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ETF Plaintiffs Find No Footing For Pursuit Of '33 Act Claims In California Court

Section 11 of the Securities Act is an anti-fraud statute.  Like its Exchange Act cousin, Section 10(b), Section 11 requires (i) an omission or misrepresentation, and (2) that the omission or misrepresentation be material, that is, it would have misled a reasonable investor about the nature of his or her investment.  Section 11 offers two significant advantages for plaintiffs: (i) the is no requirement to allege scienter on the part of the defendant; and (ii) the claims may be brought in state or federal court. 

These advantages, however, are tempered by a strict tracing requirement.  The plaintiffs must be able to trace their securities to the registration containing the alleged omission or misrepresentation.  This tracing requirement does not automatically exclude purchasers in the secondary market, but it becomes a real problem when the after-market becomes "tainted" with securities that were issued in exempt offerings or multiple registration statements.

Last Friday, a California Court of Appeal applied the tracing requirement to offerings of Exchange Traded Shares (ETFs) issued by an open-end management investment company under the Investment Company Act of 1940 (ICA).  Jensen v. iShares Trust, 2020 Cal. App. LEXIS 61.  The plaintiffs argued that that the tracing requirement did not deprive them of standing under section 11 because the issuer is governed by the ICA and, under section 24(e) of the ICA.  Both the trial court and and the Court of Appeal disagreed, finding that Section 24(e) "does not appear to have been intended to expand standing under the 1933 Act and certainly could not have been enacted with secondary market transactions in mind".   The Court supports its conclusion with a thorough discussion but alas hanc marginis exiguitas non caperet.

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About this Author

Keith Paul Bishop, Corporate Transactions Lawyer, finance securities attorney, Allen Matkins Law Firm

Keith Paul Bishop is a partner in Allen Matkins' Corporate and Securities practice group, and works out of the Orange County office. He represents clients in a wide range of corporate transactions, including public and private securities offerings of debt and equity, mergers and acquisitions, proxy contests and tender offers, corporate governance matters and federal and state securities laws (including the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Act), investment adviser, financial services regulation, and California administrative law. He regularly advises clients...