Benzon v. Morgan Stanley Distributors, Inc.

• Citation: 420 F.3d 598
• Decision Date: 22 August 2005
• Docket Number: No. 04-5230.,04-5230.
• Parties: Edward B. BENZON, et al., Plaintiffs-Appellants, v. MORGAN STANLEY DISTRIBUTORS, INC.; Morgan Stanley Investment Advisors, Inc.; Morgan Stanley Investment Management, Inc.; Morgan Stanley Investments, L.P.; Morgan Stanley DW, Inc.; and Morgan Stanley, Defendants-Appellees.
• Court: United States Courts of Appeals. United States Court of Appeals (6th Circuit)

420 F.3d 598

Edward B. BENZON, et al., Plaintiffs-Appellants, v. MORGAN STANLEY DISTRIBUTORS, INC.; Morgan Stanley Investment Advisors, Inc.; Morgan Stanley Investment Management, Inc.; Morgan Stanley Investments, L.P.; Morgan Stanley DW, Inc.; and Morgan Stanley, Defendants-Appellees.

No. 04-5230.

United States Court of Appeals, Sixth Circuit.

Argued: March 18, 2005.

Decided and Filed: August 22, 2005.

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ARGUED:

H. Naill Falls, Jr., Falls & Veach, Nashville, Tennessee, for Appellants. Richard A. Rosen, Paul, Weiss, Rifkind, Wharton & Garrison, New York, New York, for Appellees.

ON BRIEF:

H. Naill Falls, Jr., Falls & Veach, Nashville, Tennessee, Jonathan D. Rose, Boult, Cummings, Conners & Berry, Nashville, Tennessee, for Appellants. Richard A. Rosen, Paul, Weiss, Rifkind, Wharton & Garrison, New York, New York, for Appellees.

Before: CLAY, Circuit Judge; GRAHAM, District Judge.^*

OPINION

CLAY, Circuit Judge.

Plaintiffs in this putative class action, all of whom are investors in Class B shares of Morgan Stanley mutual funds, appeal the district court's order of dismissal for failure to state a claim upon which relief can be granted in connection with their federal law claims¹ against Defendants, Morgan Stanley Distributors, Inc., Morgan Stanley Investment Advisors, Inc., Morgan Stanley Investment Management, Inc., Morgan Stanley Investments L.P., Morgan Stanley DW, Inc., and Morgan Stanley.

Specifically, Plaintiffs appeal the district court's dismissal of: 1) their claim that Defendants violated federal securities law, including § 12 of the Federal Securities Act of 1933, 15 U.S.C. § 77l, § 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78j, and Rule 10b-5(b) of the Securities and Exchange Commission ("SEC") Regulations promulgated under the 1934 Act, by failing to disclose information in their prospectuses regarding the relative value of Class B shares in mutual funds offered by Defendants; 2) their claim that Defendants violated SEC Rule 10b-5(a) and Rule 10b-5(c), by selling Class B shares in mutual funds, which Plaintiffs allege assess unnecessary fees; and 3) their claim that Defendants violated 15 U.S.C. § 77l(a)(2) and SEC Rule 10b-5(b) by failing to disclose a broker compensation scheme which they allege works a conflict of interest. Plaintiffs also appeal from the district court's denial of their motion, filed after the entry of judgment in this case, for leave to file an amended complaint.

For the reasons that follow, we AFFIRM the district court in all respects.

I. BACKGROUND

A. Substantive Facts

1. The Facts Set Forth in the Complaint

This case is before us on an appeal from a dismissal for failure to state a claim upon which relief can be granted, pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure. In reviewing such a dismissal, this Court "must accept all well-pleaded factual allegations of the complaint as true and construe the complaint in the light most favorable to the plaintiff." Inge v. Rock Fin. Corp., 281 F.3d 613, 619 (6th Cir.2002) (citing Turker v. Ohio Dep't of Rehab. & Corr., 157 F.3d 453, 456 (6th Cir.1998)). The facts alleged by Plaintiffs in their second amended complaint are set forth below.

Defendants operate over sixty mutual funds, the shares of which are marketed to U.S. investors. The "Morgan Stanley Funds" are marketed as a "family of mutual funds." Investors are permitted to exchange shares in one Morgan Stanley Fund for shares in another Morgan Stanley fund at no cost. Most Morgan Stanley Fund shares are marketed and sold to investors who have brokerage accounts with Morgan Stanley DW, Inc.

The majority of Morgan Stanley Funds are offered in different share classes, designated as "A," "B," "C," and other share classes. The share classes are for the same underlying portfolio of investments, but each class differs in its expense structure.

