A proposed investor class action against Horizons ETFs Management (Canada) Inc. over the collapse of an inverse ETF has been given new life by an Ontario court.
The Court of Appeal for Ontario has overturned a lower court decision from June 2019 that dismissed a proposed class action suit against Horizons on the basis that it didn’t set out a reasonable cause of action.
On appeal, the proposed case has been revived and sent back to the lower court judge to determine whether the other criteria for certifying the case as a class action suit are established.
The claim has yet to be certified as a class action, and none of the allegations has been proven.
According to the appeal court’s decision, the suit stems from the collapse of an inverse ETF (Horizons BetaPro S&P 500 VIX Short-Term Futures Daily Inverse ETF) that lost 90% of its value overnight in February 2018 and was ultimately closed down by the company.
The proposed plaintiff in the case, Graham Wright, sued the firm, alleging that “Horizons was negligent and was liable for making misrepresentations in its prospectus.”
The lower court judge dismissed the claim on the basis that, among other things, Horizons didn’t owe investors a duty of care, and therefore the plaintiff couldn’t make a claim for negligence.
The lower court ruling said, “Extending a duty of care for pure economic loss to the creator of an index tracking ETF would: deter useful economic activity where the parties are best left to allocate risks through the autonomy of contract, insurance, and due diligence; encourage a multiplicity of inappropriate lawsuits; arguably disturb the balance between statutory and common law actions envisioned by the legislator; and introduce the courts to a significant regulatory function when existing causes of action, the regulators, and the marketplace already provide remedies.”
On appeal, Wright argued that the lower court judge was incorrect.
He claimed that the company was “negligent in designing, developing, offering, and promoting a financial product that was not adequately tested before launching, excessively risky, complex and doomed to fail.”
He also alleged that the risks of investing in the fund were not adequately disclosed, and that Horizons “failed to take action to prevent investors from sustaining massive losses.”
Wright argued that “the prospectus failed to disclose the real risks attached to the fund, including the disparity in the way gains and losses are experienced, and that it was inevitable that the fund would lose all or substantially all of its value in a single day,” the decision noted.
According to the appeal decision, Horizons maintained that the lower court’s ruling was correct, that it had no duty to protect investors from losses in a risky product, and that the prospectus clearly disclosed the risks, among other things.
The appeal court sided with the plaintiff, finding that Wright may be able to make his case that the fund was “doomed to fail” and that this was not disclosed to investors.
“Read generously, the pleading provides that investors were not given sufficient information about the nature and extent of the risks and possible rewards to enable them to make an informed decision as to whether to invest, nor were they told that there was a design flaw and that the investment was doomed to fail. Without this information, the undertaking to provide a risky but viable investment was not met, and the risk of injury flowing from producing a product doomed to fail was reasonably foreseeable,” the appeal court said.
The appeal court also found that it’s possible that a novel claim against the company could succeed.
“Assuming the allegations in the pleading are proven, Horizons created a fund that was not suitable for any investors because the design flaw rendered it doomed to fail,” the court said.
“The failure to provide full disclosure of the risks and/or the fact that the product was doomed to fail and the fund manager’s failure to develop a viable strategy for the fund might constitute a breach of a prima facie duty of care and/or a breach of the fund managers’ statutory duties,” the court added.