrelevant SEC orders, and unfounded policy arguments to support their position. But none of these arguments areavailing; if anything, the materials relied on by Plaintiffs reflect a deliberate intention by Congress and the SEC not to broadenSection 11 liability beyond the original constructs. Further, Plaintiffs' policy arguments apply just as equally to investors inother securities that are traded principally on the secondary market (e.g., equities), but those arguments have not been adoptedby Congress or the courts.
1. Plaintiffs Were Required To Demonstrate That the Shares They PurchasedWere Traceable to a Misleading Registration Statement or Amendment.
Section 11 of the 1933 Act provides, in relevant part, as follows:
In case any part of the registration statement, when such part became effective, contained an untruestatement of a material fact or omitted to state a material fact required to be stated therein or necessary tomake the statements therein not misleading, any person acquiring such security (unless it is proved that atthe time of such acquisition he knew of such *33 untruth or omission) may, either at law or in equity .sue... [a list of specific categories of defendants].
(15 U.S.C. § 77k, emphasis added.)
Section 11's tracing requirement derives from its plain language. In order to state a Section 11 claim, a purchaser must provethat “such security” that is the basis of the cause of action was purchased pursuant to a registration statement (or part thereof)
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that misstated or omitted material facts at the time the registration statement became effective. (See Hertzberg v. DignityPartners, Inc. (9th Cir. 1999) 191 F.3d 1076, 1080, cited in Pl. Br. at p. 37 [“The limitation on ‘any person’ is that he or shemust have purchased ‘such security.’ Clearly, this limitation only means that the person must have purchased a security issuedunder that, rather than some other, registration statement.”].) “Such security” refers only to the specific securities registeredpursuant to the allegedly defective filing; it does not refer to all securities of the same class as those registered by the allegedly
misleading filing. (See Barnes v. Osofsky (2d Cir. 1967) 373 F.2d 269, 271-72.)
*34 Section 11's tracing requirement is well established. As courts across the country have recognized, Section 11 “providesa cause of action to any person who buys a security issued under a materially false or misleading registration statement.” (See
Century Aluminum, supra, 729 F.3d at p. 1106.) A plaintiff need not have purchased in an initial public offering to havestanding under Section 11, but secondary market purchasers have standing only if “they can trace their shares back to the relevantoffering.” (Ibid.; see also In re ARIAD Pharm. Sec. Litig. (1st Cir. 2016) 842 F.3d 744, 755-756 [affirming dismissal of Section
11 claim for failure to plead facts sufficient to satisfy tracing requirement]; Krim v. pcOrder.com, Inc. (5th Cir. 2005) 402 F.3d489, 498-499 [affirming dismissal of Section 11 claim where plaintiff's statistical tracing method was insufficient to demonstratethat their shares were traceable to a challenged registration statement]; TransEnterix Inv. Grp. v. TransEnterix, Inc. (E.D.N.C.2017) 272 F.Supp.3d 740, 760-762 [plaintiffs failed to adequately allege tracing where 92% of the shares in the market camefrom offering documents that pre-dated the allegedly false and misleading prospectus]; Scott v. ZST Dig. Networks, Inc. (C.D.
Cal. 2012) 896 F.Supp.2d 877, 887-888 [dismissing Section 11 claim based on a failure to adequately allege tracing].) 18
Tracing is a critical requirement of a Section 11 claim because a plaintiff generally need not prove normal fraud requirementssuch as scienter and reliance. It is precisely because of these “relaxed liability *35 requirements” that Congress and the courts
have imposed a strict tracing requirement, which serves as a necessary limit on Section 11 liability. (See Century Aluminum,
supra, 729 F.3d at p. 1107; Barnes, supra, 373 F.2d at pp. 271-73 [explaining that because Section 11 does not include themore-difficult-to-prove intent requirement, potential liability is limited to claims relating to securities traceable to a defectiveregistration statement].)
2. Plaintiffs Utterly Failed To Demonstrate That the Shares They PurchasedWere Traceable to a Misleading Registration Statement or Amendment.
At the outset, it is beyond dispute that Plaintiffs were not able to trace their shares to an allegedly defective registration statementat trial. Indeed, before trial, Plaintiffs stipulated that the iShares' registration statements and amendments that pre-dated May6, 2010 were not misleading. Thus, Plaintiffs' shares could have been issued pursuant to a registration statement that had noalleged misstatements. Given that Plaintiffs did not even attempt to establish that their shares were purchased in connectionwith a post-May 6, 2010 offering of fund shares, Plaintiffs failed to meet Section 11's tracing requirement.
Moreover, Plaintiffs could not trace their shares to a post-May 6, 2010 offering document even if they tried. Because all sharesPlaintiffs purchased were held in fungible bulk at DTC, Plaintiffs cannot trace their shares to any specific registration statementor amendment, let alone one after May 6, 2010. (See 4AA1476-77.) The Ninth Circuit Court of *36 Appeals has held thatshares held in fungible bulk cannot be traced to any one of multiple registration statements, explaining in language equallyapplicable here:
[Plaintiff] cannot trace its shares to an offering made under a false or materially misleading registrationstatement. The... shares owned by [plaintiff] were part of a fungible mass of... shares held by a [DTCParticipant]... Such situation effectively prevented any chain of title from ever being built becauseshares from several offerings were entirely indistinguishable. Because [plaintiff] could not demonstrate
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that its shares originated from the relevant registration statement, it lacked standing to pursue its Section11 claim.
( Hemmer Grp. v. Sw. Water Co. (9th Cir. 2016) 663 F.App'x 496, 498, emphasis added; accord In re Puda Coal Sec. Inc.(S.D.N.Y. Oct. 1, 2013, 11 Civ. 2598 (KEF)) 2013 U.S. Dist. LEXIS 142081, at *24 [the “steps necessarily involving the [DTC]are fatal to traceability”], judg. vacated in part on other grounds, (S.D.N.Y. Apr. 7, 2014) 2014 U.S. Dist. LEXIS 49718; Abbey
v. Comput. Memories, Inc. (N.D. Cal. 1986) 634 F.Supp. 870, 872-875 [plaintiff could not establish tracing where all CMIshares he purchased “were a part of the common pool of CMI shares held in DTC's vault on the day of the transfer”].)
