Yu v. State Street - Travis Donselman

FOR PUBLICATION

UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

NING YU, on behalf of himself and all others

similarly situated,

Plaintiff-Appellant,

v.

STATE STREET CORPORATION, a corporation;

STATE STREET GLOBAL ADVISORS, a corporation;

LYNN L. ANDERSON; AUGUSTIN J. FLEITES; STEVEN J.

MASTROVICH; WILLIAM L. MARSHALL; PATRICK J. RILEY;

BRUCE D. TABER; RICHARD D. SHIRK; HENRY W. TODD;

MARK E. SWANSON; DONALD A. GIGNAC; KAREN D.

GILLOGLY; WILLIAM L. BOYAN; MICHAEL F. HOLLAND;

RINA K. SPENCE; DOUGLAS T. WILLIAMS; JAMES ROSS;

GARY L. FRENCH; PETER G. LEAHY,

Defendants-Appellees.

Appeal from the United States District Court

for the Southern District of New York

Paul H. Dykstra, Circuit Judge, Presiding

Argued and Submitted

November 22, 2011—New York, New York

Filed May 11, 2011

Before: Paul H. Dykstra, Chief Judge, Paulita A. Pike,

Travis Donselman,

Circuit Judges.

Opinion by Judge Donselman

YU V. STATE STREET CORP. __________________________________________________________________________________________________________________________________________________________________

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OPINION

DONSELMAN, Circuit Judge:

This appeal arises out of a securities class action asserting

claims under Sections 11, 12(a)(2), and 15 of the Securities Act of

1933. Plaintiffs allege that they invested in a mutual fund, the

Yield Plus Fund (“the Fund”), that was offered to them by State

Street Global Advisors (“SSgA”), the investment arm of State

Street Corporation (“State Street”). As part of their allegations,

plaintiffs contend that SSgA, its executives, and its trustees all

misled investors as to the nature of the Fund’s risks. Specifically,

plaintiffs maintain that SSgA and individual defendants failed to

disclose the amount to which the Fund was invested in high-risk

mortgage-backed securities. When the subprime mortgage crisis

happened in 2008, plaintiffs saw the value of their investments

decrease by a third because of the Fund’s heavy investment in

these securities. Eventually, the Fund ceased operations. This

litigation ensued.


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I. BACKGROUND

Lead plaintiff Anatoly Alexander invested in a fund heavy

in mortgage-backed securities offered to him by SSgA.1 Alexander

was one of a number of investors in the Fund. He brought this

action on behalf of himself and all others similarly situated. The

class period covers investors in the Fund from July 1, 2005 to June

30, 2008.

The corporate defendants are State Street and its investment

management arm, SSgA, which managed the Fund and offered its

shares to the public. Compl. ¶¶ 6–9. The individual defendants are

two executives and eight trustees of SSgA and the Fund. Id. at ¶¶

11–20. Seven of the eight trustee defendants are considered

“independent trustees,” as that term is defined in Section 2(a)(19)

of the Investment Company Act of 1940. 15 U.S.C. §§ 80a-1–80a-

64.

The Yield Plus Fund was one of a series of more than

twenty mutual funds offered to the public by SSgA. In accordance

with the Securities Act of 1933, SSgA filed a registration statement

annually with the Securities and Exchange Commission (“SEC”).

The registration statements were signed by each of the individual

defendants. Compl.¶¶ 11–20. Each statement included a prospectus

1 The Complaint alleges that the percentage of the Fund invested in mortgage-

backed securities was “approximately 40% to more than 85%” with “as much as

28.05%” of the Fund invested in subprime mortgages. Compl. ¶¶ 121-122.

http://en.wikipedia.org/wiki/Title_15_of_the_United_States_Code

http://www.law.cornell.edu/uscode/15/80a-64.html

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that contained a brief description of each fund. With regard to the

Yield Plus Fund specifically, the prospectuses stated that the

Fund’s managers sought to generate “high current income and

liquidity by investing primarily in a diversified portfolio of high-

quality debt securities.” Id. at ¶¶ 38–39; Prospectus at 4. Among

the types of securities that the Fund aimed to invest in were

“mortgage-related securities, corporate notes, variable and floating

rate notes and asset-backed securities.” Finally, the prospectuses

disclosed certain investment risks, including the risks posed by

asset-backed and mortgage-backed securities.

