Opposition Brief — Olkey v. Hyperion 1999 Term Trust, Inc.

No. 96-1592 ii

IN THE

Supreme Court of the Gnited Stagtes!

October Term 1996

ee

Brow wisiees

MARILYN OLKEY. et ai.

Petitioners.

v.

HYPERION 1999 TERM TRUST, INC.. et ai..

Respondents.

ON PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

RESPONDENTS’ BRIEF IN OPPOSITION

ALAN J. HRUSKA

Counsel of Record

CRAVATH, SWAINE & MOORE

Worldwide Plaza

825 Eighth Avenue

New York, NY 19019

(212) 474-1000

Attorneys for Respondents

Hyperion 1997 Term Trust, Inc.,

Hyperion 1999 Term Trust, Inc.,

Hyperion 2002 Term Trust, Inc.,

Rodman L. Drake, Garth

Marston, Harry E. Petersen, Jr.

and Leo M. Walsh, Jr.

GERALD A. FORD

GREGORY E. BIRKENSTOCK

Of Counsel

May 8, 1997

i

COUNTERSTATEMENT OF THE

QUESTION PRESENTED

Whether a securities claim resting on an alleged material

omission from a prospectus is dismissible under Fed. R. Civ.

P. Rule 12(b)(6) when the prospectus in fact contains the

allegedly omitted proposition?

il

STATEMENT PURSUANT

TO SUPREME COURT RULE 29.6

This is to certify that respondents Hyperion 1997 Term

Trust, Inc., Hyperion 1999 Term Trust, Inc., and Hyperion

2002 Term Trust, Inc. do not have any corporate parents or

non-wholly owned subsidiaries.

iil

TABLE OF CONTENTS

Page

Counterstatement of the Question Presented ...... i

Statement Pursuant To Supreme Court Rule 29.6 ... li

I oe iV

Counterstatement of the Case ............._.. l

A. Factual Background .............._.. 3

B. Petitioners’ Shifting Theories of the Case... 4

C. The Decisions Below ................ 5

Correction of Misstatements in the Petition....__. 6

A. The Petition’s Assertion of “No

Warning” of “Risk to Investor Capital”;

the Plain Existence of Such Warnings. .... 6

B. The Petition’s Assertion that the Court of

Appeals “Speculated” as to “What

Plaintiffs Might Have Believed and Must

Have Expected”; the Court’s Reading of

Clear Words to Rule on the

Prospectuses’ Plain Meaning............ 1]

C. The Petition’s Assertion of “Tllogical”

Speculation; the Illogical Speculation on

Which the Assertion is Premised. ......_. 13

D. The Petition’s Assertion of a Promised

“Conservative” Investment; the

Prospectuses’ Explicit Warnings to the

SE SNES Ea a 14

Reasons for Denying the Writ ................ 16

I ee ei 19

iv

TABLE OF AUTHORITIES

Cases Page(s)

Basic Inc. v. Levinson, 485 U.S. 224 (1988) .... 12

Chapin v. Knight-Ridder, Inc., 993 F.2d 1087

COR Ge Bee 5 0c eka wns Ce eekeree 1]

Decker v. Massey-Ferguson, Ltd., 681 F.2d

bat Gee Ge See ee oe ee es Pee 16

Fudge v. Penthouse Int'l, Ltd., 840 F.2d 1012

to ge | | Bees ere ew ere eee Te 11-12

Gasner v. Board of Supervisors, 103 F.3d 351

(1s CO TIO cbc hs coi ca eee ena 17

I. Meyer Pincus & Assocs., P-C., v.

Oppenheimer & Co., 936 F.2d 759 (2d Cir.

REE x8 6 hes Re ee EL} eee 16

In re Stac Electronics Sec. Litig., 89 F.3d

1399 (9th Cir. 1996), cert. denied, __

US. Pete ee) i re 16

In re Syntex Sec. Litig., 95 F.3d 922 (9th Cir.

oe” eer ae rarer hp hg peer ge 17

Luce v. Edelstein, 802 F.2d 49 (2d Cir. 1986) ... 16

Mitchell v. Random House, Inc., 865 F.2d 664

CO Ea Se ss og heehee weer Ka 1]

Venture Assocs. Corp. v. Zenith Data Systems

Corp., 987 F.2d 429 (7th Cir. 1993) ........ 12

Statutes and Rules

1S USA... & Toe en TES kc bw eee 4, 16

1S U.SL..§ 7702) Goction 1202) ... . .. ee en 4, 16

Vv

Page(s)

15 U.S.C. § 770 (Section cc AE Ee PP ES Pos 4

IS U.S.C. § 78j(b) (Section oe. RR aia 4

15 U.S.C. § 78t(a) (Section ME hi ee eae 4

17 C.F.R. § 240.10b-5 (Rule a: See eee 4, 16

vee. %, OS Oe 2 passim

No. 96-1592

IN THE

Supreme Court of the United States

October Term 1996

MARILYN OLKEY, et ai.,

Petitioners,

HYPERION 1999 TERM TRUST, INC., et ai..