Plaintiffs do not seriously dispute that they are unable to trace their shares to an actionable registration statement. Rather, theyclaim that, for procedural reasons, the issue of standing is not properly before this court. (See Pl. Br. pp. 20-22.) These argumentsare meritless.
*37 First, contrary to Plaintiffs' suggestion, tracing is not an affirmative defense; rather, Plaintiffs bear the burden on the issue
of statutory standing, which, for Section 11's purposes, requires them to demonstrate tracing. (See Guenther v. Cooper LifeSci., Inc. (N.D. Cal. 1990) 759 F.Supp. 1437, 1439 [“The burden of tracing shares to a particular public offering rests withplaintiffs.”].) Where, as here, “a company has issued shares under more than one registration statement, the plaintiff must provethat her shares were issued under the allegedly false or misleading registration statement, rather than some other registration
statement.” ( Century Aluminum, supra, 729 F.3d at p. 1106; accord In re Puda Coal, supra, 2013 U.S. Dist. LEXIS 142081,
at p. *18; Abbey, supra, 634 F.Supp. at 876, fn. 5.) Indeed, recognizing this burden of proof, Plaintiffs' complaints alleged
that their purchases were made “pursuant and traceable to the Offering Documents” (emphasis added). 19 Defendants wereneither required to raise tracing as an affirmative defense or to have raised it in their first motion for judgment on the pleadings.
Second, Plaintiffs waived whatever objection they claim to have here when they agreed to a trial on the issue of standing withoutobjecting that the issue had not been raised previously. In the Joint Case Management Conference Statement, both Plaintiffsand Defendants agreed *38 that the tracing issue should be resolved through a bench trial. (See 1AA0226, 0228, 0230, 0236(“Parties make a joint proposal to the Court for a bench trial.” (1AA0236)).) Thus, Plaintiffs' procedural arguments fail.
3. To Satisfy the Tracing Requirement, Plaintiffs Must Trace the ETF SharesThey Purchased to a Misleading Registration Statement or Amendment and Not
Merely to the Latest Amendment Filed Before Their Secondary Market Purchase.
Plaintiffs argue that each amendment becomes the operative registration statement for all previously issued shares, even the
millions of shares issued pursuant to non-defective registration statements. That argument was rejected in Guenther v.Cooper Life Sci., Inc., supra, 759 F.Supp. at pp. 1439-1441. There, the court rejected the plaintiffs' claim that the non-defectiveregistration statement could be retroactively rendered blemished by a later misleading amendment. (Ibid.) To have Section 11standing, the court held that plaintiffs had to trace securities purchased on the secondary market after the allegedly defectiveamendment to a misleading registration statement. (Ibid.)
Under Plaintiffs' argument, an issuer of securities would be liable under Section 11 if the shares were issued pursuant to anaccurate registration statement, i.e., one that was accurate on its effective date. That is inconsistent with the language of Section11. Section 11 only creates potential liability if “any part of the registration statement, when such part *39 became effective,contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to
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make the statements therein not misleading.” (15 U.S.C. § 77k(a), emphasis added.) Thus, Plaintiffs' argument is contrary tothe plain language of Section 11, which looks at the accuracy of the registration statement at the time the shares were issued.
Moreover, there is no evidence that Congress intended to subject investment companies to Section 11 liability for shares issuedunder an accurate registration statement. As the trial court persuasively stated, that was not the intent of the ICA:
If plaintiffs are right and there is no tracing requirement, and plaintiffs need only show they bought in thesecondary market after an infirm registration statement, then all securities, including those sold in an initialoffering pursuant to a perfectly innocent registration statement, could be the subject of a § 11 suit if thesecurities ended up in the hands of someone - anyone - after a much later infirm registration statement.Plaintiffs do not demonstrate this was the legislative intent behind the ICA.
(4AA1547-48.)
4. Section 24(e) of the Investment Company Act Left Intact the TracingRequirement of Section 11 of the 1933 Act and Did Not Alter or Weaken It
Plaintiffs' appeal relies heavily on Section 24(e) of the ICA. That statute permits investment companies to file amendmentsinstead of new registration statements. But Section 24(e) does not alter the well-established tracing requirement of Section 11.
*40 (a) Section 24(e)'s Purpose Was To Allow Investment Companies To FileAmendments to Their Registration Statements Rather than New Registration
Statements While Preserving the Status Quo with Respect to Sections 11 and 13.
(i) Section 24(e) Eliminated Paperwork and Expense for Investment Companies.
Section 24(e) permits updated disclosures to be “filed as part of an amendment to the registration statement under [the 1933Act].” (15 U.S.C. § 80a-24(e).) Its goal was to relieve investment companies of the expense and paperwork associated witheach new share issuance by allowing them to file annual amendments to their registration statements (known as “post-effectiveamendments”), rather than having to incur the substantially greater expense of filing a new registration statement each time
they issue new shares. 20 (See Frankel & Laby, Regulation of Money Managers: Mutual Funds and Advisers (3d ed. 2015)25.01, p. 18.) As a leading treatise noted:
“[A] new § 24(e) was added to the [ICA] so as to permit those investment companies engaged in continuous offerings... toregister additional securities under the Securities Act either by filing a new registration *41 statement as they formerly didor by filing an appropriate amendment, approximately once a year, to the latest effective registration statement for securitiesof the same class.”
(Loss & Seligman, Securities Regulation (4th ed. 2006) p. 538, fn. 69, 1AA0391.) 21
Section 24(e)'s legislative history confirms this purpose. The Senate and House Committee Reports state that 24(e) intends that“only those revised prospectuses which reflect a periodic general revision, to bring up to date the latest prospectus containedin the registration statement, or other important change must be filed as a part of the registration statement.” (Sen.Rep. No.83-1036, 2d Sess., p. 21 (1954) (1AA0382); H.R.Rep. No. 83-1542, 2d Sess., p. 30 (1954) (1AA0 388).) Courts have consistently
recognized this legislative intent. (P. Stolz Fam. Partn. L.P. v. Daum (2d Cir. 2004) 355 F.3d 92, 105 [“This amendment
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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.”]; Morse v. Peat, Marwick, Mitchell & Co. (S.D.N.Y. 1977) 445 F.Supp.619, 623 [1954 amendment “permitted] investment companies engaged in the continuous offerings of their shares periodicallyto increase the number of shares registered under the Securities Act by filing amendments to their *42 existing registrationstatements rather than by filing new registration statements”] (hereafter Morse).)
