This post comes to us from David M. Geffen, Counsel at Dechert LLP who specializes in working with investment companies and their investment advisers. This post is based on a Dechert memorandum by Mr. Geffen, William K. Dodds, Matthew L. Larrabee and Grace M. Guisewite. The post relates to the decision in the case of Yu v. State Street Corp., which relies in part on certain arguments set forth in an article by Mr. Geffen which was described in this post.
In a decision that could sharply curtail the potential liability of mutual funds and their advisers and directors for non-fraudulent prospectus misrepresentations, on March 31, 2011, the U.S. District Court for the Southern District of New York dismissed a putative class action arising out of the precipitous decline in the share price of a mutual fund during the 2007 and 2008 credit crisis. [1] The plaintiffs asserted claims under §§ 11 and 12(a)(2) of the Securities Act of 1933 (Securities Act), alleging that the prospectus for the SSgA Yield Plus Fund misrepresented the Fund’s exposure to mortgage-related securities.
The court rejected the plaintiffs’ claims on loss causation grounds. The measure of permissible damages under §§ 11 and 12(a)(2) is limited to the decline in a security’s value that results from the revelation of the artificial inflation of the security’s purchase price by a misrepresentation. Because the only price at which a mutual fund may sell or redeem its shares is determined by a statutory formula based on the net asset value (NAV) of the securities owned by the fund, prospectus misrepresentations cannot inflate a fund’s NAV nor, upon revelation, cause the NAV to decline. Accordingly, the court found that the plaintiffs’ complaint failed to allege the requisite loss causation and, therefore, dismissed the action with prejudice.