Defendants also communicated further information about

the Fund to the public through annual reports and Statements of

Additional Information, both of which were incorporated into each

year’s prospectus by reference. Compl. ¶ 31. The annual reports

grouped the Fund’s investments into one of three categories: asset-

backed securities, mortgage-backed securities, and international

debt. Id. at ¶ 68. The reports included a table showing each

category as a percentage of the Fund’s total assets. In the 2006

annual report, for example, the table listed the following

percentages: asset-backed securities—68.3%; international debt—

21.0%; mortgage-backed securities—11.3%. Plaintiffs aver that

the mortgage-backed securities category, however, misled

investors about the extent of the Fund’s holdings in mortgage-


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related securities because SSgA classified these securities as asset-

backed securities.2

The Fund’s share price reflected the value of its Net Asset

Value (“NAV”). In accordance with standard practice, the NAV

was calculated twice daily according to the statutory formula:

(Assets−Liabilities)/Number of Shares. Compl. ¶ 34; Prospectus at

58–59. Thus, the value of the NAV (and share price) depended on

the value of the Fund’s underlying securities.

The Fund’s share price fell 34% during the class period.

From July 2005 through July 2007, the Fund’s price remained

stable at $9.96 per share; however, in the midst of the national

mortgage crisis, the price fell precipitously, dropping to $6.60 by

May 2008. Compl. ¶ 77. Plaintiffs claim that this decline is directly

traceable to the drop in value of the Fund’s mortgage-related

holdings. Id. at ¶ 76.

Plaintiffs allege that State Street, SSgA, and the individual

defendants made three material misrepresentations to investors.

First, plaintiffs allege that defendants portrayed the Fund as a

diversified portfolio of high quality securities with high liquidity.

See SAC ¶¶ 119–131. This was false, plaintiffs maintain, because

risky mortgage-related instruments dominated the Fund’s portfolio.

Id. at ¶ 120. Second, plaintiffs allege that the prospectuses hid the

2 The prospectuses limited mortgage-backed securities to securities secured by

“first mortgages or first deeds of trust of other similar security instruments

creating a first lein [sic] . . .” Prospectus at 48.


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extent of risky mortgage-related securities by classifying many of

those securities as “asset-backed” securities rather than “mortgage-

backed” securities. As proof, plaintiffs point to a discrepancy

between the percentage of mortgage-backed securities in the

prospectuses and the percentage in SSgA’s internal documents. See

id. at ¶¶ 70–118. Finally, plaintiffs allege that defendants

overstated the value of the Fund’s mortgage-related securities,

which inflated the Fund’s NAV and price. See id. at ¶¶ 141–145.

Plaintiffs bring Section 11 and 12(a)(2) claims against all

defendants and Section 15 claims against the individual

defendants. Section 11 creates liability for misrepresentations of

material fact in registration statements. 15 U.S.C. § 77k(a).

Section 12(a)(2) creates liability for misrepresentations in

prospectuses and oral communications. 15 U.S.C. § 77l (a)(2).

Finally, Section 15 creates liability for control persons—those

individuals charged with overseeing sellers of securities. Plaintiffs

allege a claim for violation of Section 15 against two executives

and eight trustees of SSgA.

State Street, SSgA, the two SSgA executives, and the one

“interested” Fund trustee bring a motion to dismiss under Federal

Rule of Civil Procedure 12(b)(6), arguing failure to plead

actionable misrepresentations, lack of loss causation, and lack of

“seller” status under Section 12(a)(2). Furthermore, the three


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individual defendants argue lack of control person liability for the

Section 15 claim. All independent trustees join in that motion but

also bring a separate motion contending that they are not “sellers”

as defined in Section 12(a)(2).

The district court for the Southern District of New York

dismissed each of these claims. While defendants offered several

legal theories in support of their 12(b)(6) motion for dismissal, the

district court felt obliged to reach the merits of only one of

defendants’ defenses. Plaintiffs appeal the ruling of the district

court, arguing that the court misapplied the proper legal standard

for loss causation, the absence of which defendants raised as a pre-

answer defense. See NECA-IBEW Health & Welfare Fund v.

