Hunt v. Alliance North American Government Income Trust, Inc.
| Decision Date | 15 October 1998 |
| Docket Number | Docket No. 97-9477 |
| Citation | 159 F.3d 723 |
| Parties | Fed. Sec. L. Rep. P 90,294 Robert B. HUNT, IRA; Paul James, IRA and Paul James, Plaintiffs-Appellants, v. ALLIANCE NORTH AMERICAN GOVERNMENT INCOME TRUST, INC.; Alliance Capital Management L.P.; Alliance Capital Management Corporation; Alliance Fund Services, Inc.; Wayne D. Lyski; Robert M. Sinche and David H. Dievler, Defendants-Appellees. |
| Court | U.S. Court of Appeals — Second Circuit |
James C. Krause, San Diego, CA (Patrick N. Keegan, Krause & Kalfayan, San Diego, CA; David J. Bershad, Robert P. Sugarman and Paul D. Young, Milberg Weiss Bershad Hynes & Lerach, New York, NY, On the Brief), for Plaintiffs-Appellants.
John L. Hardiman, New York, NY (Lori S. Sherman, Sullivan & Cromwell, New York, NY, Of Counsel), for Defendant-Appellee, Alliance North American Government Income Trust, Inc.
James H.R. Windels, New York, NY (Dennis E. Glazer and Katharine L. Strobos, Davis Polk & Wardwell, New York, NY, Of Counsel), for Defendants-Appellees, Alliance Capital Management L.P., Alliance Capital Management Corporation, Alliance Fund Distributors, Inc., Wayne D. Lyski, Robert M. Sinche and David H. Dievler.
Before: OAKES, WALKER, and LEVAL, Circuit Judges.
Plaintiffs are shareholders in Alliance North American Government Income Trust, Inc. (the "Fund"), an open-ended mutual fund formed to make investments in government-guaranteed securities of Mexico, Canada, the United States, and countries in Central and South America. Plaintiffs brought this action against the Fund (and related persons and entities 1) alleging various violations of the federal securities laws and common law claims after the value of their shares declined dramatically due to the collapse of the Mexican peso in December 1994. The United States District Court for the Southern District of New York (Lawrence M. McKenna, Judge ) dismissed the original complaint. The court also denied plaintiffs' motion for leave to replead on the ground that the Proposed Amended Complaint failed to state an actionable claim. With respect to three of the four proposed claims, we affirm. With respect to plaintiffs' allegation that the Fund's prospectuses misleadingly stated that
the Fund manager intended to use hedging techniques to reduce currency risk when the defendants knew (or recklessly disregarded) that, as a practical matter, the Fund could not use hedging techniques to protect against currency fluctuations, we reverse.
Plaintiffs purchased their shares in the Fund from March 27, 1992 to December 23, 1994 ("the Relevant Period"). During the Relevant Period the Fund was an open-ended mutual fund that sold shares on a continuing basis pursuant to registration statements and prospectuses. Between February 1992 and December 1994, the Fund issued seven prospectuses, each containing representations that were substantially identical for the purposes of this case. 2 The prospectuses represented that the Fund's investment objective was to "seek[ ] the highest level of current income, consistent with what the Fund's Adviser consider[ed] to be prudent investment risk, that is available from a portfolio of debt securities issued or guaranteed by the governments of the United States, Canada, and Mexico, their political subdivisions, ... agencies, instrumentalities, or authorities...." The prospectuses also stated, "There can be, of course, no assurance that the Fund will achieve its investment objective." The Fund would invest at least 65 percent of its total assets in debt securities issued or guaranteed by the governments of the United States, Canada, and Mexico. The balance of the Fund's assets would be invested in debt securities issued by the governments of countries located in Central and South America.
The prospectuses explained that investing in securities issued by foreign governments involved "possible risks not typically associated with investing in U.S. Government Securities." The value of the Fund's assets could be diminished by, inter alia, changes in currency exchange rates. The prospectuses stated,
If not hedged ... currency fluctuations could affect the unrealized appreciation and depreciation of non-U.S. Government Securities as expressed in U.S. dollars.
