Youngers v. Virtus Inv. Partners Inc.

195 F.Supp.3d 499

Mark YOUNGERS, et al., individually and on behalf of all others similarly situated, Plaintiffs,

v.VIRTUS INVESTMENT PARTNERS INC., et al., Defendants.

15cv8262

United States District Court, S.D. New York.

Signed July 1, 2016

Laurence M. Rosen, Jonathan Stern, Laurence Matthew Rosen, The Rosen Law Firm, P.A., New York, NY, for Plaintiffs.

Joseph Michael McLaughlin, Daniel Joseph Stujenske, Shannon Kyle McGovern, Simpson Thacher & Bartlett LLP, Beth Kressel Itkin, Paul W. Ryan, Serpe Ryan LLC, Aric Hugo Wu, Gibson, Dunn & Crutcher, LLP, New York, NY, Michael David Kibler, Simpson Thacher & Bartlett LLP, Michael R. Matthias, Baker Hostetler LLP, Los Angeles, CA, Geoffrey Hunter Coll, Baker & Hostetler LLP, New York City, NY, Alexandra G. Watson, Anthony E. Fuller, Justin P. O'Brien, Collora LLP, Boston, MA, for Defendants.

OPINION & ORDER

WILLIAM H. PAULEY III, District Judge:

Lead Plaintiffs Mark Youngers, et al.("Plaintiffs"), bring this securities class action on behalf of themselves and others who purchased various mutual funds issued by Virtus Opportunities Trust ("Virtus Trust") between May 8, 2010 and December 22, 2014. Plaintiffs also bring shareholder derivative claims under Delaware law. Defendants Virtus Investment Partners, Inc. ("Virtus Partners"), et al., move to dismiss the Second Amended Class Action Complaint ("Complaint"). Defendants' motions to dismiss are granted in part and denied in part.

BACKGROUND

The allegations in the Complaint are presumed to be true for purposes of this motion. In 2008, defendant Howard Present, founder of defendant F-Squared Investments, Inc. ("F-Squared") began to market an investment strategy called AlphaSector. Present claimed that AlphaSector had outperformed the S&P 500 index over the long term and avoided most of the investor losses stemming from the 2002 bear market and the 2008 financial crisis. (Complaint ¶ 4.) But AlphaSector was not created until 2008, when the algorithm for that strategy was formulated by a 20-year old college intern. (Complaint ¶ 4.) To conceal this fact, F-Squared ran a simulation called a "back-test" showing how the strategy would have performed between 2001 and 2008 had it been in existence. (Complaint ¶ 4.) The back-tested results were reported as if they were achieved through live trading with real client assets in two indices: the AlphaSector Rotation Index and the Premium AlphaSector Index (the "AlphaSector Indices" or the "Indices"). (Complaint ¶ 51.) A comparison of the Indices to the S&P 500 showed great results for the AlphaSector strategy. For instance, between 2001 and 2010, the AlphaSector Premium Index purportedly returned 198%, while the S&P 500 only returned 13.5%. (Complaint ¶ 55.)

In 2009, Present pitched the AlphaSector strategy to Virtus Partners, the parent company of Virtus Trust's investment adviser, Virtus Investment Advisers, Inc. ("Virtus Advisers"), claiming that it had "consistently outperformed the benchmark S&P 500 since its inception in April, 2001." (Complaint ¶ 48.) Later that year, Virtus Advisers retained F-Squared as a sub-adviser, and Virtus Trust offered two mutual funds: the Virtus Dynamic AlphaSector Fund and the Virtus AlphaSector Rotation Fund. As a result of the initial success of those mutual funds, Virtus Trust offered three more: the Virtus Premium AlphaSector Fund (July 2010), the Virtus Allocator Premium AlphaSector Fund (March 2011), and the Virtus Global Premium AlphaSector Fund (March 2011). (Complaint ¶ 56.)

From January 2010 until October 2013,¹ every post-effective amendment to Virtus Trust's registration statements contained a chart comparing the AlphaSector Indices to the S&P 500 index. In a footnote that accompanied the chart, Virtus Trust announced that "[t]he Index inception date is April 1, 2001; it commenced daily calculation and dissemination by NASDAQ OMX with a base value 1,000.00 on October 13, 2008." (Complaint ¶¶ 69–76.)

Early on, Virtus Partners received credible intelligence that the AlphaSector Indices contained back-tested information. For instance, in November 2009, the Financial Industry Regulatory Authority ("FINRA") notified Virtus Partners that the performance history of the AlphaSector Rotation index, prior to October 13, 2008, was back tested. (Complaint ¶ 58.a.) And beginning in 2011, market participants also alerted Virtus Partners to the back testing. Despite this information, Virtus Partners took no steps to ascertain whether the strategy had been used in any real-time trading between April 2001 and September 2008. (Complaint ¶ 57–58.)