Respondents.

ON PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

RESPONDENTS’ BRIEF IN OPPOSITION

Respondents request that the Court deny the petition for

a writ of certiorari seeking review of an opinion of the Court

of Appeals for the Second Circuit reported at 98 F.3d 2

(2d Cir. 1996) (1a—citations herein to the opinions below are

to the pages of the copies attached as an appendix to the

petition).

COUNTERSTATEMENT OF THE CASE

The petition attacks the court of appeals for “decisions”

the court never made on “issues” that were never presented.

For example, petitioners define the question they wish this

Court to address as: whether “express misrepresentations”

regarding investment risks can somehow be “insulated from

-

liability” because of “generalized, ‘implicit’ cautionary

statements that do not bear on the actual misrepresented

risks’—a question that petitioners say the Second Circuit

answered in the affirmative (Pet. i).

In reality, the court of appeals as well as the district court

dismissed petitioners’ complaint—not because of

“generalized” statements or those failing to “bear on the”

purportedly “misrepresented risk”, as petitioners would have

it—but because, as the appellate court itself stated: (1) the

prospectuses “warn[ed] investors of exactly the risk the

plaintiffs claim was not disclosed” (10a, emphasis added);

(2) did so “explicitly”, “fully” and “clearly” in “detailed” and

“extensive” statements that were “too prominent and specific

to be disregarded” (10a, 14a, 16a, 18a); (3) petitioners’

averments were thus “contradicted by the prospectuses on

their face” (4a); and (4) “therefore no set of additional facts

could prove the plaintiffs’ claims” (id.).

Petitioners’ actual argument with the court of appeals

decision consists of their assertion that the court somehow

misread the prospectuses by failing to discern alleged errors

and omissions. To create that impression, however, petitioners

shut their eyes to the prospectuses’ disclosures cited and

quoted by the courts below and mischaracterize those

documents as well as the court of appeals’ opinion itself. In

point of fact, both the court of appeals and the district court

read the prospectuses correctly; but there is an even stronger

reason why this petition should be denied.

The decisions below held that three prospectuses alleged

to have misrepresented or omitted material facts were not

actionable when revealed plainly on the face of the

prospectuses themselves to have done neither. The rule of law

underlying that holding is fully in conformity with this

Court’s precedents and the case law of other circuits; hence,

no certworthy issue is presented.

A. Factual Background.

This is a securities case addressed to three prospectuses

issued in connection with underwritings of stock in three

separate investment trusts (Hyperion 1999 Term Trust, offered

June 18, 1992 (A274-332); Hyperion 1997 and Hyperion

2002, both offered October 23, 1992 (A333-403 and A404-

474, respectively)). As is typical of underwriting prospectuses,

those at issue in this case contained statements of aspiration

and opinion as to possible future gains as well as statements

of the risks necessarily to be hazarded before any such gains

might be realized.

As to possible gains, the prospectuses stated the goals of

achieving

“a higher level of current income than could be obtained

by investing in a portfolio of intermediate-term (five- to

ten-year) U.S. Treasury securities... .” (Hyperion 1999

at A276, 287-88; 2002 at A409, 423: see Hyperion 1997

at A338, 352)

and returning, at the termination of each Trust each

shareholder’s initial investment of $10 a share (e.g., Hyperion

1999 at A274; 1997 at A335; 2002 at A406).

As for warnings, the prospectuses stated, among many

other expressions of risks, that, to earn income greater than

that generated by investing in a portfolio of medium-range

U.S. Treasuries, the Trusts would invest primarily in

mortgage-backed securities, with as much as 25-35% of the

total Trust investment in IOs (a security representing the right

to receive the interest portion of a pool of mortgages)

(Hyperion 1999 at A280, 288, 302: see 1997 at A343, 352,

367; 2002 at A414, 423, 437); that, if interest rates fell, there

would likely be more prepayments of the underlying

| “A” citations are to pages of the joint appendix filed in the Second

Circuit.

