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Federal District Court Hands Fund Prospectus Liability Win

The US District Court for the Southern District of New York dismissed a class action suit brought by plaintiffs alleging that risks associated with the fund's investments in mortgage backed securities were not adequately disclosed in the fund's prospectus.  Arising out of the decline in the share price of SSgA Yield Plus Fund during the 2007 and 2008 credit crisis, the plaintiff's alleged that the fund's disclosures misrepresented or concealed the fund's exposure to mortgage backed securities.  The Court rejected the plaintiff's claims on the grounds that the alleged prospectus misrepresentations would not have the effect of inflating the market price of a security.  That is, in order for the plaintiffs to show the prospectus statements caused their financial loss from investing in the fund, "the misstatement or omission" must "conceal something from the market that, when disclosed, negatively affected the value of the security."  

According to the Court, in the case of a mutual fund, prospectus misrepresentations neither cause inflation of a fund's NAV nor, when revealed, depreciation of a fund's NAV. Therefore, loss causation cannot be established for claims against a mutual fund under §§ 11 and 12(a)(2). 

The case, Yu v. State Street Corp., raises interesting questions about investors' ability to overcome a "loss causation" defense by defendant funds.  For a full discussion of the facts of the case, the court's reasoning, and some implications for future litigagtion, see Dechert's client memo at:  http://www.dechert.com/files/Publication/31f2154b-2ddc-4aa1-ad60-69891683b8c5/Presentation/PublicationAttachment/723ac411-1446-457b-b8c7-70958efd164c/FS_WCSL_04-11_Federal_District_Court_Rebuffs.pdf