For Class A shares in equity funds, Morgan Stanley typically charges a "front-end load," paid at the time of the initial investment. The front-end load is 5.25% for investments less than $25,000, decreases incrementally as the amount of the investment increases, and is eliminated altogether for investments of at least one million dollars. Class A shareholders are charged an annual distribution fee of .25%.

Class B shares, which are at the center of the dispute in this case, are offered with no initial sales charge, but are subject to a "back-end load," or contingent deferred sales charge ("CDSC"), ranging from five percent in the first year the shares are held to one percent in the sixth year. There is no CDSC for Class B shares held for more than six years. Class C shares are also offered with no initial sales charge, but are subject to a CDSC of one percent if sold within a year of purchase. Class C shares never convert to Class A shares. According to Plaintiffs, Morgan Stanley claims to "normally" charge Class B and C shareholders an annual distribution fee of one percent, but in practice many Morgan Stanley funds charge slightly lower annual fees for Class C shares than for Class B shares.

Plaintiffs allege that Class B shares are inferior to Class A and/or C shares for any type of investment strategy, whatever the amount of the investment or intended holding period. We emphasize here that Plaintiffs are not asserting that Class B shares are always inferior to both Class A or Class C shares, but rather that Class B shares are always inferior to at least one of either Class A or Class C shares. In other words, Plaintiffs contend that B shares are never the best option, but not that they are always the worst. Plaintiffs further allege that Defendants promote Class B shares even though they know that Class B investors will pay more fees and earn less profits than if they had chosen, depending on their circumstances, either Class A or Class C shares, and that Defendants knowingly fail to inform investors of this fact.

Plaintiffs also allege that Morgan Stanley earns more money per dollar invested in Class B shares than in other class shares, and that its broker compensation structure creates more attractive incentives for the sale of Class B shares and for the sale of in-house mutual funds generally, but that this information is not disclosed to investors.

Additionally, the complaint alleges facts related to the individual claims of each of the eight named plaintiffs. Because those individual claims are not before us, we will not engage in an extensive discussion of those allegations. It will suffice to note that all of the plaintiffs assert that Morgan Stanley financial advisors inappropriately invested their money in Class B shares, without explaining the differences between the share classes or explaining that Class B shares involved "unnecessary fees," and that they sustained significant losses as a consequence.

2. A Note On The Prospectus

In addition to the facts set forth in the complaint, the district court considered the prospectus at issue in this case.² Ordinarily, when a district court considers evidence outside the pleadings, a 12(b)(6) motion will "be treated as one for summary judgment and disposed of as provided in Rule 56." FED. R. CIV. P. 12(b)(6). However, a written instrument attached as an exhibit to a pleading is considered a part of the pleading, and thus does not fall under the just-cited rule. See FED. R. CIV. P. 10(c). The district court and the parties apparently assumed that the prospectuses attached to the motion to dismiss constitute written instruments, as they all agreed that the prospectuses should be considered, and yet did not suggest that the 12(b)(6) motion was thus converted into a summary judgment motion. We will also consider the prospectuses in our review, as neither party objects and they are obviously central to Plaintiffs' claims that the prospectuses include material omissions and misrepresentations. See I. Meyer Pincus & Assocs. v. Oppenheimer & Co., 936 F.2d 759, 762 (2nd Cir.1991) (court "examine[s] prospectus together with the allegations contained on the face of the complaint" where claims within the complaint are based only on an alleged written misrepresentation appearing within the prospectus).

Many facts disclosed in the prospectus are set forth in the complaint and therefore have already been discussed. We note that Defendants point out in their brief on appeal that, in addition to the facts included in the complaint, the prospectus states that investors in B shares, but not A shares, may make annual withdrawals of up to twelve percent of their investment in B shares without paying a CDSC. The prospectus also states that B shares, unlike C shares, automatically convert to A shares after ten years.

B. Procedural History

Plaintiffs filed their first complaint in this case in the United States District Court for the Middle District of Tennessee on February 24, 2003, asserting class action claims under the federal securities laws on behalf of the named plaintiffs and all others who purchased Class B shares of Morgan Stanley mutual funds between February 25, 1998, and the present. Specifically, the complaint alleged that: 1) Defendants violated § 12(a)(2) of the Federal Securities Act of 1933 ("FSA"), 15 U.S.C. § 77l (a)(2), by failing to disclose material facts necessary to make statements made in connection with the sale of securities not misleading; 2) Defendants violated § 11 of the FSA by omitting material facts in the registration statements of Morgan Stanley's mutual funds necessary to make the statements therein not misleading; 3) Defendants intentionally and/or recklessly employed devices, schemes, and artifices to defraud in violation of § 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78j, and Rule 10b-5(a) of the SEC Regulations promulgated under that Act; 4) Defendants intentionally and/or recklessly omitted to state material facts necessary to make...