[ ] Because Fund assets will be invested in fixed income securities denominated in ... foreign currencies and because a substantial portion of the Fund's revenues will be received in currencies other than the U.S. Dollar, the U.S. Dollar equivalent of the Fund's net assets and distributions will be adversely affected by reductions in the value of certain foreign currencies relative to the U.S. Dollar.
The prospectuses discussed several techniques available to the Fund Adviser to hedge against currency risk, including futures contracts and options on futures contracts, options on foreign currencies, forward foreign currency exchange contracts, and options on U.S. and Foreign Government securities. For example, the prospectuses stated the Fund "may" enter into futures contracts and options on futures contracts, which "will be used only to hedge against anticipated future changes in interest or exchange rates which otherwise might adversely affect the value of the Fund's portfolio securities ... ", and that
the Fund intends to write covered put and call options and purchase put and call options on U.S. Government Securities and foreign government securities that are traded on United States and foreign securities exchanges.... The Fund intends to write call options for cross-hedging purposes.
Regarding these hedging techniques, the prospectuses stated,
The successful use of the foregoing investment practices draws upon the Adviser's special skills and experience with respect to such instruments and usually depends on the Adviser's ability to forecast interest rate and currency exchange rate movements correctly. Should interest or exchange rates move in an unexpected manner, the Fund may not achieve the anticipated benefits of futures contracts, options or forward contracts or may realize losses and thus be in a worse position than if such strategies The Fund's ability to dispose of its position in futures contracts, options and forward contracts will depend on the availability of liquid markets in such instruments. Markets in options and futures with respect to a number of fixed-income securities and currencies are relatively new and still developing. It is impossible to predict the amount of trading interest that may exist in various types of futures contracts, options, and forward contracts. If a secondary market does not exist with respect to an option purchased or written by the Fund over-the-counter, it might not be possible to effect a closing transaction in the option (i.e., dispose of the option) with the result that (i) an option purchased by the Fund would have to be exercised in order for the fund to realize any profit and (ii) the Fund may not be able to sell currencies or portfolio securities covering an option written by the Fund until the option expires or it delivers the underlying security, futures contract or currency upon exercise. Therefore, no assurance can be given that the Fund will be able to utilize these instruments effectively for the purposes set forth above. Furthermore, the Fund's ability to engage in options and futures transactions may be limited by tax considerations.
had not been used. Unlike many exchange-traded futures contracts and options on futures contracts, there are not daily price fluctuation limits with respect to options on currencies and forward contracts, and adverse market movements could therefore continue to an unlimited extent over a period of time. In addition, the correlation between movements in the prices of such instruments and movements in the price of the securities and currencies hedged or used for cover will not be perfect and could produce unanticipated losses.
The Fund held significant investments in Mexican and Argentine government securities in the months leading up to December 1994. These positions were disclosed to shareholders in annual and semi-annual reports dated November 30, 1993, and May 31, 1994, respectively. The reports did not state whether the Fund had employed hedging techniques to reduce currency risk.
In December 1994, the Mexican government devalued the peso over 15 percent against the U.S. dollar and, in a change of policy, allowed the peso to float freely against the dollar. As a consequence, the value of the peso fell rapidly against the dollar, investors sold large quantities of Mexican and other Central and South American securities, and the Fund's net asset value declined dramatically.
In early 1995, plaintiffs filed several class action complaints against the Fund and related entities in the United States District Court for the Southern District of New York and the United States District Court for the Southern District of California. Plaintiffs agreed to consolidate these claims in the Southern District of New York. On July 25, 1995, plaintiffs filed a Consolidated and Supplemental Class Action Complaint ("Consolidated Complaint" or "original complaint") alleging that the name of the Fund was misleading, that the Fund had changed its investment objective without a shareholder vote, that the risks of investing in the Fund were not properly disclosed, and that the Fund had falsely represented it would use hedging techniques to reduce currency risk.
The district court granted defendants' motion to dismiss all counts of the Consolidated Complaint pursuant to Federal Rules of Civil Procedure 9(b) and 12(b)(6). See In Re Alliance North American Government Income Trust, Inc. Securities Litigation, No.95 Civ. 0330(LMM), 1996 WL 551732 (S.D.N.Y. Sept.27, 1996). The court found that the Fund's name and investment objectives could not have misled a reasonable investor and...
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