Opinion
Civil Action No. 00-1237
July 2, 2002
Ronald B. Rubin, RUBIN MONAHAN, CHARTERED, Rockville MD.
Joel C. Feffer, WECHSLER, HARWOOD, HALEBIAN FEFFER, LLP, New York, NY.
Timothy Michael Monahan, SHAR, ROSEN WARSHAW, L.L.C., Baltimore, MD., for Linda B. Rohrbaugh, plaintiff.
Ronald B. Rubin, Joel C. Feffer, Timothy Michael Monahan, (See above), for Richard Krantz, Plaintiff.
Danial Erickson Loeb, Jonathan M. Jacobs, FRIED, FRANK, HARRIS, RHRIVER JACOBSON, Wahsington DC., for Investment Company Institute, defendant.
MEMORANDUM OPINION
The matter is before the Court on the Motion to Dismiss the Complaint of Defendant the Investment Company Institute. Upon consideration of the motion, opposition, reply, the numerous submissions of supplemental authority, the Motions Hearing held on June 10, 2002, and the entire record herein, the Court grants Defendant's Motion to Dismiss.
I. BACKGROUND
plaintiffs, Linda Rohrbaugh and Richard Krantz, are individual shareholders in three investment companies, namely T. Rowe Price Growth Stock Fund, Fidelity Equity Income II Fund and Fidelity Value Fund. T. Rowe Price Growth Stock Fund is a mutual fund that is advised and managed by T. Rowe Price Associates, Inc. ("TRPA"). Fidelity Equity Income II Fund and Fidelity Value Fund are mutual funds that are advised and managed by Fidelity Management Research Company ("FMRC")
Defendant is the Investment Company Institute ("ICI"), a District of Columbia corporation serving as the national trade association for the investment company industry. ICI's members include approximately 7,700 mutual funds and approximately 500 closed-end funds, as well as the investment advisers to these funds and their principal underwriters. ICI represents nearly 96% of the assets in the investment company industry.
The gravamen of Plaintiffs' Complaint is that Defendant uses membership dues paid by investment companies, including those in which Plaintiff s own share, to engage in activities that benefit investment advisers and injure the interests of investment companies and their investors, such as Plaintiffs, in violation of the Investment Company Act of 1940 ("ICA"), 15 U.S.C. § 80a-17 (d) ("section 17(d)"), § 35(b) ("section 36(b)"). See Compl. ¶¶ 1, 20.
Before turning to the particulars of the Complaint, a brief explanation of the statutory context is in order.
A. The Investment Company Act of 1940
The ICA was originally enacted to protect investors who entrusted their savings to others for expert management and diversification of investments. A central purpose of the ICA was to remedy widespread abuses arising from the conflicts of interest among managers of investment companies, who regularly engaged in self-dealing to advance their private pecuniary interests at the expense of shareholders. Investors had relatively little protection under state law against these abuses, and the ICA was Congress's recognition that a federal response was essential.
See S. Rep. No. 76-1775, at 7 (1940) ("`Self-dealing' — that is, transactions between officers, directors, and similar persons and the investment companies with which they are associated — presented opportunities for gross abuse by unscrupulous persons, through unloading of securities upon the companies, unfair purchases from the companies, the obtaining of unsecured or inadequately secured loans from the companies, etc."); H.R. Rep. No. 76-2639, at 10 (1940) ("In the opinion of the committee, the Securities and Exchange Commission, and the industry itself, this legislation is needed to protect small investors from breaches of trust upon the part of unscrupulous managements and to provide such investors with a regulated institution for the investment of their savings."); see also, United States v. Deutsch, 451 F.2d 98, 108 (2d Cir. 1971), cert. denied, 404 U.S. 1019 (ICA was a response to the "fantastic abuse of trust by investment company management and wholesale victimizing of security holders."); see also Comment, The Investment Company Act of 1940, 50 Yale L.J. 440, 441 (1941) (same).
The ICA addresses mismanagement in the investment company industry in a variety of ways, including registration requirements; disclosure and reporting requirements; anti-pyramiding provisions; assurance of at least a minimum voting control by stockholders on key questions; and direct prohibition of certain practices which are either themselves fraudulent or create serious temptations to fraud.
See, e.g., 15 U.S.C. § 80a-8 (registration); 15 U.S.C. § 80a-29, 80a-44(a) (disclosure and reporting); 15 U.S.C. § 12 (d) (anti-pyramiding); 15 U.S.C. § 80a-1(b)(6), 80-15 (consent of shareholders on key questions, such as changes in advisory agreements).
As the animating concern of the ICA was to minimize conflicts of interest within the mutual fund industry and, in particular, to ensure management's fidelity to its stockholders, there are numerous provisions aimed at this goal. For example, the ICA requires that companies have an independent board of directors and separate investment advisers. The ICA also protects against money managers' conflicts of interest by closely regulating an investment company's relationship with its investment adviser. Plaintiffs' Complaint is predicated on these latter provisions.