4

mortgages than would otherwise be the case, which would

reduce the flow of interest income to security-holders

(Hyperion 1999 at A284, 300-01, 301-02, 1997 at A348,

365-66, 366-67; 2002 at A418-19, 436, 437); and that, with

these kinds of securities, if such mortgage prepayments

occurred, the Trusts (and, necessarily, their investors) could

“fail to recoup their initial investment”, in addition “to

suffer[ing] a !ower than anticipated yield” (Hyperion 1999 at

A290; 1997 at A354; 2002 at A425).

Those statements were made in June 1992 in the Hyperion

1999 prospectus (and in October 1992 in the 1997 and 2002

prospectuses) when home mortgage interest rates had already

fallen to an 18-year (or 19-year) low. As is now known, with

the benefit of hindsight, those rates thereafter fell to their

lowest point since FHLMC began compiling weekly interest

rates in 1971.7 Heace prepayments of mortgages occurred,

and the Trusts’ net asset values (“NAVs”) and share prices

declined. In other words, there transpired some of the ill

consequences the prospectuses predicted could result if

interest rates continued to go down.

B. Petitioners’ Shifting Theories of the Case.

According to petitioners’ third generation of pleadings (the

second consolidated amended complaint), the prospectuses in

question constituted violations of either or all of Sections 11,

12(2) and 15 of the °33 Act and Sections 10(b) (including

Rule 10b-5) and 20(a) of the °34 Act and amount to common-

law fraud.

These charges were originally inspired, it would appear,

by opinions expressed by a Barron’s columnist in an article

dated October 18, 1993 (Pet. 2-3). Before that day ended, the

> For each of five consecutive weeks, beginning in February 1993,

rates fell to new 20-year lows, culminating at 7.44%. Then, in July 1993

and continuing until this suit was commenced in October 1993, interest

rates fell even further, hitting a new recorded low of 6.81%.

ee

5

first of what turned out to be 16 securities class action

complaints was filed against the Trusts, their investment

advisor, various directors and officers and an asserted

defendant class of underwriters. The complaints were largely

identical, and all accused the Trusts of failing to disclose to

investors that the Trusts would make “huge” purchases of IOs

and that such securities tend to lose value when interest rates

decline (e.g., A481-95, 99 18-20). The plain fact was,

however, that the prospectuses had elaborately described the

nature and risks of IOs as well as the extent to which the

Trusts would invest in such securities. By the time plaintiffs

filed their first amended complaint, they presumably had

sufficient opportunity so to realize, since they then abandoned

this argument in favor of a new, more generalized theme

relating to the entirety of the portfolios.

Petitioners’ theory of the case thereafter underwent

additional radical shifts, expressed in yet another round of

pleadings and various briefs and arguments to the courts

below. The present petition emphasizes, as did plaintiffs’ oral

argument to the court of appeals, one of the themes set forth

in the latest version of the complaint—specifically, that while

the prospectuses warned that significant declines in interest

rates could cause reductions in Trust income, it purportedly

gave no such warming with regard to the comparable

vulnerability of Trust capital (e.g., Pet. 6).

C. The Decisions Below.

Both the district court and the court of appeals found that

the prospectuses clearly and unambiguously informed

investors of precisely the proposition that petitioners assert

had been misrepresented or omitted.

The district court noted that the “prospectuses disclosed

that a decline in interest rates could trigger a deluge of

mortgage prepayments” and that such “prepayment[s] could

produce an irretrievable loss of capital” (39a); that “the risks

threatening capital were revealed” with “candor” (41a); and

6

that “[n]o investor could have believed that net asset values

would not be volatile and capital would not be vulnerable

unless that investor deliberately ignored [those] explicit

warnings” (43a). The court of appeals observed, based on the

same warnings, that the “risks involved” were “fully and

explicitly disclosed” (16a) so that the “prospectuses contained

no material misstatements or omissions of fact” (19a). Thus,

the courts below ruled that the second amended consolidated

complaint failed to state a claim upon which relief could be

granted and dismissed it.

CORRECTION OF MISSTATEMENTS

IN THE PETITION

Petitioners’ theory of the existence of a certworthy issue

is that (1) the prospectuses misrepresented that there would

be little or no risk of capital loss as a consequence of

declining interest rates (Pet. 6), (2) their warnings were

“vague” and “generalized” “boilerplate” that did not go to that

risk (Pet. 14-15), and (3) the court of appeals improperly

“speculated” that investors would interpret such “boilerplate”

as warnings that did go to that risk (Pet. 17).

Each of those assertions self-evidently misstates the

record.

