The United States Court of Appeals for the Second Circuit recently reversed a decision of the Southern District of New York denying class plaintiffs leave to replead their dismissed securities fraud complaint against an investment fund. Specifically, Judge Leval revived plaintiffs' claim that defendants misleadingly represented that hedging techniques would in fact be available to the fund. The "bespeaks caution" doctrine, the court held, was not applicable because "the prospectuses warned that the fund's hedging maneuvers might fail, not that the fund would have no opportunity to use hedging maneuvers."
The plaintiffs in the action were a class of shareholders in Alliance North American Government Income Trust, Inc. (the "Fund"), an open-ended mutual fund that was formed to invest in a portfolio of debt securities issued or guaranteed by the governments of the United States, Canada, Mexico and other Central and South American countries. After the Mexican government devalued the peso in December 1994, the peso fell rapidly against the dollar, and investors began selling off large quantities of Mexican and other Central and South American securities, and the value of the Fund plummeted dramatically.
Plaintiffs filed suit in the Southern District of New York, alleging that the Fund had falsely represented in its registration statements and prospectuses that it would use hedging techniques, including options and futures contracts, to protect its assets from fluctuations in currency exchange rates. The District Court dismissed the complaint, stating that "due to the explicit warning of such devices' possible unavailability and ineffectiveness, any misstatements or omissions were immaterial as a matter of law." The District Court also denied plaintiff's motion for leave to replead, finding the claim legally insufficient in light of the fact that defendants had explicitly warned investors that "no assurance can be given that the Fund will be able to utilize these instruments effectively for the purposes set forth [in the prospectus]."
The Second Circuit reversed. According to the Second Circuit, the statements in the prospectuses, namely, (i) that hedging devices could reduce the impact of currency fluctuations, (ii) that the Fund intended to use such devices, and (iii) a ten-paragraph discussion of the numerous hedging devices that were available to the Fund, "taken together and in context, would have misle[d] a reasonable investor" to understand that the hedging devices were available and would be used to reduce the risk of currency fluctuations, even if such devices would have been ineffectual. By alleging that the Fund managers knew or recklessly disregarded that these hedging devices were not available because they were too costly to use, the court held that the plaintiffs had stated an actual claim for misrepresentation.
The Second Circuit also rejected defendants' assertion that the prospectuses "bespoke caution" by warning that the hedging devices might fail. According to the court, the cautionary language contained in the prospectus "d[id] not necessarily foreclose liability because it warned investors of a different contingency than that which plaintiffs allege was misrepresented." Because a reasonable investor could have been mislead by the prospectuses, and would have considered the availability of hedging devices important in deciding whether to purchase Fund shares, the Second Circuit concluded that the proposed amended complaint stated a claim for which relief could be granted, and reversed the district court's order denying leave to replead this claim.
Hunt v. Alliance North American Government Income Trust, Inc., 159 F.3d 723 (2d Cir. 1998).
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