Section 10 requires that at least 40% of the board of directors be "disinterested" or unaffiliated with the investment adviser. 15 U.S.C. § 80a-10. To these statutorily disinterested directors, the ICA assigns a host of responsibilities involving supervision of management and financial auditing. This independent director provision has repeatedly been recognized as the "cornerstone of the ICA's effort to control conflicts of interest within mutual funds." Burks v. Lasker, 441 U.S. 471, 482 (1979).
The ICA regulates this relationship by, inter alia, requiring that fees for investment advice and other services be governed by a written contract approved by the directors as well as the shareholders of the investment company, 15 U.S.C. § 80a-15, and strictly regulates most transactions between investment companies and their advisers. 15 U.S.C. § 80a-17.
B. Plaintiffs' Complaint
Plaintiffs allege that ICI is using membership dues to engage in activities that ultimately injure the interests of investment companies and benefit investment advisers. See Compl. ¶ 20 ("Defendant ICI is using funds provided by investment companies (and indirectly, by the public investors in investment companies, such as plaintiffs) to advance the interests of investment advisers.")
Specifically, Plaintiffs allege that ICI, a trade association, is "dominated" by investment advisers "who control the affairs of the ICI through, among other things, their control over the ICI's governing body . . . the Board of Governors." Compl. ¶ 8
In support of their Complaint, plaintiffs allege that "in 1997, 1998, and 1999, employees or representatives of investment advisers have held more than 80% of the seats on the ICI's Board of Governors" and that "apart from the ICI's president, the entire membership of the ICI's Executive Committee is made [sic] of employees or representatives of investment advisers." Compl. ¶ 9.
Plaintiffs further allege that "such control allows the investment advisers not only to select the officers and other key employees of the ICI but also to determine its policy agenda vis-a-vis Congress, the SEC and the courts in which the ICI regularly files brief[s]." Compl. ¶ 10.
Plaintiffs maintain that "investment advisers run the ICI for their own benefit despite that [sic] fact that more than 50% of the ICI's funding comes from fees paid by investment companies . . ." Compl. ¶ 11.
Plaintiffs aver, for example, that during ICI's fiscal year 1998, approximately "79% of defendant's total revenue was derived from membership dues and assessments, most of which was provided by mutual funds. Yet . . . 39 of the 45-member Board of Governors of defendant, or 87%, were employed by, or were principals of, investment advisers." Compl. ¶ 13.
Plaintiffs believe that Defendant's conduct violates sections 17(d) and 36(b) of the ICA.
1. Section 17(d)
Section 17(d) prohibits joint transactions by an investment company and an "affiliated person" of such company, such as an investment adviser, in contravention of rules prescribed by the Securities Exchange Commission ("SEC"). Section 17(d) provides in pertinent part:
(d) Joint or joint and several participation with company in transactions
It shall be unlawful for any affiliated person of or principal underwriter for a registered investment company or any affiliated person of such a person. . . . acting as principal to effect any transaction in which such registered company, or a company controlled by such registered company, is a joint or a joint and several participant with such person, principal underwriter, or affiliated person, in contravention of such rules and regulations as the Commission may prescribe for the purpose of limiting or preventing participation by such registered . . . company on a basis different from or less advantageous than that of such other participant.15 U.S.C. § 80a-17(d).
Pursuant to this statutory mandate, the SEC promulgated Rule 17d-1, which requires that an application be filed and approved by the SEC before a transaction described in section 17(d) may be consummated. See 17 C.F.R. § 270.17d-1(a)-(c).
Plaintiffs allege that ICI is an "affiliated person" of investment advisers "as a result of investment advisers' domination and control over the entire ICI apparatus." Compl. ¶ 19. Plaintiffs also allege that ICI is a "joint transaction" in which investment companies participate on a "basis different from or less advantageous than" investment advisers. Compl. ¶ 25.
Plaintiffs plead their section 36(b) claim in the alternative because that section prohibits claims for any conduct covered by section 17. Section 36(b)(4) provides in pertinent part: "This subsection shall not apply to compensation or payments made in connection with transactions subject to [section 17] of this title, or rules, regulations, or orders thereunder. . . ." 15 U.S.C. § 80a-35 (b)(4)
Plaintiffs' other claim arises under section 36(b) of the ICA, which creates an express federal remedy for an investment adviser's breach of fiduciary duty related to fees paid by an investment company to that adviser.