A. The Petition’s Assertion of “No Warning” of “Risk to

Investor Capital”; the Plain Existence of Such

Warnings.

1. The prospectuses stated that the Trusts would design

and manage each portfolio “in an attempt to minimize the

impact of changes in interest rates on the net asset value of

the portfolio” (9a, emphasis added). Also, as the petition itself

expressly acknowledges, “[eJach prospectus warned of a

possible decrease in the Trusts’ yield if interest rates should

decline ‘significantly’” (Pet. 6). But, say petitioners, “[t]here

was no warning given of any corresponding risk to investor

capital’”—and that, according to petitioners, was a material

7

omission that rendered the first statement a misrepresentation

(id.). |

That alleged omission is petitioners’ case. It is the

supposed platform for all petitioners’ hyperbole regarding

“secret” “bets” on interest rates, hidden “risky” strategy, and

so forth. But, as the courts below found with ample basis,

there was no such omission.

Each prospectus stated plainly and repeatedly about each

Trust portfolio:

one, that it would be composed primarily of mortgage-

backed securities (34a);

two, that what depressed the market value of mortgage-

backed securities were prepayments of the underlying

mortgages;

; E.g.:

“S&P and Moody’s determine ratings for Mortgage-Backed Securities

. . .. The ratings do not represent an assessment of the likelihood that

principal prepayments will be made by mortgagors or other obligors,

which may cause investors to suffer a lower than anticipated yield or

fail to recoup their initial investment.” Hyperion 1999 at A290; 1997

at A354; 2002 at A425.

“The investment characteristics of Mortgage-Backed Securities differ

from traditional debt securities. The major differences include the fact

that . . . principal may be prepaid at any time . . . . These differences

can result in significantly greater price and yield volatility than is the

case with traditional debt securities. As a result, if the Trust purchases

Mortgage-Backed Securities at a premium, a prepayment rate that is

faster than expected will reduce both the market value and the yield

to maturity from that which was anticipated . . . .” Hyperion 1999 at

A279; 1997 at A341-42: 2002 at A412.

8

three, that what caused mortgage prepayments was

declining interest rates;*

four, that, if the Trust used leverage, the negative impact

on the entire Trust net asset value (“NAV”) would be

magnified;> and

five, that the Trust would, in fact, use leverage.°

To be sure, the expression of those propositions did not

use the words “bias toward a rising interest rate

environment’—a fact (together with the court of appeals’

description of that conclusion as being “implicit”) to which

petitioners attach great importance (Pet. 14-15). But once a

prospectus states, as these unmistakably did, that the NAV of

" E.g.:

“Prepayment rates are influenced by changes in current interest rates

.. . In periods of declining mortgage interest rates, prepayments on

Mortgage-Backed Securities generally increase.” Hyperion 1999 at

A300; 1997 at A365-66; 2002 at A436.

> Eg:

“The use of leverage by the Trust ... creates special risk ....

[S]ince any decline in the value of the Trust’s investment portfolio

is borne entirely by the holders of the Shares, the use of leverage in

a declining market will cause a greater Jecline in the asset value of

the Shares than if the Trust were not leveraged.” Hyperion 1999 at

A302-03; 1997 at A367-68; 2002 at A438.

“{Lleveraging may magnify changes in the net asset value of the

Shares.” Hyperion 1999 at A281; see 1997 at A345; 2002 at A415.

“The use of leverage poses the additional risk that . . . decline in the

value of the Trust’s investment portfolio may exaggerate the decline

in the net asset value or market price of the Shares.” Hyperion 1999

at A283; 1997 at A347; 2002 at A418.

© Eg:

“The Trust intends to use investment leverage.” Hyperion 1999 at

A283; 1997 at A347; 2002 at A418.

9

a portfolio of securities will decline in a declining interest rate

environment, the concept that the portfolio has a bias towards

a rising interest rate environment is not only “implicit”; the

two statements are alternative verbalizations of the same

point.

That is why the court of appeals also stated that, while the

word “bias” wasn’t used, the warning itself of vulnerability

to declining interest rates was “fully and explicitly disclosed”

(16a) in an “unmistakable” fashion (13a) that was “too

prominent and specific to be disregarded” (10a). Obviously,

what matters is that the risk be disclosed, not that one

formulation of words rather than another be articulated.

2. Moreover, what, other than precisely the warning

petitioners claim wasn’t given, was the following passage in

the context of prospectuses addressed to portfolios said to be

invested in mortgage-backed securities and only to “a limited

amount” in anything else:

“The investment characteristics of Mortgage-Backed

Securities differ from those of traditional debt securities.