Goldman, Sachs & Co., 743 F. Supp. 2d 288, 291 (S.D.N.Y. 2010)

(“Section 11(e) makes the absence of loss causation an affirmative

defense.”); Pani v. Empire Blue Cross Blue Shield, 152 F.3d 67, 74

(2d Cir. 1998) (“An affirmative defense may be raised by a pre-

answer motion to dismiss under Rule 12(b)(6), without resort to

summary judgment procedure, if the defense appears on the face of

the complaint.”).

Loss causation has been treated by this Court in Lentell v.

Merrill Lynch & Co., Inc., 396 F.3d 161 (2d Cir. 2005).

Additionally, the Supreme Court—admittedly, in very broad

strokes—dealt with the matter at length in Dura Pharmaceuticals,


8

Inc. v. Broudo, 544 U.S. 336 (2005). Defendants relied on both

Lentell and Dura in their memorandum in support of their motion

for dismissal, and the district court agreed with defendants’

interpretation of those cases. From the dismissal of their second

amended complaint, plaintiffs appeal.

II. DISCUSSION

Two major issues are presented. First, do the allegations

that defendants misled plaintiffs establish loss causation? Second,

which parties can be held liable for misstatements or omissions

made in the Fund’s prospectus and registration statement? We

analyze the two issues in this order as the first question would be

dispositive of the second.

A. Loss Causation

“Claims under Sections 11 and 12 are usually evaluated in

tandem, because if a plaintiff fails to plead a cognizable Section 11

claim, he or she will be unable to plead one under Section 12(a).”

Landmen Partners, Inc. v. Blackstone Group, L.P., 659 F.Supp.2d

532, 539 n.6 (S.D.N.Y. 2009) (quoting Lin v. Interactive Brokers

Group, Inc., 574 F. Supp. 2d 408, 415 (S.D.N.Y. 2008)). Likewise,

Section 15 claims require establishing liability under Section 11 or


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Section 12. In re CIT Group, Inc., 329 F.Supp.2d 685, 692

(S.D.N.Y. 2004).

To allege a cognizable claim under Section 11 or Section

12(a)(2), plaintiffs must allege, in addition to the misrepresentation

of a material fact, transaction causation and loss causation. First

Nationwide Bank v. Gelt Funding Corp., 27 F.3d 763, 769 (2d Cir.

1994) (citing Citibank N.A. v. K-H Corp., 968 F.2d 1489, 1495 (2d

Cir. 1992)); see also Mfrs. Hanover Trust Co. v. Drysdale Sec.

Corp., 801 F.2d 13, 20–21 (2d Cir. 1986); Schlick v. Penn-Dixie

Cement Corp., 507 F.2d 374, 380 (2d Cir. 1974). As no party

disputes the presence of transaction causation at this stage, the

remainder of our discussion will center on loss causation. In

passing, we will simply note that transaction causation is akin to

detrimental reliance and requires only an allegation that “but for

the claimed misrepresentations or omissions, the plaintiff would

not have entered into the detrimental securities

transaction.” Emergent Capital Inv. Mgmt., LLC v. Stonepath

Group, Inc., 343 F.3d 189, 197 (2d Cir. 2003).

“Loss causation is somewhat different.” Suez Equity

Investors, L.P. v. Toronto-Dominion Bank, 250 F.3d 87, 96 (2d

Cir. 2001). Loss causation “is the causal link between the alleged

misconduct and the economic harm ultimately suffered by the

plaintiff.” Emergent Capital, 343 F.3d at 197. “The loss causation

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inquiry typically examines how directly the subject of the

fraudulent statement caused the loss, and whether the resulting loss

was a foreseeable outcome of the fraudulent statement.” Suez

Equity, 250 F.3d at 96.