Specifically, section 36(b) provides:
The investment adviser of a registered investment company shall be deemed to have a fiduciary duty with respect to the receipt of compensation for services, or of payments of a material nature, paid by such registered investment company, or by the security holders thereof, to such investment adviser or any affiliated person of such investment adviser. An action may be brought under this subsection by the Commission, or by a security holder . . . against such investment adviser, or any affiliated person of such investment adviser . . . for breach of fiduciary duty in respect of such compensation or payments paid by such registered investment company. to such investment adviser or person.15 U.S.C. § 80a-35 (b).
plaintiffs maintain that ICI is an "affiliated person" of investment advisers to whom investment companies make "payments, West Page" in the form of membership dues. Compl. ¶ 31. Plaintiffs claim ICI has breached its fiduciary duty under this section because it uses those dues to pay for "operations primarily benefit[ing] investment advisers, even when their interests conflict with the interests of investment companies." Compl. ¶ 32.
Plaintiffs want this Court to award (1) "actual damages resulting from the breach of fiduciary duty" under section 36(b) up to and including "the amount of. . . . payments received" by defendant from investment companies; (2) a declaratory judgment that Defendant violated either ICA section 17(d) or ICA section 36(b); and (3) injunctive relief directing Defendant to comply with the ICA and to cease accepting payments from registered investment companies. See Compl. ¶¶ 33-35.
II. STANDARD OF REVIEW
"[A] complaint should not be dismissed for failure to state a claim unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46 (1957); Davis v. Monroe County Rd. of Educ., 119 S.Ct. 1661, 1676 (1999). The factual allegations of the complaint must be presumed true and liberally construed in favor of the plaintiff. Shear v. National Rifle Ass'n of Am., 606 F.2d 1251, 1253 (D.C. Cir. 1979).
III. ANALYSIS
As explained above, the heart of Plaintiffs' Complaint is that Defendant ICI is using membership dues paid partly by investment companies, including the three companies in which Plaintiffs own shares, to finance activities that ultimately inure to the benefit of investment advisers at the expense of investment companies. For the reasons discussed below, the Court concludes that Plaintiffs' Complaint fails to state a claim under either sections 17(d) or 36(b) of the ICA.
A. The Case Must Be Dismissed Because Plaintiffs Fail to Allege that Defendant Is An "Affiliated Person" Within the Meaning of Sections 17(d) or 36(b).
Both sections 17(d) and 36(b) regulate conduct between investment advisers, investment companies and any "affiliated persons" thereof. Plaintiffs concede that ICI is neither an "investment company" nor an "investment adviser," but contend that it is an "affiliated person." Defendant argues that it is not an "affiliated person" and therefore not subject to either provision of the ICA.
1. Sections 17(d) and 36(b) Require Plaintiffs To Show That ICI Is An "Affiliated Person" of TRPA and FMRC.
As Plaintiffs themselves recognize, to state a claim under either section 17(d) or 36(b), they must plead that the ICI is an "affiliated person" of the particular advisers to Plaintiffs' mutual funds, namely TRPA and FMRC. It is not enough for Plaintiffs to plead that ICI is an affiliated person of the investment company and investment adviser industry as a general matter. See Def.'s Mot. to Dismiss ("Def.'s Mot.") at 17-19; Pls.' Opp'n to Def.'s Mot. to Dismiss ("Pls.' Opp'n") at 30-33 (discussing how ICI is an affiliate of T. Rowe Price and Fidelity).
Indeed, this pleading requirement is evident from the statutory language. Section 36(b) provides that "an action may be brought by a security holder of such registered investment company on behalf of such company, against such investment adviser, or any affiliated person of such investment adviser (emphasis added)." Similarly, Section 17(d) makes it unlawful "for an affiliated person of . . . a registered investment company . . . or any affiliated person of such a person . . . to effect any transaction in which such registered company, is a joint . . . participant with such person . . . in contravention of [SEC rules]" (emphasis added). Thus, the plain language of sections 36(b) and 17(d) require Plaintiffs to plead that ICI is an affiliated person of TRPA and FMRC.
Upon careful review of the Complaint, it is clear that Plaintiffs have failed to meet their pleading burden. They have alleged that ICI is affiliated with the investment adviser industry generally. See Compl. ¶¶ 19, 25, 31. However, nowhere have Plaintiffs alleged that Defendant was an "affiliated person" of the advisers to their particular funds, namely FMRC and TRPA. Nor have Plaintiffs sought leave to amend their Complaint since the time they filed it over two years ago in May of 2000.
In fact, Plaintiffs' Complaint contains only three paragraphs about the particular funds in which they own shares. See Compl. ¶¶ 16-18. These paragraphs contain no mention of whether ICI is an "affiliated person."
2. ICI Is Not An "Affiliated Person" Because There Are No Allegations That TRPA and FMRC "Control" ICI
Even if the allegation that ICI is affiliated with investment advisers generally could be read as an assertion that ICI is affiliated with FMRC and TRPA in particular, Plaintiffs would still fail to meet their pleading burden.
