Set Capital LLC v. Credit Suisse Grp. AG

996 F.3d 64

SET CAPITAL LLC, Stefan Jager, Nikolay Drozhzhinov, Aleksandr Gamburg, ACM, Ltd., Lead Plaintiffs-Appellants,

Rajan Chahal, individually and on behalf of all others similarly situated, Shaolei Qiu, Glenn Eisenberg, Plaintiffs,

v.CREDIT SUISSE GROUP AG, David R. Mathers, Tidjane Thiam, Credit Suisse AG, Credit Suisse International, Janus Henderson Group PLC, Janus Index & Calculation Services LLC, Janus Distributors, LLC, dba Janus Henderson Distributors, Defendants-Appellees.

No. 19-3466-cv

August Term, 2019

United States Court of Appeals, Second Circuit.

Argued: April 30, 2020

Decided: April 27, 2021

Michael Eisenkraft (Laura H. Posner, Carol V. Gilden, and Eric S. Berelovich, on the brief), Cohen Milstein Sellers & Toll PLLC, New York, New York, for Appellants Set Capital LLC, Stefan Jager, Nikolay Drozhzhinov, Aleksandr Gamburg, and ACM, Ltd.

Herbert Scott Washer (David G. Januszewski, Nola B. Heller, Peter J. Linken, on the brief), Cahill Gordon & Reindel LLP, New York, New York, for Appellees Credit Suisse Group AG, Credit Suisse AG, Credit Suisse International, Tidjane Thiam, and David R. Mathers

Jason M. Halper (Jared J. Stanisci, Gillian Groarke Burns, Tianyin Luo, Victor M. Bieger, on the brief), Cadwalader, Wickersham & Taft LLP, New York, New York, for Appellees Janus Henderson Group PLC, Janus Index & Calculation Services LLC, and Janus Distributors, LLC

Before: Walker, Pooler, and Lynch, Circuit Judges.

John M. Walker, Jr., Circuit Judge:

Set Capital LLC, Stefan Jager, Nikolay Drozhzhinov, Aleksandr Gamburg, and ACM, Ltd. (collectively, Set Capital) brought this securities class action lawsuit against Credit Suisse Group AG, Credit Suisse AG, and Credit Suisse International (collectively, Credit Suisse); Credit Suisse's CEO Tidjane Thiam and CFO David R. Mathers (together, the Individual Defendants); and Janus Henderson Group PLC, Janus Index & Calculation Services LLC, and Janus Distributors, LLC, doing business as Janus Henderson Distributors (collectively, Janus). Set Capital principally alleges that, on February 5, 2018, Credit Suisse, Janus, and the Individual Defendants executed a complex fraud to collapse the market for VelocityShares Daily Inverse VIX Short Term Exchange Traded Notes (XIV Notes), earning hundreds of millions of dollars in profit at their investors’ expense. The district court (Torres, J. ) dismissed the complaint for failure to plead a strong inference of scienter. For the reasons that follow, we AFFIRM in part and VACATE and REMAND in part.

BACKGROUND

This appeal stems from the February 5, 2018 collapse of the market for certain investment vehicles called XIV Notes. XIV Notes were a derivative financial product that increased in value when the market was calm and decreased in value when the market was volatile. The notes were issued by Credit Suisse and priced based on the inverse of a volatility index called the S&P 500 VIX Short-Term Futures Index (VIX Futures Index).

This case concerns Set Capital's allegation that, after observing prior episodes of market volatility, Credit Suisse discerned an ability to depress prices for XIV Notes by purchasing VIX futures contracts on days when volatility spiked. In essence, Set Capital claims that Credit Suisse used this knowledge as part of a scheme to sell millions of XIV Notes before engineering a near-total collapse in their price through just 15 minutes of its own trading. Set Capital further alleges that Janus, although not directly involved in this manipulative scheme, exacerbated the damage by failing to publish accurate prices for XIV Notes during the window of time when the value of those notes collapsed. The complaint alleges that the scheme cost investors $1.8 billion while at the same time allowing Credit Suisse to realize more than $475 million in gains.