Contrary to Plaintiffs' contention, Section 24(e) was not intended to address trading in the secondary market. Indeed, Plaintiffs'argument that Congress “intended [to create] broader standing for Securities Act claims involving investment companies” thattraded in the secondary market through enacting Section 24(e) is necessarily false, since that section was enacted in 1954 andETFs did not exist until around 40 years later. Surely, Congress' intent could not have been to expand the rights of investorsrelated to a product that would not exist for another four decades.
(ii) Section 24(e) Does Not - and Did Not - Change the Standing orTracing Requirements Necessary for Bringing Section 11 and 13 Claims.
While it did reduce compliance costs for investment companies, Section 24(e) left shareholders' ability to bring Section 11claims unaltered. The pertinent language of Section 24(e) is as follows:
For the purposes of Section 11 of the Securities Act of 1933, as amended, the effective date of the latestamendment filed shall be deemed the effective date of the registration statement with respect to securitiessold after such amendment shall have become effective. For the purposes of section 13 of the Securities Actof 1933, as amended, no such security shall be deemed to have been bona fide offered to the public priorto the effective date of the latest amendment filed pursuant to this subsection.
This language reflects that, at the same time as Congress sought to allow investment companies to issue shares in a less expensivemanner, it *43 also wanted to maintain Section 11 liability for the less costly post-effective amendments utilized by investmentcompanies. As written, Section 11 only applies to “registration statements,” not post-effective amendments to those registrationstatements. Thus, without the added reference to Section 11, investors could have been barred from bringing Section 11 claimswhere the original registration statement did not contain misleading statements but the shares at issue were sold pursuant to apost-effective amendment that was misleading on its effective date. (This, of course, is not the situation here because Plaintiffsfailed to prove whether the shares they purchased were issued pursuant to an accurate offering document or an offering documentPlaintiffs claimed was misleading.)
Section 24(e)'s language referencing Section 13 also reinforced the status quo for Section 11 claims. Again, Section 13 onlyreferences claims being time barred “more than three years after the security was bona fide offered to the public.” Thus, withoutthe Section 13 reference, any investor who purchased shares issued pursuant to a post-effective amendment that became effectivemore than three years after the investment company first bona fide offered shares to the public would be automatically time-
barred from bringing Section 11 claims. (See P. Stolz Fam. Partn., supra, 355 F.3d at p. 106 [“In 1954 Congress amendedthe Investment Company Act to eliminate th[e] problem [that arises when an offering extends beyond three years] in connectionwith the sale of mutual fund shares, where it was *44 most acute.”'], citation omitted.) By adding the reference to Section13, Congress made clear that investors who purchased in these circumstances would not face statute of limitations issues inbringing a Section 11 claim for the misleading post-effective amendment.
This language of Section 24(e) thus has been rightly interpreted as expressing Congress's desire to maintain the status quo for
Sections 11 and 13 22 of the 1933 Act, while allowing investment companies to file post-effective amendments:
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The intention of the legislation was thus to conform the registration procedures of the Securities Act to the special needs ofinvestment companies but, simultaneously, to preserve intact the [Section] 11 liability of investment companies... [T]hatprovision was in the view of Congress simply a means of maintaining the status quo with respect to the liability ofinvestment companies under [Section] 11 of the Securities Act.
( Morse, supra, 445 F.Supp. at p. 623, emphasis added; see also 5 Jacobs, Disclosure and Remedies Under the SecuritiesLaws (2017) § 3:72 (hereafter Disclosure and Remedies) (1AA0398) [“[Section 24(e) is] merely... a restatement of existingSection 11 law.”].)
Finally, the House and Senate Committee Reports that accompanied the passage of Section 24(e) likewise reflect its purposeto maintain the *45 status quo regarding Sections 11 and 13.Paragraph (3) also contains references to sections 11 and 13 of the Securities Act so that there will be no departure fromeither the disclosure standards or the liabilities imposed upon sellers. Thus, under the new section 24(e) of the InvestmentCompany Act, the registration statement under the Securities Act of 1933 of an issuer referred to in this subsection must meetthe standards of section 11 of the Securities Act not only on the original effective date but also on the effective date of eachpost-effective amendment to such registration statement, and the periods of limitation on actions provided by section 13 of theSecurities Act start anew with respect to securities sold thereafter each time such registration statement is effectively amendedeither to increase the number or amount of securities registered or to make the above-mentioned revisions of the prospectusa part of the registration statement.
(H.R.Rep. No. 83-1542, at 31 (1954) (1AA0386), emphasis added; Sen.Rep. No. 83-1036, 2d Sess., p. 21(1954) (1AA0382),emphasis added.)
*46 Plaintiffs argue that, if the Court does not adopt their interpretation, Section 24(e)'s references to Sections 11 and 13would be rendered “surplusage.” (See Pl. Br. at p. 28.) That is simply not accurate. As discussed above, that language playedthe important role of maintaining the status quo for Section 11 claims and the Section 13 limitations period in the context ofinvestment companies being permitted to file post-effective amendments. Simply put, the plain language and legislative historyof Section 24(e) show it was designed to maintain the status quo for Sections 11 and 13 and not to expand Section 11 liability
by eliminating the need to trace. 23
(b) Section 24(e)'s Reference to “Securities Sold After Such Amendment” Is to theSale of Shares by the Issuer, Not to Sales in the Secondary Market By Investors.
The trial court correctly observed that Section 24(e)'s language “the effective date of the latest amendment filed pursuant to thissubsection or otherwise shall be deemed the effective date of the registration statement with respect to securities sold after suchamendment shall have become effective” refers to securities sold by the issuer and not to sales by investors in the secondarymarket. (4AA 1546-48.) There is no merit to Plaintiffs' argument that Section 24(e)'s reference to “securities sold after suchamendment” refers to the sale of ETF shares in the secondary market. (Pl. Br. at pp. 27-29.)