In order to properly plead that ICI is an "affiliated person" of TRPA and FMRC, Plaintiffs must put forward facts in support of the elements establishing an "affiliated" relationship. The ICA explicitly defines an "affiliated person" as, inter alia: "(C) any person directly or indirectly controlling, controlled by, or under common control with, such other person . . ." 5 U.S.C. § 80a-2(a)(3)(C). The term "control," in turn, is defined under the ICA as "the power to exercise a controlling influence over the management or policies of a company, unless such power is solely the result of an official position with such company." 15 U.S.C. § 80a-2(a)(9). The plain language of the ICA therefore requires Plaintiffs to plead facts showing that ICI is somehow "controlled by" FMRC and TRPA.
Upon review of the Complaint, it is apparent that it contains absolutely no allegations that ICI is "controlled by" FMRC and TRPA. While there are allegations that a total of four FMRC and TRPA executives held official positions with the ICI over a three year period, Plaintiffs have not alleged that FMRC and TRPA "controlled" the ICI through these positions. Nor could they.
Plaintiffs argue in their Opposition that ICI is controlled by T. Rowe Price and Fidelity, but do not assert control in their Complaint, Ordinarily, absent a formal motion to an amend the complaint, a court does not treat the contents of an opposition to a motion to dismiss as an amendment to a complaint. See Confederate Memorial Association v. Hines, 995 F.2d 295, 399 (D.C. Cir. 1993); Ali v. District of Columbia, 278 F.3d 1, 8 (D.C. Cir. 2002).
The Complaint states that the: (1) Vice Chairman of the Board of TRPA served on the ICI's Board of Governors and the ICI's Executive Committee in 1997 and 1999. See Compl ¶ 16; (2) the President of FMRC served on the ICI's Board of Governors and the ICI's Executive Committee in 1997, 1998, and 1999. See Compl. ¶ 17; and (3) the General Counsel of TRPA served as the Chair of the ICI's Standing Committee on SEC Rules, while the president served as the Chair of the ICI's Standing Committee on Direct Marketing Practices. See Compl. ¶ 18.
Plaintiffs argue in their Opposition, however, that the positions held within ICI by TRPA and FMRC executives demonstrate control and therefore an "affiliate" relationship. See Pls.' Opp'n at 13 ("Here, plaintiffs allege that defendant is an affiliate of the investment adviser industry generally and, in view of the significant positions held by their executives in defendant, an affiliate of T. Rowe Price and Fidelity, in particular.").
First, the ICA contains the following exception to the definition of "control": "`control' means the power to exercise a controlling influence over the management or policies of a company, unless such power is solely the result of an official position with such company." 15 U.S.C. § 80a-2 (a)(9). Thus, in order to establish "control" over the ICI, plaintiffs must allege something other than the fact that TRPA and FMRC executives held "official positions" within ICI. Plaintiffs have failed to include any allegations that TRPA and FMRC asserted a "controlling influence" over the ICI in ways that are not "solely the result of [their] official position" as board members with ICI.
For example, there are no allegations that TRPA and. FMRC possess the "legal power" to control the policies of the ICI; have the authority to select ICI's other board members or influence board member decisions; or have an economic relationship with ICI, its board members or the affiliates of its board members. See, e.g., Phillips v. SEC, 388 F.2d 964, 972 (2nd Cir. 1968) (stock sellers who selected eight of ten directors and all but one major officer of parent controlling subsidiary that had investment advisory contracts with mutual funds had retained a "controlling influence" in parent). See, e.g., Acampora v. Birkland, 220 F. Supp. 527, 543 (D. Col. 1963) (plaintiff could not establish that fund was "controlled" by adviser because there was insufficient evidence that board members of fund benefited financially from relationship with adviser, even though board members were personal friends of adviser); Coran v. Thorpe, 203 A.2d 620, 623 (Del.Ch. 1964) (proof of a relationship resulting in an economic benefit or interest is a factor in determining whether a person is controlled within meaning of ICA).
Second, the text, statutory context, and legislative history of the ICA make clear that Congress intended an "affiliated person" or person with a "controlling" influence to refer specifically to those individuals or companies with "voting control" or ownership in an investment company. These persons were typically officers, directors, and advisers of investment companies, as well as brokerage firms, investment banks, and any other entities who were in a position to control directly the management of investment companies. Those terms have never been applied to ICI, or to any similar entity or person, i.e., an entity without power to influence the management of investment companies through voting or ownership control.
For example, the ICA provision defining "affiliated person" focuses primarily on those persons with voting or ownership control:
(A) any person directly or indirectly owning, controlling, or holding with power to vote, 5 per centum or more of the outstanding voting securities of such other person; (B) any person 5 per centum or more of whose outstanding voting securities are directly or indirectly owned, controlled, or held with power to vote, by such other person; . . . (D) any officer, director, partner, copartner, or employee of such other person; (E) if such other person is an investment company, any investment adviser thereof or any member of an advisory board thereof;.15 U.S.C. § 80a-2 (a)(3) (emphasis added). Similarly, the ICA provision defining "control" is concerned primarily with voting and ownership control:
Control means the power to exercise a controlling influence over the management or policies of a company, unless such power is solely the result of an official position with such company.