In December 2012, during a conference in Boca Raton of Virtus Partners' wholesalers, Present touted AlphaSector's returns and performance record, noting that "the AlphaSector Premium Index is based on an active strategy with an inception date of April 1, 2001. Inception date is defined as the date as of which investor assets began tracking the strategy." (Complaint ¶ 62.) After Present addressed the conferees, Virtus Advisers' product manager cautioned the wholesalers to disregard Present's claim that AlphaSector's performance was based on a live strategy going back to 2001 because the strategy was only developed in 2008, and pre-2008 returns were based on back-tested, hypothetical assets. (Complaint ¶ 63.)

In July 2013, the SEC initiated an investigation into F-Squared and AlphaSector's performance history. In the wake of the investigation, Virtus Trust excised the portion of its registration statement that discussed AlphaSector's pre-2008 track record without making any corrective disclosure. Shortly thereafter, Aylward (and other non-defendants) organized a conference call, telling Virtus employees to destroy any materials they had relating to AlphaSector's track record. (Complaint ¶ 64.) In December 2013, The Wall Street Journal reported that F-Squared was "under scrutiny" because its marketing materials reflected theoretical performance, not actual investor returns.

In November 2014, Present resigned from F-Squared. (Complaint ¶ 80.) The next month, F-Squared admitted to violating the securities laws and settled with the SEC for $35 million in disgorgement and civil monetary penalties. (Complaint ¶ 82.a.)

In May 2015, Plaintiffs filed this securities class action asserting claims under Sections 10(b) and 20(a) of the Exchange Act of 1934, Rule 10b-5 promulgated thereunder, Sections 11, 12(a)(2) and 15 of the Securities Act of 1933, and claims for breach of fiduciary duty under Delaware law. Concurrently, Virtus Partners announced that the SEC had initiated an investigation into Virtus Advisers and AlphaSector's performance history. In November 2015, Virtus Advisers consented to entry of a cease and desist order and settled with the SEC for $16.5 million in disgorgement and civil monetary penalties. (See Complaint ¶ 57.)

The Virtus Defendants,² Independent Trustees,³ Present, and F-Squared⁴ move separately to dismiss the Complaint.

LEGAL STANDARD

To withstand dismissal, a pleading "must contain sufficient factual matter, accepted as true, to ‘state a claim to relief that is plausible on its face.’ " Ashcroft v. Iqbal, 556 U.S. 662, 678, 129 S.Ct. 1937, 173 L.Ed.2d 868 (2009) (quoting Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 570, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007) ). Courts must accept as true all well-pleaded factual allegations. See Hooks v. Forman, Holt, Eliades & Ravin, LLC, 717 F.3d 282, 284 (2d Cir.2013). In addition, a court may consider "legally required public disclosure documents filed with the SEC" as well as documents "incorporated into the complaint by reference" or relied upon by the plaintiff "in bringing suit." ATSI Commc'ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 98 (2d Cir.2007). However, "[t]hreadbare recitals of the elements of a cause of action, supported by mere conclusory statements, do not suffice." Iqbal, 556 U.S. at 678, 129 S.Ct. 1937.

Under Fed. R. Civ. P. 9(b), a securities fraud complaint must satisfy heightened pleading requirements, "stating with particularity the circumstances of fraud." Employees' Ret. Sys. Of Gov't of the Virgin Islands v. Blanford, 794 F.3d 297, 304 (2d Cir.2015) (citation omitted). In addition, securities fraud claims are subject to the "[e]xacting pleading requirements" of the Private Securities Litigation Reform Act of 1995 ("PSLRA"), Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 313, 127 S.Ct. 2499, 168 L.Ed.2d 179 (2007), which provides that a complaint shall state with particularity "all facts on which [the] belief [that a statement is misleading] is formed," 15 U.S.C. § 78u4(b)(1)(B), and "facts giving rise to a strong inference that the defendant acted with the required state of mind," 15 U.S.C. § 78u–4(b)(2)(A).

DISCUSSION

I. Standing

As a preliminary matter, Defendants assert that Plaintiffs lack standing to pursue claims on behalf of the shareholders of two of the five funds—the Allocator Premium AlphaSector Fund and the Global Premium AlphaSector Fund—because Plaintiffs never purchased shares in these funds.

The Second Circuit has held that a plaintiff may pursue claims on behalf of a putative class of investors for securities that he did not purchase if he alleges both Article III standing and class standing. NECA – IBEW Health & Welfare Fund v. Goldman Sachs & Co., 693 F.3d 145, 162 (2d Cir.2012). In the context of class actions, Article III standing requires that "for every named defendant there must be at least one named plaintiff who can assert a claim directly against that defendant." NECA, 693 F.3d at 159. If that requirement is satisfied, the inquiry shifts to a class standing analysis. NECA, 693 F.3d at 159.

Class standing requires that the conduct allegedly causing Plaintiffs' Article III loss "implicates the same set of concerns as the conduct alleged to have caused injury to other members of the putative class by the same defendants." NECA, 693 F.3d at 162. Where the alleged injury is based on misrepresentations, "the...