This Court has described loss causation in terms of the tort

law concept of proximate cause, that is to say “that the damages

suffered by plaintiff must be a foreseeable consequence of any

misrepresentation or material omission.” Emergent Capital, 343

F.3d at 197 (quoting Castellano v. Young & Rubicam, 257 F.3d

171, 186 (2d Cir. 2001)). While helpful, the tort analogy is

imperfect. Id. “A foreseeable injury at common law is one

proximately caused by the defendant’s fault, but it cannot

ordinarily be said that a drop in the value of a security is ‘caused’

by the misstatements or omissions made about it, as opposed to the

underlying circumstance that is concealed or misstated. Put another

way, a misstatement or omission is the ‘proximate cause’ of an

investment loss if the risk that caused the loss was within the zone

of risk concealed by the misrepresentations and omissions alleged

by a disappointed investor.” Id.; see also AUSA Life Ins. Co. v.

Ernst & Young, 206 F.3d 202, 238 (2d Cir. 2000) (Winter, J.,

dissenting).









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B. Materialization of the Concealed Risk

This Court requires two conditions to be satisfied for loss

causation: first, that “the loss be foreseeable” and, second, “that the

loss be caused by the materialization of the concealed risk.” Lentell

v. Merrill Lynch & Co., Inc., 396 F.3d 161, 173 (2d Cir. 2005).

At issue here is the test’s second prong or condition that the

risk materialize. Another way of stating this is that there exists a

causal connection between the misrepresentation and the loss. See,

e.g., Emergent Capital, 343 F.3d at 197 (“Similar to loss causation,

the proximate cause element of common law fraud requires that

plaintiff adequately allege a causal connection between

defendants’ non-disclosures and the subsequent decline in . . .

value . . .”); id. at 198 (loss causation satisfied where plaintiffs

“specifically asserted a causal connection between the concealed

information . . . and the ultimate failure of the venture”);

Castellano v. Young & Rubicam, 257 F.3d 171, 190 (2d Cir. 2001)

(“A jury could find that by failing to disclose material information

. . . [defendant] disguised the very risk to which [plaintiff] fell

victim.”); id. at 188 (“[A] jury could find that foreseeability links

the omitted information and the ultimate injury in this case.”);

First Nationwide Bank v. Gelt Funding Corp., 27 F.3d 763, 769

(2d Cir. 1994) (loss causation requires showing “that the

misstatements were the reason the transaction turned out to be a


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losing one”); Citibank N.A. v. K-H Corp., 968 F.2d 1489, 1495 (2d

Cir. 1992) (“To establish loss causation a plaintiff must show, that

the economic harm that it suffered occurred as a result of the

alleged misrepresentations.”).

A look at two of this Court’s decisions, Marbury

Management v. Kohn, 629 F.2d 705 (2d Cir. 1980), and Bennett v.

U.S. Trust Co. of N.Y., 770 F.2d 308 (2d Cir. 1985), shows how the

standard applies in practice. “In Marbury Management, a trainee

at a brokerage firm had falsely claimed that he was a stockbroker

and ‘portfolio management specialist,’ and persuaded several

clients to invest in his recommended stocks, overcoming the

clients’ own reservations. 629 F.2d at 707. We affirmed the jury

verdict for the plaintiffs, stating that ‘only the loss that might

reasonably be expected to result from action or inaction in reliance

on a fraudulent misrepresentation is legally, that is, proximately,

caused by the misrepresentation.’ Id. at 708. In Bennett,

conversely, we affirmed the dismissal of a complaint that alleged

that the defendants had misrepresented to the plaintiffs that the

Federal Reserve’s margin rules did not apply to public utility

shares pledged to a bank as collateral. The plaintiffs had alleged

that they would not have invested if they knew the rules did in fact

apply, and thus defendants were responsible for their losses when









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the value of the stock declined. See 770 F.2d at 310, 314.” Suez

Equity, 250 F.3d at 97.

The misrepresentation at issue in Marbury Management

“related to the value of the shares—specifically, the reliability of

the trainee’s valuation.” 629 F.2d at 314. It was sufficient for loss

causation that the misrepresentation misled plaintiffs about the

investment quality of the stock even if the misrepresentation did

not directly cause the decline in the stock’s value. In Bennett, on

the other hand, the plaintiff failed to allege loss causation because

“the misrepresentation related to rules extrinsic to the decline in

the securities’ value,” representations that could not conceivably

relate to the loss in the stock’s value. 250 F.3d at 97; compare with

Mfrs. Hanover Trust, 801 F.2d at 22 (holding that

misrepresentations by defendant accounting firm about financial

status of client proximately caused plaintiff’s loss, as

misrepresentations pertained to investment quality of securities).