Any person who owns beneficially, either directly or through one or more controlled companies, more than 25 per centum of the voting securities of a company shall be presumed to control such company. Any person who does not so own more than 25 per centum of the voting securities of any company shall be presumed not to control such company.15 U.S.C. § 80a-2(a)(9) (emphasis added).
The legislative history confirms this interpretation of "control." See, e.g., H.R. Rep. No. 76-2639, at 17 (explaining that sections 17(a) and (d), which on their face proscribe certain conduct between investment companies and their "affiliates," are intended to reach conduct occurring between investment companies and their "officers, directors, investment advisers, and principal underwriters."). See generally S. Rep. No. 76-1775, at 7, 14 (discussing sections 17 and 10 and their intended effect on the conduct of investment advisers, bankers, brokers, officers, and directors).
Finally, the case law reinforces the view that "control" over an entity means voting control of, or ownership in, that entity. See, e.g., Fogel v. Chestnutt, 296 F. Supp. 530 (S.D.N.Y 1969) (issue of fact existed as to whether defendant corporation "controlled" investment company since defendant owned 166 out of 350 shares of voting stock of a second corporation, which, in turn, held over 27% of voting stock of investment company); Entel v. Allen, 270 F. Supp. 60, 65 (S.D.N.Y. 1967) (plaintiffs' allegations that Defendant was the largest single stockholder raised question of fact as to whether Defendant controlled company)
Third, Plaintiffs' allegations, when taken together, establish that ICI could not be controlled by TRPA and FMRC. ICI has over 8,000 members, with forty-five people sitting on its Board. Plaintiffs' suggestion that FMRC and TRPA could somehow "control" ICI solely because an executive from each served on the forty-five member Board — each with only one vote out of forty-five possible votes — is, without more, insufficient as a matter of law to establish "a controlling influence" over the "management and policies" of the ICI Board.
In sum then, because Plaintiffs have not put forward any facts showing that ICI is "controlled" by TRPA and FMRC, and therefore an "affiliated person," they have failed to state a cognizable claim under either section 17(d) or 36(b)
B. Plaintiffs Cannot Bring a Section 17(d) Claim.
Even assuming ICI were an "affiliated person" of the advisers to plaintiffs' funds, their section 17(d) claim still fails for two additional reasons. First, plaintiffs lack standing to bring a direct claim against ICI. Second, plaintiffs have not alleged a "joint transaction."
1. plaintiffs Lack Standing to Bring A Direct Claim
Plaintiffs are not themselves members of ICI. Rather, they are shareholders in three mutual funds, which, in turn, are members of ICI. Even though Plaintiffs are not direct members of ICI, they have brought their claim against Defendant directly.
Whether they can bring their claim directly against Defendant, as they contend, or whether their claim is actually "derivative," i.e., brought on behalf of the investment company and therefore subject to a demand requirement, is a question that is determined by state law. See, e.g., Strougo, 282 F.3d 162 (2nd Cir. 2002) (Maryland law, rather than uniform federal law, applies to question of whether plaintiff's ICA claim is direct or derivative); Lapidus v. Hecht, 232 F.3d 679, 682 (9th Cir. 2000) ("[We] rely upon state law to determine whether the plaintiffs' claims are direct or derivative."); Kamen, 500 U.S. at 108-111 (holding that law of the state of incorporation provides the rule of decision on question of whether a plaintiff who has brought a derivative suit under the ICA can avail herself of the "demand futility" exception to the demand requirement)
To pursue a derivative claim in federal court, a plaintiff must either make a "demand" on the board of directors of the injured corporation that the corporation initiate litigation to remedy its injury, or must allege that it would be futile to make such demand, because, for example, the board of directors could not act in an unbiased or objective fashion. See Fed.R.Civ.P. 23.1.
Plaintiffs' principal argument in support of standing is that the Court should not apply state law to determine the question of whether a claim is direct or derivative, but rather should essentially fashion some uniform federal standard that derives from the ICA itself. See Pls.' Opp'n at 25-27.
There are, of course, some instances in which federal law would govern a question of shareholder standing, such as when state law conflicts with the policy goals of the underlying federal law. See Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 108 (1991) (strong presumption that state corporation law applies to shareholder standing "unless particular state law in question is inconsistent with the policies underlying the federal statute.") That concern, however, is not present here.
Nearly every court to evaluate the question of whether federal or state law governs questions of shareholder standing under the ICA has determined that state law applies. See Bassini, 282 F.3d at 168 (collecting cases). Nor have Plaintiffs offered any basis upon which to find that the policy goals of the ICA conflict with the applicable state laws in this case.