The major differences include the fact that, on Mortgage-

Backed Securities . . . prepayments of principal may be

made at any time. Prepayment rates are influenced by

changes in current interest rates and a variety of

economic, geographic, social and other facts and cannot

be predicted with certainty. In periods of declining

mortgage interest rates, prepayments on Mortgage-Backed

Securities generally increase. . . . Under certain interest

rate or prepayment rate scenarios, the Trust may fail to

recoup fully its investment in such securities

notwithstanding the assignment of a rating of AAA to such

securities.” Hyperion 1999 at A300-01; 1997 at A365-66;

2002 at A436 (emphasis added).

” Hyperion 1999 at A274; 1997 at A335: 2002 at A406.

10

And surely the statement on page 2 of each prospectus

that “[c]hanges in interest rates will also lead to changes in

the Trust’s net asset value” (emphasis added) immediately

coupled with the warning that the Trust could suffer so

substantial a negative change in net asset value as to be

forced “to return less than $10 a share” also constituted such

a warning (Hyperion 1999 at A275; 1997 at A336; 2002 at

A407).°

Likewise, in each prospectus the statement was made that,

while the Trust will “seek to minimize the impact” on “the

net asset value” caused by “changes in interest rates”, “there

can be no assurance that it will achieve this result” (Hyperion

1999 at A284; 1997 at A348; 2002 at A418). What else could

such a statement mean than: if the Trust does not “achieve

this result” of which “no assurance” can be given, interest rate

changes could well bring about reductions in the net asset

value of the Trust?

Indeed, every time the prospectuses warned that the Trusts

or the Trusts’ Adviser will “attempf’ to prevent such a

reduction in NAVs (and such are the very passages most

frequently quoted in this second amended complaint, e.g.,

paras. 47, 56, 57), the message was undeniably delivered that

the “attempt” might not succeed; and then the prospectuses

8 In isolation and out of context, the statement that interest rate

changes will change the portfolio’s NAV would be “vague”, as the court

of appeals noted, as to the direction of those changes (13a). Petitioners

seize upon the word “vague” as they did with the word “implicit” and

equally misuse it (Pet. 14), making it appear that it was a general court

of appeals’ description of warnings that the court itself described as

“specific”, “explicit”, “full”, “appropriate”, “prominent”, etc (e.g., 10a,

16a). Not only, however, did the court of appeals limit the word, as the

court itself stated, to the hypothetical condition of this one sentence

standing “by itself’, but it went on to state that placing this sentence in

context (“the juxtaposition of the two sentences”) “creates an unmistakable

inference that a drop in interest rates could decrease net asset value” (13a,

emphasis added).

11

so stated explicitly (e.g., Hyperion 1999 at A277, 280 284

(twice), 288, 289; 1997 at A338, 343, 348, 349, 352, 353:

2002 at A409, 413-14, 418-19, 419-20, 423, 424).

3. Petitioners’ response is that such explicit and

particularized warnings should be disregarded as “boilerplate”

in the light of the statements in the prospectuses regarding

“balance” (Pet. 15).? However, what the prospectuses said

about “balance” was that the Trust managers would attempt

to achieve it; that such efforts might not succeed because of

market forces beyond their control, including interest rate

drops causing prepayments; that nobody should rely on it

being achieved; and that the failure of achievement could

result in a capital loss (i.e., the return of less than $10 a share

upon the Trust’s liquidation). In that context, the above-

quoted statements, far from being meaningless “boilerplate”,

were clear explications of how such capital losses could occur.

B. The Petition’s Assertion that the Court of Appeals

“Speculated” as to “What Plaintiffs Might Have

Believed and Must Have Expected”; the Court’s

Reading of Clear Words to Rule on the Prospectuses’

Plain Meaning.

1. When a court determines that an accused publication

is not susceptible of a defamatory meaning, the court properly

dismisses a libel complaint (e.g., Chapin v. Knight-Ridder,

Inc., 993 F.2d 1087, 1091 (4th Cir. 1993); Mitchell v. Random

House, Inc., 865 F.2d 664, 669 (Sth Cir. 1989); Fudge v.

9 The prospectuses themselves never used the word “balance”, but

rather stated in various ways that an “attempt” would be made “to

minimize the impact of changes in interest rates on the net asset value of

the portfolio”, such as by purchasing securities that tend to react in

different ways to given interest rate changes (Hyperion 1999 at A277;

1997 at A338; 2002 at A409). We have no objection to the use of the

word “balance” as a shorthand reference to such statements (although

plaintiffs’ usage seems erroneously to imply an ability to achieve

“balance” in some mechanical and foolproof fashion).