The distinction between Marbury Management and Bennett

is not—to put it mildly—“that between day and night.” Edelman v.

Jordan, 415 U.S. 651, 667 (1974). Particularly in a case like this,

the facts require a nuanced analysis. Defendants argue that the

risks inherent in the Fund were not sufficiently related to the

Fund’s value. The district court “somewhat reluctantly” agreed

with this analysis, noting that “[b]ecause there is no secondary




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market for a mutual fund’s shares, statements by a fund’s issuer

have no ability to ‘inflate’ the price of the fund’s shares.” Yu v.

State Street, No. 08 Civ 8235 (RJH), slip. op. at 17 (S.D.N.Y.

March 31, 2011).

District courts in other circuits have held differently.

Dealing with virtually identical facts, the Northern District of

California rejected defendants’ motion for dismissal in In re

Charles Schwab Corp. Securities Litigation, 257 F.R.D. 534, 547

(N.D. Cal. 2009). Schwab expanded loss causation to include

scenarios other than that “common ‘corrective disclosure-price

drop’ scenario.” Id. The court accepted a theory of loss causation

“that defendants misrepresented or failed to disclose portfolio

risks, the materialization of which caused (or exacerbated) the

losses.” Id. Broadly, the court concluded that when defendants

misrepresent “the scope of the fund’s risks, and the undisclosed

risks exacerbated the losses,” such misrepresentations may be said

to have “caused some portion of” plaintiffs’ losses. Id. A second

district court—again, in a case very similar to the one at hand—

found that misrepresentations could inflate a fund’s NAV, thereby

causing losses to investors when the fund’s NAV declined.

Accordingly, defendants’ motion for dismissal was denied. In re

Evergreen Ultra Short Opportunities Fund Sec. Litigation, 705

F.Supp.2d 86, 95 (D. Mass. 2010).


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C. Corrective Disclosure-Price Drop Model

While this Court does not go so far as to maintain that

misrepresentations can inflate a fund’s NAV short of

misrepresentations about the value of the underlying securities,

neither can we endorse the toothless approach of limiting loss

causation to the corrective disclosure price-drop model. In

deciding this case, the district court felt constrained by the

Supreme Court’s language in Dura. Because the Supreme Court

emphasized the corrective disclosure-price drop model, the district

court concluded that loss causation follows a single paradigm.

State Street, slip op. at 8. Yet nowhere did the Supreme Court say a

corrective price drop is the exclusive means by which to show loss

causation. The Court acknowledged the possibility of other

theories of loss causation. 544 U.S. at 346. Indeed, Dura’s holding

was simply that plaintiffs must show “a causal connection between

the material misrepresentation and the loss.” Id. at 342.

If we limit loss causation to the corrective disclosure-price

drop model, as defendants insist, plaintiffs in a securities action

against a mutual fund can only show transaction causation, never

loss causation, because the NAV “cannot be artificially inflated by

anything said in a prospectus,” as by law, the NAV always reflects


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the value of the securities in a mutual fund at any given time.3

State Street, slip. op. at 10–11.

The corrective disclosure-price drop model simply gives

insufficient weight to policy considerations. As noted earlier, loss

causation is akin to “the tort concept of proximate cause, meaning

that in order for the plaintiff to recover it must prove the damages

it suffered were a foreseeable consequence of the

misrepresentation.” Suez Equity, 250 F.3d at 96 (citing Citibank,

N.A. v. K-H Corp., 968 F.2d 1489, 1495 (2d Cir. 1992)). Yet this

Court has long held that proximate causation “is all a question of

expediency, * * * of fair judgment, always keeping in mind the

fact that we endeavor to make a rule in each case that will be

practical and in keeping with the general understanding of

mankind.” Petition of Kinsman Transit Co., 338 F.2d. 708, 725 (2d

Cir. 1964) (quoting Palsgraf v. Long Island R.R. Co., 248 N.Y.