Indeed, the language of Section 24(e) provides ample support for the trial court's conclusion. First, the reference to Section11 in the first sentence of Section 24(e) (“For the purposes of section 11 of the Securities Act of 1933”) indicates that Section24(e) applies to new issuances of a company's shares, rather than to aftermarket trading governed by the *47 Exchange Actof 1934. As discussed above, the 1933 Act and Section 11 address disclosures for newly issued securities, not in connectionwith aftermarket trading. Given that it is “[f]or the purposes of section 11,” the most reasonable inference is that Section 24(e)'sreference to “securities sold” is to securities sold by the issuer in a new offering, rather than sales by other shareholders in thesecondary market. (See 5 Disclosure and Remedies, supra, at § 3:72 [stating that “sold” or “offered” within the intendment
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of Section 24(e) means “(1) securities sold pursuant to the registration statement after the effective date of the post-effectiveamendment, not (2) securities sold in the open market after such effective date”] (1AA0398, emphasis added).)
Second, given the context of its enactment, it would be anomalous if Section 24(e) applied to open market transactions, ratherthan to sales of securities by issuers. As noted, when promulgated in 1954, Section 24(e) applied to open-end mutual funds,where there was no secondary market and the issuer was the sole seller of shares. Thus, in using the language “securities sold,”
Congress could not mean securities traded in the secondary market. 24
*48 (c) The Other Statutory Construction Arguments Plaintiffs AdvanceDo Not Support Their Argument That Section 24(e) Eliminates Tracing.
Plaintiffs' other statutory construction arguments for the ICA supposedly taking precedence over the 1933 Act are also unavailingfor two additional, independent reasons.
First, Plaintiffs' claim that the ICA somehow takes precedence over the 1933 Act because the former is a “specific statute”while the latter is a general one is not accurate. (See Pl. Br. at pp. 28-29.) The more specific statute is Section 11, whose specific
language “any person acquiring such security” yields the tracing requirement. (See Krim v. pcOrder.com, Inc. (5th Cir. 2005)402 F.3d 489, 497 [“In limiting those who can sue to ‘any person acquiring such security,’ Congress specifically conferredstanding on a subset of security owners...”].)
Second, Plaintiffs' argument - that Section 24(e) confers broader standing than Section 11 because of the supposed use of “soldafter” in Section 24(e) as compared to “specified therein as proposed to be offered” in Section 6(a) of the 1933 Act (15 U.S.C.§ 77j(a)) and “offered therein” in 17 C.F.R. § 229.512 (2018) of the SEC regulations (Pl. Br. at pp. 26-28) - is also groundless.These linguistic distinctions do nothing more than permit investment companies to file amendments rather than new registrationstatements, as other companies are required to do. They do not *49 speak to tracing.
5. Interpreting the ICA in a Way That Expands Standing Under the Securities Lawsfor Disclosure Violations Would Contravene the Purpose and History of the ICA.
(a) The ICA Should Not Be Construed in a Manner That Would Effectively Createa New Private Right of Action for Alleged Violations of the Federal Securities Laws.
Plaintiffs' appeal rests on the notion that the ICA in Section 24(e) dramatically enlarged the scope of the remedies affordedunder Section 11 of the 1933 Act. This is inconsistent with the fundamental nature of both statutes. As a general matter, asdiscussed in the Legal Standard section above, the 1933 Act is the source of a remedy for disclosure violations in the offeringof new shares, while the ICA is focused on the business practices of investment companies.
More specifically, however, Plaintiffs' argument that Section 24(e) expands liability under Section 11 is contradicted bynumerous holdings that private rights of action cannot be implied under the ICA. (See, e.g., Laborers' Local 265 Pension Fund v.iShares Trust (6th Cir. 2014) 769 F.3d 399, 406-408 [finding no intent by Congress to imply private right of action under Section36(a) of the ICA]; Northstar Fin. Advisors, Inc. v. Schwab Invs. (9th Cir. 2010) 615 F.3d 1106, 1122 [recognizing the “modern
trend” “has been for federal courts to deny the existence of implied private rights of action under the ICA”]; Santomenno exrel. John *50 Hancock Tr. v. John Hancock Life Ins. Co. (3d Cir. 2012) 677 F.3d 178, 186 [“Congress empowered the [SEC]
to enforce all ICA provisions [pursuant to] Section 42 [of the statute], see 15 U.S.C. § 80a-41, while creating an exclusiveprivate right of action in Section 36(b).”], emphasis added.)
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Therefore, notwithstanding the specific language of Section 24(e) and any of Plaintiffs' arguments about it, using this statute tosignificantly expand the scope of Section 11 would effectively be creating a private right of action under Section 24(e) withoutany expression of Congressional intent to do so. The United States Supreme Court has held that courts should disfavor creating
new rights in such circumstances by implication. (See Alexander v. Sandoval (2001) 532 U.S. 275, 291-293.) 25
Similarly, Plaintiffs' argument that “the interpretation favoring investor protection controls” (Pl. Br. at p. 41) contravenes judicialinterpretations of the ICA. As the United States Court of Appeals for the Sixth Circuit observed, the statutory language mustbe followed:*51 [A]lthough the plaintiffs invoke the broad remedial purposes of the ICA, generalized references to the remedial purposes
must yield to the unambiguous text and structure of a statute. See Touche Ross & Co., 442 U.S. at 578... (explaining thateven if a statute was enacted with a broad remedial purpose, this fact “will not justify reading a provision ‘more broadly than[the statute's] language and the statutory scheme reasonably permit”’).
(Laborers' Local, supra, 769 F.3d at p. 408.) Simply put, the ICA's general goal of investor protection cannot be the basisfor a dramatic expansion of potential liability that has no foundation in the statutory scheme, is otherwise unsupported and iscontrary to black-letter law.
(b) Plaintiffs' Arguments About the Registration Requirements Do Not Support Their Appeal.
