Xu v. Direxion Shares ETF Trust

Background

Lee Xu and Stephen M. Szymanski sued Direxion Shares ETF Trust, Rafferty Asset Management, LLC, Direxion Family of Investment Companies, Direxion Advisors, LLC, U.S. Bancorp Fund Services, LLC, Foreside Fund Services, LLC, and several individuals. They sought to recover losses from investments in four leveraged exchange-traded funds: NUGT, JNUG, DUST, and JDST. The funds sought to produce a multiple or inverse multiple of the daily performance of underlying indexes.

The Third Amended Complaint asserted seven counts under the Securities Act of 1933 and the Securities Exchange Act of 1934. The claims alleged misleading statements or omissions about the risks of holding the funds for longer than one day or trading them during the day, market manipulation, insider trading, and secondary liability for alleged controlling persons. The defendants moved to dismiss the entire complaint under Federal Rule of Civil Procedure 12(b)(6), which permits dismissal when a complaint does not allege enough facts to state a legally viable claim.

Court’s Analysis

The court found that the complaint was nearly incomprehensible and relied largely on conclusory, nonspecific allegations. It also noted that the complaint did not clearly identify which disclosures or registration statements violated the securities laws, particularly in connection with the plaintiffs’ earlier investments.

For Counts I through III, involving alleged misstatements or omissions under Section 11 of the Securities Act and Sections 10(b), 18(a), and Rule 10b-5 of the Exchange Act, the court held that the plaintiffs had not identified materially false or misleading statements. The fund disclosures warned that the funds were intended for short-term trading, that their performance over periods longer or shorter than one trading day could differ from their stated objectives, and that volatility and compounding could produce losses. The court concluded that the disclosures warned of the risks that allegedly materialized. It also noted that the plaintiffs did not adequately allege reliance for the applicable Exchange Act claims.

The court rejected the market-manipulation allegations in Count III and Count IV under Sections 9(a)(2) and 9(f) of the Exchange Act because the complaint did not identify facts showing a series of transactions intended to raise or depress the funds’ prices or induce purchases or sales. The Section 20A insider-trading claim in Count V also failed because the plaintiffs did not allege that any defendant traded the funds, traded contemporaneously with the plaintiffs, or traded using nonpublic information.

Counts VI and VII asserted secondary liability under Sections 15 of the Securities Act and 20(a) of the Exchange Act. The court dismissed those counts because those claims depend on an adequately pleaded primary securities-law violation, and the plaintiffs had not adequately pleaded any primary violation.

Disposition

Judge Valerie Caproni granted the defendants’ motion to dismiss as to all claims. The court dismissed the complaint with prejudice and without leave to amend. The court also concluded that another proposed amended complaint would still be inadequate and that further amendment would be futile. The Clerk of Court was directed to terminate all open motions and close the case.