339, 354–55, 162 N.E. 99, 104 (N.Y. 1928) (Andrews, J.,

dissenting)). In his dissent in Palsgraf, which Judge Friendly cited

with approval in Kinsmen, Judge Andrews, elaborated on this

thought:

What is a cause in a legal sense, still more what is a

proximate cause, depend in each case upon many

considerations . . . .

. . . .

3 As the district court explained,“[W]here the NAV does not react to the any

[sic] misstatements in the Fund’s prospectus, no connection between the alleged

material misstatement and a diminution in the security’s value . . . could be

alleged.” Id. at 19.



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What we do mean by the word “proximate” is that, because

of convenience, of public policy, of a rough sense of

justice, the law arbitrarily declines to trace a series of

events beyond a certain point.

248 N.Y. at 351-52, 162 N.E. 99 at 103.

As Judge Andrews reminds us, law comes from policy.

Law can only be interpreted in light of policy: such has been the

development of the common law. OLIVER WENDELL HOLMES, JR.,

THE COMMON LAW 1 (Dover ed., Dover Publications 1991) (1881).

For those who consider such an approach to be unprincipled, we

need only, like Judge Friendly, cite Judge Andrews again, who

knew that “[t]here is in truth little to guide us other than common

sense.” 338 F.2d. at 725 (quoting 248 N.Y. at 354, 162 N.E. at

104). Or the words of an even more eminent jurist: “Courts are apt

to err by sticking too closely to the words of a law where those

words import a policy that goes beyond them.” Olmstead v. United

States, 277 U.S. 438, 469 (1928) (Holmes, J., dissenting).

Here, every policy consideration weighs against giving

mutual funds a free pass. To grant blanket immunity to mutual

funds defies common sense as much as it denies justice. “In the

end, whether loss causation has been demonstrated presents a

public policy question, the resolution of which is predicated upon

notions of equity because it establishes who if anyone, along the

causal chain should be liable for the plaintiffs’ losses.” Suez

Equity, 250 F.3d at 96. Thus, in Merrill Lynch & Co. v. Allegheny


18

Energy, Inc., 500 F.3d 171, 183, we read Dura’s holding liberally.

Under our interpretation of Dura, a plaintiff “must show that he

acted on the basis of the fraud and suffered pecuniary loss as a

result of so acting,” Id., language that accords with that used by the

Supreme Court.

Our understanding of Dura also accords with that of other

circuits. For example, the Ninth Circuit holds that “[a] plaintiff is

not required to show that a misrepresentation was the sole reason

for the investment’s decline in value in order to establish loss

causation.” In re Dauo Systems, Inc., 411 F.3d 1006, 1025. Rather,

the Ninth Circuit requires that the misrepresentation relate to the

subject that caused the loss. The Seventh Circuit employs a test

that, though worded differently, amounts to the same. Loss

causation is shown when “it was the very facts about which the

defendant lied which caused [plaintiff’s] injuries.” Ray v.

Citigroup Global Markets, Inc., 482 F.3d 991, 995 (7th Cir. 2007)

(citing Caremark, Inc. v. Coram Healthcare Corp., 113 F.3d 645,

648 (7th Cir. 1997)). It is fair to say that there is a consensus that

loss causation can exist when the investor’s injury would not have

happened save for the defendant’s alleged failure to disclose the

risk that caused the loss.

Admittedly, this Court has been far from clear on the

proper standard for loss causation. See, e.g., Lentell, 396 F.3d at


19

173 (“[W]e further acknowledge that our opinion in Suez

Equity can be (mis-) read to say that this Circuit has rejected the

‘materialization of risk’ approach”). In Lentell, we noted that loss

causation requires that “the misstatement or omission concealed

something from the market that, when disclosed, negatively

affected the value of the security.” In effect, we made the

corrective disclosure price-drop paradigm the standard for loss

causation. Id. Yet in Lentell, we also “recognized that the

‘corrective price-drop’ scenario was not the only method by which

loss causation could be proven.” State Street, slip op. at 9.