The fact that ETFs are registered under the ICA does not exempt ETFs from Section 11's tracing requirements, as Plaintiffsimply. (See Pl. Br. at p. 31.) Generally, if an investment company, such as an ETF, is organized under the laws of the United
States, it must register as an investment company with the SEC pursuant to the ICA. (See Section 8(a) of the ICA, 15 U.S.C.§ 80a-8(a).) In addition, it must also register the shares that it is publicly offering under the 1933 Act pursuant to Section 24(a)of the ICA (15 U.S.C. § 80a-24(a)). Indeed, while Plaintiffs single out a statement on the cover page of certain RegistrationStatement Amendments indicating it is a “Registration Statement Under the Investment Company Act of 1940,” in each instance,that declaration is preceded by a declaration that is a “Registration Statement Under the *52 Securities Act of 1933.” (See,e.g., 2AA0733; 3AA0879; 4AA1267.)
Plaintiffs similarly grasp at straws in arguing that “the form S-1 registration statements... include[d] the ‘Title of Each Classof Securities to be Registered’ and the ‘Amount to be Registered,”’ while “defendants' Form N-1A registration statements forETFs registered pursuant to the ICA, do not contain these specifics.” (Pl. Br. at p. 32, citation omitted.) This difference in thedisclosures required of an investment company does not bear on the requirements of Section 11. The variance Plaintiffs point tois merely a function of investment companies being permitted to issue an indefinite number of shares. And although investmentcompanies and non-investment companies have some different disclosure obligations, they both are subject to claims underSection 11 and shareholders bringing claims under that statute must satisfy its requirements, including tracing.
(c) None of the Differences Between the 1933 Act and the ICA Address Tracing
Plaintiffs also attempt to conjure a basis for their arguments from some of the differences between the 1933 Act and the ICA,but none of those differences bear any relevance to the tracing requirement under Section 11. Rather, the discrepancies reflectthe ways that investment companies operate differently from non-investment companies.
For example, one such basic difference, as Plaintiffs note, is that open-end investment companies continuously distribute and
redeem shares *53 (Pl. Br. at p. 30). (See United States v. Nat'l Ass'n. of Sec. Dealers, Inc., supra, 422 U.S. at 698[recognizing that investment companies continuously issue and redeem shares].)
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Another basic difference is that open-end investment companies register an indefinite number of shares as opposed to othercompanies that issue a pre-specified number of shares. (See Pl. Br. at p. 30-31.) Because investment companies do not knowthe number of shares they will need to satisfy daily inflows of cash, Congress authorized them to issue an indefinite numberof shares. Permitting the issuance of an indefinite number of shares decreases the risk that an investment company will befined for not paying the proper registration fee under Section 24(f)(2) of the ICA, 15 U.S.C. § 80a - 24(f)(2). To accommodatethat continuous issuance of shares, Congress amended Section 24(f) of the ICA (which relates to registration fees payableby investment companies) as part of the National Securities Markets Improvement Act of 1996 in order to allow investmentcompanies to pay registration fees based on the net number of shares they issue during the year. SeeH.R. Rep. No. 104-622,at 44 (1996).
Both of these are core features of investment companies, which allow such companies to operate efficiently and in line with theirintended purpose. But in defining these features, Congress in no way altered the tracing requirement for investment companies.Given that the tracing requirement derives from the language of Section 11, and that language is *54 the same for investmentcompanies and non-investment companies alike, there is no basis to override the plain meaning of the statute and eliminate thetracing requirement for investment companies.
6. The SEC's Exemptive Orders Allowing Secondary Trading for ETFs DidNot Eliminate, But Rather Affirmed, Section 11's Tracing Requirements.
There is also no merit to Plaintiffs' argument that the tracing requirement should be discarded because the SEC had recognizedin exemptive orders pursuant to which ETF shares trade that investors in the secondary market are beneficiaries of the updateddisclosures made by ETFs. (Pl. Br. at pp. 33-36.) These features of ETFs in no way eliminate the tracing requirement and, infact, the SEC affirmed tracing in granting exemptive relief.
Indeed, in responding to iShares's request for an exemption to the prospectus delivery requirement of Section 24(d) of the ICA,the SEC itself recognized the tracing requirement in connection with iShares' sales of ETFs. (See Investment Company ReleaseNo. 25,623, Order Under Section 6(C) of the Investment Company Act of 1940 Granting an Exemption from Section 24(D) ofthe Act (June 25, 2002) (4AA1446.)) This exemption is a critical component of how ETFs are permitted to be traded on thesecondary market. In granting it, the SEC expressly stated that the exemption “does not affect a purchaser's rights under the civilliability and anti-fraud provisions of the Securities Act.” (Ibid.) The SEC then *55 observed that “rights under section 11 andsection 12(a)(2) of the Securities Act extend to all purchasers who can trace their securities to a registration statement filedwith the Commission, whether or not they were delivered a prospectus in connection with their purchase.” (Ibid.) (emphasisadded.) Thus, where the SEC granted an exemptive order to allow secondary market trading of ETFs, it did so with the provisothat tracing applied.
As is the case with the statutory language and legislative history, nothing in the SEC comments or exemptive orders surroundingSection 11 or Section 24(e) suggests that ETF investors do not have to trace their shares to a misleading offering document. Infact, critical SEC statements regarding ETF secondary market trading explicitly reaffirm Section 11's tracing requirements forsecondary market purchases such as those made by Plaintiffs here.
7. Plaintiffs' Policy Arguments Regarding Sections 11 and 24(e) Are Unavailing.
*56 Plaintiffs' policy arguments that the trial court's interpretation of the tracing requirement would “dissipate” Section 11liability for investment companies (see Pl. Br. at p. 40) are likewise without merit. Under the Superior Court's tracing paradigm,investment companies remain liable for shares issued pursuant to misleading registration statements in the same way as any
other non-investment companies that register shares under the 1933 Act. 26 And all such issuers may still be held liable underthe 1934 Act.