12

Penthouse Int'l, Ltd., 840 F.2d 1012, 1015-16 (1st Cir. 1988)).

When a court determines that a prospectus contains a

proposition it is claimed to have omitted, the court properly

dismisses a complaint for a purported securities violation.

In the libel case, the court applies a reasonable reader

standard, and in the securities case, a reasonable investor

standard (see Basic Inc. v. Levinson, 485 U.S. 224, 231-32

(1988)). In neither instance does the court “speculate” (to use

petitioners’ word) as to how any particular person would read

the document. In both cases, the court renders a ruling of law

based on facts it finds not reasonably contestable. !°

That is precisely what the district court did when it stated

that “[nJo investor could have believed” from reading these

prospectuses that “capital would not be vulnerable” in a

declining interest rate environment (43a). To the same effect

was the court of appeals’ conclusions regarding the beliefs

that “[rJeasonable investors” would necessarily have about

“risking low returns and erosion of capital if there was a

significant drop in interest rates” (14a).

These conclusions were not “speculation” (much less

“conceded speculation”) about “what plaintiffs might have

believed” or what any particular investor “might have

believed”, as petitioners characterize them (Pet. 1, 3, 17); they

were, as the court itself made evident, conclusions as to what

these prospectuses were clearly stating and thus, objectively,

what reasonable investors would necessarily have understood.

Indeed, based on even the brief summary of the prospectuses

set forth above, those conclusions were ineluctable.

10 And this practice is, of course, not unique to libel and securities

claims. See, e.g., Venture Assocs. Corp. v. Zenith Data Systems Corp.,

987 F.2d 429, 432-33 (7th Cir. 1993) (dismissal of complaint for alleged

breach of contract, where the executed documents showed on their face

an agreement to agree rather than an enforceable contract).

13

2. The dissenting opinion in the court of appeals, on

which petitioners heavily rely, missed exactly the same point.

To the dissent, the majority had “assert[ed]” “in the absence

of evidence, that the purchasers of the Hyperion funds bought

in the expectation of rising [interest] rates’”—which the dissent

considered “a proposition at least unsupported and in all

likelihood unsupportable” (23a, emphasis added).

In the first place, however, as noted above, the court of

appeals rendered an objective reading of the prospectus, not

a divination of the minds of particular purchasers. In the

second place, the majority determined (and not even the

dissent disagreed) that these prospectuses made clear to any

“reasonable investor” that both the capital and income of the

Trust would fare better in a rising interest rate environment

than if rates were to fall (14a). In so stating, therefore, the

majority indulged in neither “speculation” nor “unsupportable”

assumptions, but rather clear comprehension of the plain

words of the prospectuses, and the application of common

sense.

C. The Petition’s Assertion of “Illogical” Speculation; the

Illogical Speculation on Which the Assertion is

Premised.

While the dissenting opinion mistakenly chided the

majority for “speculation” (22a), it ironically embarked upon

impermissible speculation of its own (which the petition, of

course, endorses).

According to the dissent (and petition), the Trust managers

had invested so “disproportionately in instruments that would

benefit from rising [interest] rates” (20a-21a) that their “aim”

could not possibly have been “for as much balance as [they

could] achieve” (24a; Pet.5 & n.3). The basis for this

conclusion was that other “closed-end bond fund[{s]” did better

than Hyperion’s in the opinion of a Barron’s columnist (21a;

Pet. 2}—a reference that fails not only as appropriate

authority but, more importantly, as logical support.

eT

14

In essence, the dissent’s argument is a_ hindsight

contention that, since the attempt failed, it must never have

been made or even intended. And the fallaciousness of that

position is all the more ironic in the light of the dissent’s

acknowledgement of the majority’s point that even “portfolio

managers of funds claimed to be balanced must inevitably

make some predictions about future interest rates” because “‘it

is unlikely that interest rates will remain completely static for

any significant period of time” (26a).

For the dissent’s statement presupposes that fund

managers must make some “bet” on which way interest rates

will move. And since the predictions of different managers

will invariably be different, they will achieve different results

despite the commonality of their “aim”. Moreover, these

Trusts were to be invested heavily, as the prospectuses

continuously stated, in a relatively new form of security, IOs,

whose precise reaction to interest rate changes, and to the

other market and economic effects of those changes, could not

yet have been fully charted. To cite, then, the experience of

other investment trusts as a purported basis for the assertion

that the Hyperion Trusts were “disproportionately” “bet” on

an interest rate movement (26a) is to advance not simply

hindsight reasoning but a complete non sequitur.