In the background section that follows, we explain in detail: (1) the characteristics of XIV Notes, including their relationship to the VIX Futures Index; (2) the way Credit Suisse's trading impacted prices for XIV Notes during prior episodes of market volatility; (3) the extent to which Credit Suisse and Janus warned investors about risks of investing in XIV Notes; and (4) the remarkable collapse of XIV Notes following significant volatility on February 5, 2018. As always at this stage of the litigation, we draw our discussion of the facts from the complaint, which must be taken as true.¹

1. The Characteristics of XIV Notes

XIV Notes were Exchange Traded Notes (ETNs) issued and sold by Credit Suisse and placed and marketed by Janus. The notes were traded on NASDAQ and were related to the Chicago Board Options Exchange's VIX Index (VIX Index). The VIX Index is not an asset, but rather a measure of expected volatility in the stock market. When the market expects higher volatility, the VIX Index increases. When the market expects lower volatility, the VIX Index decreases. Because it measures expected swings in the market, the VIX Index is sometimes referred to as Wall Street's "fear index" or "fear gauge."²

Although the VIX Index is not a tradable asset, investors may take a position on future levels of market volatility by purchasing futures contracts on the VIX Index.³ When viewed in the aggregate, the prices of these futures contracts provide a window into whether investors expect market volatility to rise or fall over a specified period of time. To help investors digest this information, S&P created the S&P 500 VIX Short-Term Futures Index (VIX Futures Index), which tracks a portfolio of short-term futures contracts on the VIX Index.

The XIV Notes at issue in this case were designed to track the inverse (or opposite) of the VIX Futures Index. This inverse relationship between XIV Notes and the VIX Futures Index meant that investors in XIV Notes would profit from low volatility in the stock market. As market volatility declined and prices underlying the VIX Futures Index decreased, the value of XIV Notes would increase by an equivalent amount. The converse, of course, was also true. As market volatility increased and prices underlying the VIX Futures Index rose, the value of XIV Notes would decline proportionally.

In the event of early redemption, acceleration, or maturity of the XIV Notes, Credit Suisse agreed to pay noteholders based on the notes’ "closing indicative value." An affiliate of Janus, Janus Index & Calculation Services LLC (JIC), calculated the closing indicative value at the end of each trading day using a formula that automatically adjusted the notes’ value based on the inverse of price changes observed on the VIX Futures Index.⁴ Because the closing indicative value was calculated only once each day, JIC also computed an "intraday indicative value" every 15 seconds, which was used by investors trading their notes in the secondary market.⁵ JIC used the same formula to automatically calculate this value, which was promptly distributed by NASDAQ. Although the intraday indicative value reflected only a theoretical price for XIV Notes, the secondary market price tracked the intraday indicative value on a typical day.

To receive a payment from Credit Suisse based on the closing indicative value, XIV noteholders could redeem their notes early or attempt to hold their notes through maturity. But noteholders could not fully control the timing of their notes’ redemption: As disclosed to investors, Credit Suisse could accelerate the redemption of all XIV Notes either at its option or upon the occurrence of one or more pre-defined "Acceleration Events."⁶ If Credit Suisse accelerated the notes at its option, noteholders would receive a payment based on the closing indicative value on a predetermined date no earlier than five business days after receiving notice of the acceleration. If Credit Suisse declared an Acceleration Event, noteholders would receive a payment based on the closing indicative value on the day the acceleration was declared. As relevant here, one Acceleration Event would occur if, at any point, the intraday indicative value of the XIV Notes fell such that it was less than or equal to 20 percent of the prior day's closing indicative value.⁷

2. Prior Episodes of Market Volatility Impacting XIV Notes

Due to sustained periods of stability in the market, XIV noteholders for the most part saw the value of XIV Notes climb from 2010 until 2018. On three occasions in 2011, 2015, and 2016, however, significant episodes of market volatility caused the value of VIX futures contracts to spike and, correspondingly, the value of XIV Notes to drop. During these three volatility spikes, Credit Suisse, as well as other issuers of volatility-related ETNs, bought large quantities of VIX futures contracts, which were increasing in value, in order to offset or "hedge" against potential losses in the ETNs they issued, which were decreasing in value.⁸ Each time they attempted to do so, however, there was insufficient liquidity in the VIX futures market—that is, not enough VIX futures contracts to meet the hedging demand. As a result of this liquidity squeeze, Credit Suisse's hedging purchases caused the price of VIX futures contracts to spike over and above what would have been expected based on market volatility alone. At the same time, these spikes caused the value of XIV Notes—the inverse of the VIX Futures Index—to temporarily plummet.

Pursuant to Credit Suisse's internal risk protocols, all three of these liquidity incidents were promptly reported to Credit Suisse's Capital Allocation and Risk Management Committee (CARMC), of which the Individual Defendants were members. In response, Credit Suisse sought alternative ways to hedge its own exposure to XIV Notes. On July 1, 2016, Credit Suisse announced (July 2016 Announcement) that it may condition all future sales of XIV Notes on the counterparty's agreement "to sell to Credit Suisse certain hedging instruments consistent with Credit Suisse's hedging strategy, including but not limited to swaps."⁹

Following the ...