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Moreover, the challenges of tracing secondary market purchases back to primary offerings apply to both investment companies
and non-investment companies alike. (See, e.g., Century Aluminum, supra, 729 F.3d at pp. 1106-1107; In re CountrywideFin. Corp. Sec. Litig. (C.D. Cal. 2008) 588 F.Supp.2d 1132, 1164-1165.) While “difficult to meet in some circumstances,this tracing requirement is the condition Congress has imposed for granting access to the ‘relaxed liability requirements' § 11
affords.” ( Century Aluminum, supra, 729 F.3d at p. 1107, citations omitted; see also In re ARIAD Pharm. Sec. Litig. (1stCir. 2016) 842 F.3d 744, 755-56 [recognizing difficulty of alleging tracing when there were multiple stock offerings]; Krim,supra, 402 F.3d at p. 408 [“That present market realities, given the fungibility of stock held in street name, may render Section11 ineffective as a practical matter in some aftermarket scenarios is an issue properly addressed by Congress. It is not withinour purview to rewrite the statute to take account of changed conditions.”].) Thus, Plaintiffs are not in a unique predicament asETF shareholders that this or any other court needs to address by rewriting black-letter law.
*57 Finally, although any such claim would be baseless (or perhaps because any such claim would be baseless), Plaintiffs madethe strategic decision not to assert claims premised on fraud under Section 10(b) in either iteration of their complaints. Theyomitted such a claim, even though the SEC has pronounced that “[l]ike operating companies or closed-end funds, ETFs registeroffers and sales of shares under the Securities Act and list their ETF shares for trading on a national securities exchange underthe Securities Exchange Act of 1934.” (1AA0410.) Plaintiffs cannot complain about a lack of remedy for secondary markettrading when they strategically chose to not avail themselves of potential remedies under the 1934 Act. By electing to pursue thestrict liability (and relaxed requirements) of the 1933 Act, Plaintiffs chose to subject themselves to its tracing requirements. (See
Century Aluminum, supra, 729 F.3d at p. 1107 [“Though difficult to meet in some circumstances, this tracing requirement isthe condition Congress has imposed for granting access to the ‘relaxed liability requirements' § 11 affords.”], citation omitted.)
In short, Plaintiffs' policy arguments - which suggest that Section 11's tracing requirement has imposed some unique hardshipor deprivation of remedies upon them - are unavailing because the difficulties in proving tracing apply to investment companiesand non-investment companies alike.
*58 B. The Trial Court's Dismissal of the Section 12(a)(2) Claim Should Be Affirmed.
1. Plaintiffs' 12(a)(2) Claim Should Be Dismissed Because They PurchasedTheir ETFs in the Secondary Market and Not Directly From an Issuer.
The Court should affirm the Superior Court's dismissal of Plaintiffs' Section 12(a)(2) claim. The law is well settled thatpurchasers in the secondary market cannot bring claims under Section 12(a)(2). None of the individual Plaintiffs purchased inan initial offering. Each plaintiff averred that he or she purchased ETFs through a retail broker, whose purchases took placeon the New York Stock Exchange. No one alleged that they purchased ETFs directly from iShares. Plaintiffs therefore lackstanding to sue under Section 12(a)(2). (In re Countrywide Fin. Corp. Mortg.-Backed Sec. Litig. (C.D. Cal. 2013) 932 F.Supp.2d1095, 1118 [“Liability extends only to the ‘immediate sellers' of securities and ‘those who solicit purchasers to serve their ownfinancial interests or those of the securities owner.”’], citation omitted.)
*59 “Section 12... permits suit against a seller of a security by prospectus only by ‘the person purchasing such security fromhim,’ thus specifying that a plaintiff must have purchased the security directly from the issuer of the prospectus. 15 U.S.C.
§ 771(a)(2).” ( Hertzberg v. Dignity Partners, Inc. (9th Cir. 1999) 191 F.3d 1076, 1081.) The statutory language “‘give[s]a cause of action only to individuals who purchase securities directly from a person who sells the securities by means of a
prospectus.”’ (Medina v. Clovis Oncology, Inc. (D. Colo. 2017) 215 F.Supp.3d 1094, 1135, citation omitted.) 27 Because of thestatutory language, only purchasers in a public offering of securities, not purchasers in the secondary market, have standing to
bring § 12(a)(2) claims. (See Gustafson v. Alloyd Co., supra, 513 U.S. at pp. 570, 577; Welgus v. TriNet Grp., Inc.
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(N.D. Cal. Jan. 17, 2017, No. 15-CV-03625-BLF) 2017 WL 167708, at *18; Primo v. Pac. Biosciences of Cal., Inc. (N.D.Cal. 2013) 940 F.Supp.2d 1105, 1124.)
Each Plaintiff has only alleged a purchase of shares of iShares ETFs “pursuant and traceable to the Offering Documents,”without specifying whether such purchases were in an initial offering or were of previously issued shares already trading inthe secondary market. (1AA0122-39.) The Plaintiffs' declarations and attached exhibits clearly indicate that the shares werepurchased in the secondary market. (2AA0511-722.) For example, Plaintiffs admit that they did not purchase any ETFs directlyfrom iShares, acknowledging that:
ETFs can be sold only by Authorized Participants who have purchased them from issuers such as defendants,*60 who, in turn, can sell them only to broker-dealers. (1AA0247-248.) They are then limited to being
sold on a national exchange or by broker-dealers. (4AA1452-1453, 1476.)
(Pl. Br. at p. 41.) Plaintiffs also admit that they purchased the shares in anonymous transactions “over the exchange.” (1AA0144¶ 63.) Given the undisputed fact that they did not purchase directly in an offering, Plaintiffs lack standing under Section 12(a)(2). (In re Countrywide Fin. Corp. Mortg.-Backed Sec. Litig. (C.D. Cal. 2013) 932 F.Supp.2d 1095, 1118.)