All that could be said with certainty at the outset was that

these mortgage-backed securities were vulnerable to the

prepayment risk caused by declining interest rates; the

Hyperion prospectuses so stated repeatedly; and the risks of

which they warned were the risks that ultimately eventuated.

That should have been, and in the majority’s view properly

was, the end of this lawsuit.

D. The Petition’s Assertion of a Promised “Conservative”

Investment; the Prospectuses’ Explicit Warnings to the

Contrary.

Typical of petitioners’ approach to the prospectuses is

their repeated claim that respondents “represented that they

—

15

had assembled portfolios designed for conservative investors”

(Pet. 2), emphasized to the public that the Trusts were

investments of a “conservative nature” (id.), made “[t]he

promise of a conservative, capital protective approach”

(Pet. 5), made “representations of a conservative strategy”

(Pet. 6), advertised a “conservative” product (Pet. 15), and so

on.

These arguments make it appear as though the

prospectuses had the word “conservative” blazoned throughout

their pages like a mantra. Not so. The prospectuses never

described their offerings as “conservative”, nor did they

communicate such a message by implication (which is

probably petitioners’ point).

Surely, for example, there was no implication of a

“conservative” investment when the prospectuses said, in

plain English, that the objectives might well not be met!! and

that $10 a share might well not be returned.'* And certainly

there was no such implication when the prospectuses stated

that the Trusts would invest as much as 25% to 35% of each

portfolio in securities (IOs) that could lose their value,

irrespective of their triple-A rating, if the underlying

mortgages were prepaid and that such refinancings “generally”

occur when interest rates decline.!> And manifestly there was

no invitation to only risk-adverse buyers when the

a Hyperion 1999 at A275, 276; 1997 at A336, 337; 2002 at A407,

408 (“No assurance can be given that the Trust will achieve its investment

objectives.”); accord 1999 at A286, 287; 1997 at A350, 351; 2002 at

A421, 422.

2 Hyperion 1999 at A275, 276; 1997 at A336, 337; 2002 at A407,

408 (“[T]he Trust may return less than $10.00 per Share”); see Hyperion

1999 at A283, 286, 287, 289; 1997 at A347, 350, 351, 353; 2002 at A418,

421, 422, 424.

13 Hyperion 1999 at A280, 284, 288, 290, 294, 300, 301, 301-02:

1997 at A343, 348, 352, 354, 359, 365-66, 366-67; 2002 at A414, 418-19,

423, 425, 429, 436 (twice), 437.

16

prospectuses expressly warned that, given the stated risks,

these Trusts were “not appropriate for all investors” and that,

before investing, those interested “should carefully consider

their ability to assume these risks”.!4

In short, “conservative” is petitioners’ word; arguments

and claims founded on that concept are petitioners’ own

invention; they have no foundation in the prospectuses

themselves.

REASONS FOR DENYING THE WRIT

1. Contrary to petitioners’ assertion, the decision below

was not based on the “bespeaks caution” doctrine, much less

on “cautionary statements” unrelated to the allegedly omitted

disclosure of risk (Pet. i). Rather, the dismissal, as the court

of appeals itself stated expressly, was based on the clear fact

that the prospectuses contained the very statements that

“warn[ed] investors of exactly the risk the plaintiffs claim was

not disclosed” (10a).

Whether brought under Sections 11 or 12(2) or Rule 10b-

5, complaints charging “omissions” of what was disclosed, or

“misrepresentations” that were not stated, are themselves

deficient. E.g., J. Meyer Pincus & Assocs. PC. ¥y.

Oppenheimer & Co., 936 F.2d 759, 762-63 (2d Cir. 1991);

In re Stac Electronics Sec. Litig., 89 F.3d 1399, 1405-06 (9th

Cir. 1996), cert. denied, __ U.S. ____, 117 S.Ct. 1105 (1997);

Decker v. Massey-Ferguson, Ltd., 681 F.2d 111, 115-17

(2d Cir. 1982). The same rule applies whether the allegedly

omitted (but, in reality, stated) proposition is one of fact (as

in the above-cited cases) or an appraisal of the riskiness of

the security in question. E.g., Luce v. Edelstein, 802 F.2d 49,

56 (2d Cir. 1986). No clearer example could be presented for

the application of that rule than the second amended

complaint filed in this action.