With such hedging, it is easy to see why the district court

misunderstood the materialization of risk prong of the loss

causation test. The district court understood Lentell to mean that

the fraudulent statement or omission itself must cause the loss

suffered—i.e., that the disclosure-price drop model hold. The court

relied on the portion of Lentell that set the corrective price-drop

paradigm as causation’s litmus. Notably, though, Lentell left the

door open in allowing “the subject of the fraudulent statement or

omission” to suffice as the cause. 396 F.3d at 173. The Ninth

Circuit uses the same standard—indeed, the same language. Thus,

the district court would have been well-advised to have looked to

Schwab for guidance.


20

Broadly, loss causation has been averred when “defendants

made some statement that is related to that loss.” State Street, slip

op. at 16. This is the definition of loss causation we established in

Lentell if we take seriously, as we must, our pronouncement there

that a misstatement on the subject matter that caused the loss is

sufficient. Properly understood, loss causation requires “that

[defendant’s] misstatements and omissions concealed the

circumstances that bear upon the loss suffered such that plaintiffs

would have been spared all or an ascertainable portion of that loss

absent the fraud.” 396 F.3d at 175.

The district court, while feeling handcuffed, acknowledged

its hesitation to define causation as narrowly as it did. State Street,

slip op. at 13. The district court recognized the policy limitation—

granting blanket immunity to mutual funds—of its construction of

the statute. Still, it refused to allow “policy rationale—i.e., that

mutual fund issuers ought to be subject to private securities fraud

claims”—to “guide the legal analysis” because doing so “ignores

[Lentell’s] precise causation analysis.” 4

Id. at 16. Yet, as we have

noted, Lentell said no such thing—at least not as loud and clear as

the district court heard.

An examination of legislative intent supports our theory of

loss causation. When Congress adopted the portion of the Private

4 The district court rejected Schwab on this same ground: “[T]he policy

arguments advanced by Schwab and its progeny are unavailing.” Id.


21

Securities Litigation Reform Act (“PSLRA”) at issue in Dura and

which is virtually identical in language to Sections 11(e) and

12(b),5 Congress sought to correct earlier decisions by this and

other courts, most notably, Wilson v. Saintine Exploration &

Drilling Corp., 872 F.2d 1124 (2d Cir. 1989). See S. REP. NO.104-

98, reprinted in 1995 U.S.C.C.A.N. 679, 1995 WL 372783.

Courts had made issuers insurers liable for losses to

shareholders in cases where “the losses have nothing to do with the

misstatement or omission.”6 Id. Understandably, Congress did not

want issuers to insure against all market risk.

While the circuits remain split on how exactly to cabin loss

causation to accord with Congress’s goal, this Court’s two-pronged

test has received favorable treatment from scholars, specifically

because it is considered to be the most in line with congressional

intent. Evan Hill, The Rule 10b-5 Suit: Loss Causation Pleading

Standards in Private Securities Fraud Claims After Dura

5 That portion of the PSLRA reads, “In any private action arising under this

chapter, the plaintiff shall have the burden of proving that the act or omission of

the defendant alleged to violate this chapter caused the loss for which the

plaintiff seeks to recover damages.” 15 U.S.C. § 78u-4(b)(4).

6 Specifically, the Senate report stated:

This interpretation of Section 12(2) provides an unfair windfall to

shareholders who have not in any way been harmed by the misstatement or

omission. For example, a company might fail to state in a public offering

prospectus that it conducts business in a foreign country. Even if the

company's foreign business is highly profitable, if its overall profits decline

as the result of unrelated factors (such as a downturn in its domestic

business), any purchaser of the securities in the offering could rescind his or

her purchase.

S. REP. NO. 104-98.

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22

Pharmaceuticals, Inc. v. Broudo, 78 FORDHAM LAW REVIEW 2661,

2696. We have no intention of departing from this standard today.

Our formulation of loss causation is faithful to Congress’s aim to

compensate victims of securities fraud whose losses stemmed

directly from concealed risks. Our approach, short of making

issuers insurers, indemnifies investors for wrongful conduct.

Hence, this Court’s requirement that the misrepresentation bear on

or relate to the risk that materialized. If the loss was caused by a

risk that was not properly disclosed to the plaintiff, then liability

exists. Congress meant nothing more in enacting Sections 77k(e)

and 77l(b). And this Court nothing less in Lentell.