*61 Plaintiffs cannot avoid having their Section 12(a)(2) claims barred simply because iShares is an investment company.Plaintiffs offer no case law in support of their argument that the well-established privity requirement in 12(a)(2) case law shouldbe ignored just because a defendant happens to be an investment company. (Pl. Br. at pp. 44-46.) As with Section 11, Section12(a)(2) applies to investment companies and non-investment companies alike. With both subject to the same governing statute,
there should be no difference in the 12(a)(2) privity requirement as between the two types of entities. (See In re MerrillLynch & Co., Inc. Research Reports Sec. Litig. (S.D.N.Y. 2003) 272 F.Supp.2d 243, 255 [finding that plaintiff failed to allegea direct purchase from, among others, the investment company and dismissed the 12(a)(2) claim because, “only a defendant
from whom the plaintiff purchased securities may be liable”], citation omitted.) 28
Finally, there is no merit to Plaintiffs' argument that certain case law conferring liability beyond the person that passed title
applies to grant Section 12(a)(2) standing here. (Pl. Br. at p. 49.) To be sure, cases such as Pinter v. Dahl (1988) 486 U.S. 622have recognized that, in some situations, 12(a)(2) liability can extend beyond the transferor of title. But those whom the court
referred to in Pinter are those who facilitate the sale, such as “brokers and others who solicit offers to purchase securities.” ( Id.at p. 646.) Factors considered by the court were whether the person received a commission or whether the person “who solicitsthe purchase will have sought or received a personal financial benefit from the sale,” such as anticipation of a share of the profits.
( Id. at p. 654.) None of the factors are alleged to apply to Defendants with respect to sales in the secondary market. iSharesis not alleged to have been directly or indirectly involved in the selling of shares traded on the secondary market. Accordingly,even under the broader interpretation of Section 12(a)(2) standing under Pinter, liability cannot attach to iShares for Plaintiffs'*62 trading in the secondary market.
2. The Absence of a Prospectus Delivery Requirement for ETFs UnderscoresThat Defendants Are Not Statutory Sellers for Purposes of Section 12(a)(2)
There is no merit to Plaintiffs' argument that Defendants are liable as statutory sellers because Section 24(d) of the ICA allegedlyrequires them to deliver a prospectus to the buyer of an investment company's shares. (Pl. Br. at pp. 45-50.) In this connection,the prospectus delivery requirement in Section 24(d) of the ICA is “subject to such terms and conditions as the Commission,having due regard for the public interest and the protection of investors, may prescribe by rules or regulations with respect to any
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class of persons, securities, or transactions.” (15 U.S.C. § 80a-24(d).) Plaintiffs acknowledge that the SEC has exempted iSharesfrom the prospectus delivery requirement of Section 24(d). (Pl. Br. at pp. 33-34; see also 4AA1440-46.) Because iShares isexempt from the Section 24(d) prospectus delivery requirement, whatever weight that requirement would provide to a 12(a)(2)
standing argument in other circumstances, such as where the seller is required to deliver a prospectus, it has no bearing here. 29
*63 In short, the statutory seller requirement of Section 12(a)(2) bars Plaintiffs' claim in this case and that result is not alteredby the prospectus delivery requirement of Section 24(d) which does not apply to ETFs such as the Trust.
*64 VII. CONCLUSION
For the foregoing reasons, Defendants respectfully ask this Court to affirm the trial court's disposition of each of Plaintiffs'claims.
Footnotes1 The individual defendants, other than Manish Mehta and Jack Gee, are or were members of the Board of Trustees of iShares. Messrs.
Mehta and Gee are, respectively, the President and CFO of iShares. Additional individual defendants, represented by Stroock &Stroock & Lavan LLP, are independent trustees John Martinez, Cecilia H. Herbert, Charles A. Hurty, John Kerrigan, Robert H. Silver,Madhav V. Rajan and George G. C. Parker.
2 ( Krim v. pcOrder.com, Inc. (5th Cir. 2005) 402 F.3d 489, 492 fn.4, citing Black's Law Diet. (8th ed. 2004) p. 990.)3 (15 U.S.C. § 80a-24(e).)4 ( 15 U.S.C. § 78j(b).)5 (17 C.F.R. § 240.10b-5 (2018).)6 “An ‘investment company’ invests in the securities of other corporations and issues securities of its own. Shares in an investment
company thus represent proportionate interests in its investment portfolio, and their value fluctuates in relation to the changes in the
value of the securities it owns.” ( United States v. Nat'l Ass'n of Sec. Dealers (1975) 422 U.S. 694, 697-698; see also 15 U.S.C.§ 80a-3(a)(1) [Section 3(a)(1) of the ICA] [including in definition of investment companies “any issuer which [i]s or holds itself outas being engaged primarily... in the business of investing, reinvesting, or trading in securities”].)
7 For example, if an investment company with 5 million outstanding shares has assets worth $100 million and liabilities of $10 million,its total NAV will be $90 million and its per share NAV will be $18 ($90 million ÷ 5 million = $18.)
8 Here, iShares issues multiple series of shares, with each series constituting a different iShares fund (a “Fund”), and each Fundcomprising an investment portfolio of mainly equity securities tracking specific securities indexes. Examples of the series of iSharesFunds purchased by Plaintiffs include DVY (“iShares Core S & P 500 ETG”) and DVY (“iShares Select Dividend ETF”).
9 (Antoniewicz and Heinrichs, Understanding Exchange-Traded Funds: How ETFs Work (Sept. 2014) fn. 14, ICI Research Perspective(Inv. Co. Inst. < ; www.ici.org/pdf/per20-05.pdf>; [as of Oct. 22, 2018]).)
10 References herein to “Pl. Br.” are to “Appellants' Opening Memorandum,” dated July 5, 2018.11 The effective date is a temporal benchmark used in Section 11 to determine whether there was a material misstatement or omission
as of a particular date. It is the date the SEC determines that the registration statement or amendment thereto is effective. (15 U.S.C.§ 77h(c).)
12 Defendants continue to dispute that there were ever any misrepresentations in the iShares registration statements or amendments. Forthe limited purpose of this appeal, however, Defendants premise their argument on the stipulated fact that the iShares registrationstatements and amendments before May 6, 2010 did not contain any material misstatements or omissions.
13 There is concurrent federal and state jurisdiction for claims under the 1933 Act. Claims under the 1934 Act must be brought exclusively
in federal court. (See Cyan, Inc. v. Beaver County Employees Retirement Fund (2018) 138 S.Ct. 1061.)14 Section 15 imposes liability on “control persons,” those who control defendants held liable for violating Section 11 of the statute. (See
15 U.S.C. § 77o(a).) Where, as here, plaintiffs have failed to state a claim under Section 11, they have no control person claim under
Section 15. (See Morgan Stanley Information Fund Sec. Litig. (2d Cir. 2010) 592 F.3d 347, 366; Stichting Pensioenfonds ABP
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v. Countrywide Fin. Corp. (C.D. Cal. 2011) 802 F.Supp.2d 1125, 1131.) Accordingly, the Court should affirm the Superior Court'sdismissal of Plaintiffs' Section 15 claim.