Moreover, Plaintiffs cannot rely on Monheit v. Carter, 376 F. Supp. 334 (S.D.N.Y. 1974), and Langner v. Brown, 913 F. Supp. 260 (S.D.N.Y. 1996), in support of the view that a section 17(d) claim may be brought directly. Neither case addressed whether a 17(d) claim could be brought directly. In fact, in Monheit, the court refrained from deciding whether plaintiff's section 17(d) claim could proceed, and instead exercised pendant jurisdiction over the state law claim. Monheit, 376 F. Supp. at 342.
Plaintiffs allege that their mutual funds are organized in Maryland and Massachusetts. Under both states' laws, shareholders may bring suit directly only where they "suffer a distinct injury, i.e., an injury that does not derive from the corporate injury itself." See Bassini, 282 F.3d at 171 (discussing Maryland law); Lapidus, 232 F.3d at 683 (discussing Massachusetts law). Furthermore, under Massachusetts law, there is the additional requirement that a direct suit is possible only upon a showing that a plaintiff's injury is "distinct from that suffered by shareholders generally." Lapidus, 232 F.3d at 683.
A direct action may be maintained under Maryland law even where such injury is "undifferentiated," i.e., not separate and distinct from that of other stockholders. Bassini, 282 F.3d at 171.
An examination of Plaintiffs' Complaint reveals that they are not entitled to assert claims directly under either state's law. Their claim is that their mutual funds are paying membership dues that are too high and that benefit advisers rather than investment companies. Not only have Plaintiffs failed to allege any injury distinct from that allegedly suffered by other shareholders generally, but any such injury, assuming there is one, is to the investment companies, which are the parties paying those membership dues. Furthermore, the remedy Plaintiffs seek, namely restitution, would result in reimbursement to the investment company, not the individual shareholders or to plaintiffs.
This case is simply not the paradigmatic distinct shareholder claim that was recently before the Second Circuit in Bassini, where the act that allegedly harmed the shareholders actually increased the assets of the mutual fund. See Bassini, 282 F.3d at 175. Nor is this a case involving a shareholder's distinct and separate contractual right, such as the right to vote. See Lapidus, 232 F.3d at 683.
Plaintiffs' alleged injury derives solely from the fact that their mutual funds, along with all the other mutual fund members of ICI, are paying membership dues that are not being used to further the best interests of investment companies. plaintiffs have alleged no independent injury. Accordingly, Plaintiffs' claims are derivative in nature, and Plaintiffs lack standing to maintain their action directly under section 17(d).
2. Plaintiffs Have Failed to Plead a "Joint Transaction" Under Section 17(d).
Plaintiffs' section 17(d) claim also fails because Plaintiffs have failed to allege a "joint transaction" as required by that subsection.
As explained above, section 17(d) regulates joint transactions between investment companies and their affiliates. Specifically, section 17(d) makes it "unlawful for any affiliated person of . . . a company . . . to effect any transaction in which such company . . . is a joint or joint and several participant with such person . . . in contravention of such rules and regulations as the Commission may prescribe . . ." 15 U.S.C. § 80a-17(d).
Nowhere in the Complaint is there an allegation that the ICI engaged in an activity on a "joint basis" together with Plaintiffs' mutual funds or with any other entity, for that matter. Although the Complaint states that "defendant ICI [itself] is a `joint enterprise' or `joint arrangement' between investment companies and their investment advisers," Compl. ¶ 25. this allegation is insufficient to state a claim for several reasons.
First, in light of plaintiffs' other allegations, paragraph 25 of the Complaint results in an absurd reading of section 17(d) The Complaint also contains the allegation that ICI is the "affiliated person" of investment companies and advisers. Compl. ¶ 19. Defendant ICI cannot be the "affiliated person" and, at the same time, the "joint transaction" between the "affiliated person" and the "investment company." It is hardly surprising that the Court has not discovered a single case that would permit the named Defendant or "affiliated person" to simultaneously serve as the challenged "joint transaction."
Apparently recognizing the untenability of alleging that ICI is both an "affiliated person" and the "joint transaction," Plaintiffs emphasize in their Opposition that ICI's "lobbying and litigation" activities are the challenged "transactions." See Pls.' Opp'n at 23.
Even under this revised theory, Plaintiffs' claim fails, as there is still no allegation that such activities have been undertaken on a joint basis with another entity, as required under section 17(d). Plaintiffs have not alleged that ICI is operating in conjunction with any particular investment company or adviser, for example. Nor have Plaintiffs pointed to any particular instance of litigation or lobbying that they believe violates section 17(d)
Second, Plaintiffs are essentially challenging activities that have never been considered the type of transactions subject to section 17(d). Although the ICA offers no clear definition of the term "joint transaction," section 17(d) typically covers cases where, for example, an investment company and its affiliates engage in a discrete undertaking together, such as the purchase or trade of securities.