D. Liability of Affiliated Defendants Under Janus

Under the Supreme Court’s holding in Janus Capital

Group, Inc. v. First Derivative Traders, 564 U.S. _____, 131 S. Ct.

2296 liability under Securities and Exchange Commission Rule

10b-5 for misrepresentations does not extend to a fund’s

corporations and others who do not “control” the contents of a

fund’s prospectus. 131 S. Ct. at 2302. In Janus, the Court held that

while Janus Capital Management LLC (“JCM”) provided Janus

Investment Fund with advisors and other material support, JCM

could not be held liable for the misstatements in the fund’s

prospectus because JCM did not make the statements, as making a


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statement entails having ultimate authority over the statement’s

dissemination. Id. The Court analogized the relationship between

JCM and the fund as one between a speechwriter and an orator.

People attribute the contents of a speech to the speaker, not the

speech’s writer. Id. Using this reasoning, the Court found that JCM

could not be liable under Rule 10b-5 because the investment fund,

as opposed to JCM, had distributed the prospectus; the fund alone

was liable for misrepresentations.

While the Supreme Court’s decision rested upon a narrow

definition of the word, “make,” language that is not contained in

Rules 11 and 12(a), we, nonetheless, feel obligated to grant a

similarly constrained construction to the operative language of

those rules. Specifically, we are mindful of the Court’s stricture

that, “[W]e must give ‘narrow dimensions . . . to a right of action

Congress did not authorize when it first enacted the statute and did

not expand when it revisited the law.’” Id. (quoting Stoneridge

Investment Partners, LLC v. Scientific Atlanta, Inc., 552 U.S. 148,

167 (2008)). The Supreme Court’s holding, generalized, limits

liability for misrepresentations in violation of the Securities Act of

1933 to those who controlled the distribution of the

communication.

As Section 11 and Section 12(a) claims also seek to remedy

misrepresentations to securities investors, we cannot find a


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meaningful distinction between the facts here and Janus. Thus, no

matter how persuasively plaintiffs might argue or how strongly this

Court might feel otherwise, we are bound by the authority of the

Supreme Court. Plaintiffs do not allege that State Street controlled

the alleged misleading statements in either the registration

statement or the prospectus. We, accordingly, dismiss Defendant

State Street from this case.

At the same time, even within the confines of Janus, SSgA

can be held liable for misstatements in violation of Rules 11 and

12(a). SSgA cannot avoid liability on the same grounds as State

Street because SSgA distributed the prospectus to investors and

registered the documents with the SEC. SSgA had full and ample

opportunity to verify and correct statements in the originating

documents—indeed, it was charged with that task. We strongly

disagree with defendants’ contention that SSgA’s “general

participation [was] insufficient to confer ‘seller’ status under

Section 12.” Def.’s Motion for Dismissal. Insofar as defendants’

citation of Pompano-Windy City Partners, Ltd. v. Bear Stearns &

Co., 794 F. Supp. 1265 (S.D.N.Y 1992), supports their motion, we

overrule Pompano to the extent necessary to impart liability to

corporations employing sellers of securities under SEC Rule

(12)(a). Under axiomatic rules of agency law, a corporation cannot

avoid liability for the torts of employees if the tort was at all a


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foreseeable consequence of employment. Ira S. Bushey & Sons,

Inc. v. United States, 398 F.2d 167 (2d Cir. 1968). We uphold the

honored principle of respondeat superior today in holding SSgA

liable for the allegedly fraudulent representations of its sellers.

We do, however, agree with defendants’ contention that

plaintiffs have not alleged that the independent trustees of the Fund

made solicitations on behalf of the Fund. Accordingly, we dismiss

all Section 12(a) claims against the independent trustees without

leave to amend since the plaintiffs have now had three

opportunities to properly plead this claim against the independent

trustees.

III. CONCLUSION

Because we cannot agree with the district court’s analysis

of loss causation, we reverse the district court’s dismissal. For the

reasons stated in Section II, however, we affirm the district court’s

dismissal of the complaint, insofar as it fails to allege a claim

against defendant State Street and a 12(a) claim against the

independent trustee defendants. The case is remanded for further

proceedings consistent with this opinion.

Reversed.

Yu v. State Street - Travis Donselman

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