Olkey v. Hyperion 1999 Term Trust, Inc.

Marilyn Olkey and other investors (the investors) (plaintiffs) purchased stock in three closed-end investment companies formed to invest in interest-only mortgage strips (IOs) and mortgage-backed securities (MBS): Hyperion 1997 Term Trust, Inc., Hyperion 1999 Term Trust, Inc., and Hyperion 2002 Term Trust, Inc. (the trusts) (defendants). The IOs and MBS were intended as a hedge against interest-rate fluctuations because the value of IOs tends to increase when rates go up and decrease when rates go down, while the opposite usually occurs with MBS. The mix of IOs and MBS held by the trusts favored a rise in rates, which was not specifically disclosed in the trusts’ prospectuses. When rates fell precipitously, the trusts suffered a substantial decline in value. The investors filed a class-action lawsuit against the trusts and their investment adviser, among others (defendants) seeking damages for material misstatements and omissions in the trusts’ registration statements and prospectuses in violation of the Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (Exchange Act), and for common-law fraud. The investors alleged that the trusts’ bias in favor of rising interest rates, which left the trusts vulnerable to a drop in rates, was not adequately disclosed, and that they were led to believe the trusts’ mix of securities would be balanced to keep the trusts’ value stable. The investors further alleged that cautionary language in the prospectuses was too generalized to be meaningful. This language included warnings about the trusts’ use of leverage, which could magnify losses, and a statement that a significant fall in interest rates could cause a significant decrease in the trusts’ earnings while a significant rise in rates could cause only a moderate increase in earnings. The district court dismissed the investors’ lawsuit for failing to state a claim, and the investors appealed to the United States Court of Appeals for the Second Circuit.