Section 17(d) has been applied to situations where, for example, an investment company plans to purchase securities in a corporation for which an affiliate of the investment company was planning to make a take-over bid. See SEC v. Talley Industries, Inc., 399 F.2d 396 (2nd Cir. 1968). Other examples of joint transactions subject to scrutiny under this section have included joint trading by directors of mutual funds in securities that are being sold, bought, or held by the mutual funds themselves. See e.g., Cambridge Fund, Inc. v. Abella, 501 F. Supp. 598 (S.D.N.Y. 1980).
By contrast, Plaintiffs' contention is that section 17(d) should proscribe the full gamut of litigation and lobbying activities undertaken by a trade association on behalf of both its investment company and investment adviser members. Under Plaintiffs' view, ICI would need to seek SEC approval each and every time it engaged in any type of activity, such as writing a letter to Congress.
Rule 17d-1 requires an application to be filed and approved by the Commission before a section 17(d) transaction may be consummated. See 17 C.F.R. § 270.17d-1.
Accordingly, for the foregoing reasons, the Court finds that Plaintiffs cannot state a cognizable section 17(d) claim because they failed to allege a joint transaction between ICI and Plaintiffs' mutual funds and/or advisers.
C. Plaintiffs Fail to State A Claim Under 36(b).
As with Plaintiffs' section 17(d) claim, their section 36(b) claim fails for reasons independent of the fact that ICI is not an "affiliated person." Their claim fails because Plaintiffs did not allege a breach of fiduciary duty with respect to excessive compensation or payment.
Section 36(b) provides in pertinent part:
An action may be brought . . . by a security holder of such registered investment company on behalf of such company, against such investment adviser, or any affiliated person of such investment adviser . . . who has a fiduciary duty concerning such compensation or payments, for breach of fiduciary duty in respect of such compensation or payments paid by such registered investment company . . . to such investment adviser or person.
This language makes clear that section 36(b) provides an express remedy to shareholders for breaches of certain fiduciary duties by investment advisers. Section 36(b) does not apply to every alleged breach of fiduciary duty by an investment advisor, however. As plaintiffs themselves concede, most cases involve claims of excessive advisory fees. See Pls.' Opp'n at 35 ("actions against investment advisers alleging unreasonable advisory fees are by far the most common type of action under Section 36(b)")
Indeed, nearly every case under 36(b) has concerned a claim for excessive advisory fees. See, e.g., Meyer v. Oppenheimer Mgmt. Corp., 895 F.2d 861, 866 (2nd Cir. 1990); Kirnsk v. Fund Asset Mgmt., Inc., 875 F.2d 404, 409 (2nd Cir. 1989); Kalish v. Franklin Advisers, 742 F. Supp. 1222, 1227 (S.D.N.Y. 1990), aff'd 928 F.2d 590 (2nd Cir. 1991); Strougo v. BEA Associates, No. 98-3725, 1999 WL 147737, at *4-5 (S.D.N.Y. Mar. 18, 1999); In re Nuveen, 94-C-360, 1996 WL 328006, at *13 (N.D. Ill. June 11, 1996).
Plaintiffs concede that they are not challenging advisory fees but rather, membership dues. Nevertheless, they contend that their challenge is cognizable under section 36(b) because the plain language of that section permits recovery for "payments", i.e., "an action may be brought . . . against such investment adviser, or any affiliated person of such . . . who has a fiduciary duty concerning such compensation or payments . . ." 15 U.S.C. § 80a-36 (b). They argue that "payments" could be read to cover membership dues paid to ICI. Their argument fails for several reasons.
First, the legislative history makes clear that the term "payment" was intended by Congress to cover those situations where an investment adviser would try to evade liability for charging excessive fees by arranging for payments to be made to an affiliated person of the adviser rather than directly to the adviser.
The Senate Report accompanying section 36(b) explains that:
The fiduciary duty of the investment adviser is extended not only to compensation paid to the investment adviser but also to payments made by the investment company or its shareholders to an affiliated person of the investment adviser. This provision affords a remedy if the investment adviser should try to evade liability by arranging for payments to be made not to the adviser itself but to an affiliated person of the adviser.
S. Rep. No. 91-184, at 16 (1969), reprinted in 1970 U.S.C.C.A.N. 4897, 4910-11.
Second, the case law is unanimous that some connection to a claim for excessive fees is required under section 36(b); that is, a section 36(b) claim must either involve a challenge to excessive advisory fees per se or to conduct that results in excessive advisory fees. Indeed, the legislative history reveals that in fashioning 36(b), Congress was uniquely concerned with providing a remedy in federal court for fee arrangements or contracts that resulted in excessive compensation to investment advisors.