15 To prevail on a Section 10(b) claim, a plaintiff must prove (1) a material misrepresentation or omission of fact, (2) scienter, (3) a
connection with the purchase or sale of a security, (4) transaction and loss causation, and (5) economic loss. ( Rubke v. CapitolBancorp Ltd., supra, 551 F.3d at p. 1164.)
16 (See also Blue Chip Stamps v. Manor Drug Stores (1975) 421 U.S. 723, 752 [“The 1933 Act is a far narrower statute [than the1934 Act and is] chiefly concerned with disclosure and fraud in connection with offerings of securities - primarily, as here, initialdistributions of newly issued stock from corporate issuers.”].)
17 The issue in National Association of Securities Dealers, upon which Plaintiffs rely, for example, was whether dealers of investmentcompany securities were impliedly exempt under the antitrust laws for certain sales practices.
18 (See also Perrin v. Sw. Water Co. (C.D. Cal. July 2, 2014, No. CV 08-7844 DMG (AGR)) 2014 WL 10979865, at *7-8 [disposingSection 11 claim on summary judgment for failure to show tracing]; In re Vocera Commc'ns, Inc. Sec. Litig. (N.D. Cal. Feb. 11, 2015,No. C-13-3567 EMC) 2015 WL 603208, at *2 [dismissing Section 11 claim for failure to show tracing]; Johnson v. CBD Energy Ltd.(S.D. Tex. July 6, 2016, No. H-15-1668) 2016 WL 3654657, at *3-5 [same].)
19 (1AA0038 ¶¶26-33; 1AA0122 ¶28(a); 1AA0124 ¶ 29(a); 1AA0127 ¶30; 1AA0129 ¶31(a); 1AA0131 ¶32(a); 1AA0133 ¶ 33(a);1AA0135 ¶34(a); 1AA0137 ¶35(a).)
20 (See United States v. Nat'l Ass'n. of Sec. Dealers, Inc. (1975) 422 U.S. 694, 698 [“The most common form of investment company,the ‘open end’ company or mutual fund, is required by law to redeem its securities on demand at a price approximating theirproportionate share of the fund's net asset value at the time of redemption. In order to avoid liquidation through redemption, mutualfunds continuously issue and sell new shares. These features - continuous and unlimited distribution and compulsory redemption -are... ‘unique characteristic[s] of this form of investment.”], ellipsis added, citation omitted.)
21 Issuers of ETFs, such as iShares, face the same expense concern as other investment company issuers, as ETFs are constantly issuingnew Creation Units to Authorized Participants and satisfying redemption requests of those Authorized Participants.
22 Section 13 of the 1933 Act (“Section 13”) provides that the statute of limitations for a Section 11 claim is “one year after the discoveryof the untrue statement or the omission, or after such discovery should have been made by the exercise of reasonable diligence,” butno more than “three years after the security was bona fide offered to the public.” (15 U.S.C. § 77m.)
23 Although Plaintiffs purport to ground the instant appeal on Section 24(e) of the ICA, and repeatedly reference that statute as the sourceof their standing in their opening brief (see Pl. Br. at pp. 11, 13, 31, 32), that statute is not mentioned once in their First AmendedComplaint. Plaintiffs' First Amended Complaint is brought entirely under the Securities Act, including Section 11.
24 Plaintiffs themselves recognize the absence of trading of redeemable securities, such as shares of investment companies, prior to therelatively recent SEC exemptions: “[U]nder the ICA and until recent SEC exemptions, redeemable securities such as ETFs were notsold on a national exchange or secondary market.” (Pl. Br. at p. 38.)
25 Moreover, the ICA sets forth one private right of action - and one private right of action alone. That claim is articulated in Section36(b), 15 U.S.C. § 80a-35(b), and addresses fees charged to mutual funds, not disclosures, registration statements, or fraud. Therecognition in one section of the ICA of a private cause of action, while Section 24(e) does not, demonstrates that Congress did not
intend to create a claim under Section 24(e). (See Bellikoff v. Eaton Vance Corp. (2d Cir. 2007) 481 F.3d 110, 116 (per curiam)[“Congress's explicit provision of a private right of action to enforce one section of [the] statute,” namely, Section 36(b), “suggeststhat omission of any explicit private right [of action] to enforce other sections [including Section 36(a)] was intentional”], citationomitted.)
26 Investment companies and non-investment alike are subject to tracing if all the registration statements and amendments contain thesame misleading disclosure or if there is only a single registration statement.
27 17 C.F.R. § 230.159A (Pl. Br. at p. 49, fn. 30) is not to the contrary because, by its terms, it applies only to “primary offering[s],” notsecondary trading. In all events, the rule effectively has been nullified in light of a ruling finding that the SEC exceeded its authorityin adopting the rule. (See In re Countrywide Fin. Corp. Mortg.-Backed Sec. Litig. (C.D. Cal. 2013) 932 F.Supp.2d 1095, 1118.)
28 Feiner v. SS & C Technologies, Inc. (D. Conn. 1999) 47 F.Supp.2d 250 (Pl. Br. at p. 48) upon which Plaintiffs rely does not supportgranting them standing here. In that case, the 12(a)(2) claim was limited to those who purchased within 25 days of the initial offeringbecause that was part of the initial distribution of the shares, and the claims could be brought only by those who purchased directlyfrom the underwriters in a firm commitment underwriting. None of those facts are present here where all the shares were sold byiShares directly to Authorized Participants and not to retail brokers.
Garth JENSEN et al., Plaintiffs-Appellants, v. ISHARES..., 2018 WL 5778127...
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29 Regarding the letter referenced by Plaintiffs submitted by a predecessor of BlackRock (Pl. Br. at p. 45, fn. 22), there is no disputethat investors in the secondary market can bring federal securities law claims under Section 10(b) provided they sue in federal courtand can pursue Section 11 claims in federal or state court if they can trace the securities they purchased to a misleading registrationstatement or amendment.
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