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Geffen: A Shaky Future for Securities Act Claims Against Mutual Funds

David Geffen, Counsel in Dechert LLP's Boston office, recently published a paper entitled, "A Shaky Future for Securities Act Claims Against Mutual Funds," which posits that mutual funds may largely be insulated from liability for suits under the Securities Act of 1933 alleging materially false or misleading statements in a fund's registration statement and prospectus disclosures by establishing a "loss causation defense" at the outset of litigation.

As Geffen points out in his paper, directors can bear liability for the content of their fund's prospectus and SAI:
The purpose of Securities Act § 11(a) and § 12(a)(2) is to protect investors who make investments based on material misstatements. These two statutes provide for civil liability based solely on a misstatement in a prospectus.

Section 11(a) provides that every person who signs a fund’s registration statement, which includes every director or trustee of the fund, is a potential defendant. The directors and trustees can be held personally liable.
According to Geffen, asserting a "loss causation defense" is a prudent way to dispose of these types of cases, and if successful, leaves the plaintiffs with significantly constrained options under other securities regulations with a much heavier burden, particularly Rule 10b-5 of the Investment Company Act and state laws.

Simply put, this "loss causation defense" is of the "no harm, no foul" variety where the fund asserts that misstatements in a mutual fund’s prospectus and revelations of the misstatements did not decrease the fund shares’ NAV. Because the only damages recoverable by plaintiffs under the applicable Securitites Act sections are based on this price-depreciation formula, there is no damage that the plaintiff can recover.

Geffen concludes that "the inability to make out a claim against mutual funds and related parties based on prospectus misstatements should deter plaintiffs from instigating such lawsuits under the Securities Act." Funds and boards confronted with this type of litigation are wise to explore the "loss causation defense" with their legal counsel.

The full text of Geffen's paper is available for download at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1359304