Some courts take a narrow view of section 36(b), and limit 36(b) claims exclusively to challenges to the fees themselves. See, e.g., Migdal v. Rowe Price-Fleming Int'l, Inc., 248 F.3d 321, 328 (4th Cir. 2001) ("Plaintiffs contend that Section 36(b)'s private right of action is not limited solely to claims for excessive compensation. . . . Plaintiffs' position, however, is not supported by either the statutory text or the caselaw. . . . As the statutory text indicates, Section 36(b) is sharply focused on the question of whether the fees themselves were excessive . . . Congress passed Section 36(b) primarily to address the concern that `advisers' fees . . . may have become unreasonably high") (internal citations omitted); Gartenberg v. Merrill Lynch Asset Mgmt., Inc., 694 F.2d 923, 928 (2nd Cir. 1982) (to violate Section 36(b), "the adviser-manager must charge a fee that is so disproportionately large that it bears no reasonable relationship to the services rendered.").
Other courts have taken a broader view, and permitted challenges under section 36(b) for breaches of fiduciary duty as long as they result in or pertain to excessive fees. See, e.g., Green v. Fund Asset Management, L.P. 286 F.3d 682, 684, 686 (3rd Cir. 2002) (affirming dismissal of 36 (b) claim where plaintiff challenged "fee arrangement in which a fund's investment advisors had an incentive to maximize leverage in order to increase their advisory fees" because plaintiff failed to allege any instance of a breach of fiduciary duty, such as where "advisors improperly failed to de-leverage the Funds in order to maximize their fees"); Gafland v. Chestnutt, 545 F.2d 807, 811-812 (2nd Cir. 1976) (permitting a claim under 36(b) against an investment adviser who withheld information regarding his proposed contract for management fees, which permitted him to obtain a higher fee at the expense of the fund).
The Senate Report explains that the purpose of Section 36(b) was limited to providing a mechanism by which the fairness of management contracts and fee arrangements could be tested in federal court:
In the case of management fees, the committee believes that the unique structure of mutual funds has made it difficult for the courts to apply traditional fiduciary standards in considering questions concerning management fees . . . Therefore, in view of the potential conflicts of interest involved in the setting of these fees, there should be effective means for the courts to act where mutual fund shareholders of the SEC believe there has been a breach of fiduciary duty.
S. Rep. No. 91-184, at 2 (1969), reprinted in 1970 U.S.C.C.A.N. 4897, 4901.
The Senate Report goes on to explain that: "The sole purpose [of 36 (b)] is to specify the fiduciary duty of the investment adviser with respect to compensation and provide a mechanism for court enforcement of this duty. . . . It authorize[s] the court to determine whether the investment adviser has committed a breach of fiduciary duty in determining or receiving the fee." Id. at 6 (emphasis added).
Plaintiffs admit that their challenge to membership dues has absolutely no connection to excessive advisory fees. Moreover, they have cited no case in which section 36(b) has been applied to a claim that does not involve a connection to excessive advisory fees. Nor has the Court uncovered any such case.
Plaintiffs attempt to rely on the following dicta in In re Nuveen Fund Litig., 1996 WL 328006, at 15: "36(b) may regulate more than the mere terms of the fee arrangement between the investment adviser and the investment company." In fact, the district court dismissed the complaint for failure to challenge the fee arrangement, explaining:
Section 36(b) only imposes a direct fiduciary duty on the investment adviser with `respect to the receipt of compensation or payment for services.' It requires that the investment adviser not charge disproportionate fees for the services it provides, that it actually provides the services for which it obtains fees, . . . the Complaint does not challenge the fee arrangement between the Advisor and the Funds . . . [.]
Id. at 15.
In Green v. Nuveen Advisory Corp., 186 F.R.D. 486, 491 (N.D. Ill. 1999), the court stated that: "the plain language of Section 36(b) does not specify that the breach of fiduciary duty must relate to excessive compensation." Id. at 491. However, Green involved a claim challenging compensation paid to an investment advisor, and therefore did not rule on the issue of whether 36(b) applies beyond excessive payments.
Accordingly, given that Plaintiffs have failed to assert any facts alleging a breach of fiduciary duty related to advisory fees, the Court concludes that Plaintiffs do not have a cognizable section 36(b) claim.
IV. CONCLUSION
In view of the foregoing, Defendant's Motion to Dismiss is granted, and Plaintiffs' claims are dismissed. An Order will issue with this Opinion.
ORDER
The matter is before the Court on the Motion to Dismiss the Complaint of Defendant the Investment Company Institute. Upon consideration of the motion, opposition, reply, the numerous submissions of supplemental authority, the Motions Hearing held on June 10, 2002, and the entire record herein, for the reasons stated in the accompanying Memorandum Opinion, it is hereby
ORDERED, that Defendant's Motion to Dismiss is granted; it is further
ORDERED, that this case is dismissed.