14 Hyperion 1999 at A304; 1997 at A369; 2002 at A440.

ee ONT

Pl Syl Lt HE BR

ES LOS AE SS, AO” 1A OEE Here. Ee RG,

17

Whenever the second amended complaint alleges or

implies something was omitted from the prospectuses, the

supposedly omitted proposition can be found stated, not once,

but frequently. And each time the second amended complaint

attempts to characterize the prospectuses as containing a

misrepresentation, the prospectuses themselves belie the

characterization.

There are a lot of cases endorsing the “bespeaks caution”

doctrine (see, e.g., Pincus, 936 F.2d at 763; Gasner v. Board

of Supervisors, 103 F.3d 351i, 358 (4th Cir. 1996); Jn re

Syntex Sec. Litig., 95 F.3d 922, 929-30 (9th Cir. 1996)). And

these prospectuses, as the courts below properly held, bespeak

caution (10a, 42a)}—but we are far beyond that doctrine here,

as the lower courts also recognized. This is a case in which

petitioners’ purported bases for their suit are

mischaracterizations demonstrable on the face of the very

documents under which they are claiming.

2. Petitioners assert, as if it were self-evidently the case,

that these prospectuses gave “no warning” of any risk “of a

possible decrease in the Trusts’” capital “if interest rates

should decline ‘significantly’” (Pet. 6). The stark reality,

however, is otherwise. Petitioners have simply blinded

themselves to what the prospectuses manifestly set forth and

the court of appeals properly understood.

When prospectuses state, as these did, that investors may

fail to recoup their investment in mortgage-backed securities

when large prepayments are caused by declining interest rates

and that the portfolio of the Trust will consist primarily of

such securities and only to “a limited amount” anything else,

indisputably a warning has been issued “of a possibile

decrease in the Trusts’ capital “if interest rates should

decline ‘significantly’” (Pet. 6). And when prospectuses state,

as these did, that the mortgage-backed securities of which the

portfolios would be predominantly composed can be

depressed in value by mortgage prepayments that are caused

18

by declining interest rates, a phenomenon magnified and

exaggerated when leverage is used—and that this Trust

intends to use leverage—such a warning has undeniably been

issued.

In so holding, the court of appeals neither departed in any

way from precedents of this Court nor rendered an opinion

conflicting with the case law of other circuits. The decision

it reached was that the claim petitioners had attempted to state

was refuted on the face of their pleading, which was a

straightforward application of Rule 12(b)(6) in exactly the

manner the Rule was intended to be used.

3. Petitioners’ assertion that the court of appeals

“speculated” as to how shareholders might have read the

prospectuses misdescribes the court of appeals’ opinion; and

petitioners’ reliance on their own affidavits is simply

misplaced.

As mentioned above, it is as appropriate under

Rule 12(b)(6) for a court to determine whether a prospectus

actually omits or contains the allegedly missing material

disclosures as it 1s for a court to determine whether an

allegedly libelous publication is susceptible of a defamatory

meaning. In neither instance is the court “speculating”, much

less engaged in some improper deprivation of Seventh

Amendment rights. It can no longer be seriously challenged

that for plaintiff to possess a right to have his or her claim

resolved by a jury, he or she must be able to state a claim on

the face of a pleading, which is not done where, as the court

of appeals held here, “plaintiffs’ claims are contradicted by

the prospectuses on their face” (4a).

Nor do petitioners’ own self-serving affidavits remove

them from this sound precedent. Petitioners can proclaim as

often or as loudly as they wish that these prospectuses failed

to warn them of risks to capital (e.g., Pet. i, 3-4, 8, 17), but

the plain words of the prospectuses say otherwise. Affidavits

cannot change that stark fact, nor are the courts below

19

required on a Rule 12(b)(6) motion to accept them as

; changing that fact.

In sum, the ruling of the courts below that these securities

. claims could not be founded on prospectuses clearly

containing the disclosures they were alleged to have omitted

was correct, in full conformity with prior law and in no

respect worthy of the grant of certiorari.

CONCLUSION

For the foregoing reasons, the writ of certiorari should be

denied.

May 8, 1997

Respectfully submitted,

ALAN J. HRUSKA

Counsel of Record

| CRAVATH, SWAINE & MOORE

g Worldwide Plaza

3 825 Eighth Avenue

New York, NY 10019

Attorneys for Respondents

Hyperion 1997 Term Trust, Inc..

Hyperion 1999 Term Trust, Inc..,

Hyperion 2002 Term Trust, Inc.,

Rodman L. Drake, Garth

Marston, Harry E. Petersen, Jr. and

Leo M. Walsh, Jr.

GERALD A. FORD

GREGORY E. BIRKENSTOCK

Of Counsel