779 F.3d 1036 (9th Cir. 2015), 11-17187, Northstar Financial Advisors, Inc. v. Schwab Investments
|Citation:||779 F.3d 1036, 91 Fed.R.Serv.3d 315|
|Opinion Judge:||KORMAN, District Judge:|
|Party Name:||NORTHSTAR FINANCIAL ADVISORS INC., on behalf of itself and all others similarly situated, Plaintiff-Appellant, v. SCHWAB INVESTMENTS; MARIANN BYERWALTER, DONALD F. DORWARD, WILLIAM A. HASLER, ROBERT G. HOLMES, GERALD B. SMITH, DONALD R. STEPHENS, MICHAEL W. WILSEY, CHARLES R. SCHWAB, RANDALL W. MERK, JOSEPH H. WENDER and JOHN F. COGAN, as Trustees|
|Attorney:||Robert C. Finkel (argued), Wolf Popper LLP, New York, New York; Joseph J. Tabacco, Jr., Christopher T. Heffelinger, and Anthony D. Phillips, Berman DeValerio, San Francisco, California; Marc J. Gross, Greenbaum Rowe Smith & Davis LLP, Roseland, New Jersey, for Plaintiff-Appellant. Karin Kramer an...|
|Judge Panel:||Before: Richard R. Clifton and Carlos T. Bea, Circuit Judges, and Edward R. Korman, Senior District Judge.[*] Opinion by Judge Korman; Dissent by Judge Bea. BEA, Circuit Judge, dissenting:|
|Case Date:||March 09, 2015|
|Court:||United States Courts of Appeals, Court of Appeals for the Ninth Circuit|
Argued and Submitted, San Francisco, California: May 17, 2013.
[Copyrighted Material Omitted]
Appeal from the United States District Court for the Northern District of California. D.C. No. 5:08-cv-4119-LHK. Lucy H. Koh, District Judge, Presiding.
The panel reversed in part and vacated in part the district court's dismissal of a shareholder class action on behalf of investors who alleged that the managers of the Schwab Total Bond Market Fund, a mutual fund, failed to adhere to the Fund's fundamental investment objectives of seeking to track a particular index and not over-concentrating its investments in any one industry. The Fund was created by Schwab Investments (" Schwab Trust" ), a " Massachusetts trust," and its investment adviser was Charles Schwab Investment Management, Inc. (" Schwab Advisor" ).
The named plaintiff was Northstar Financial Advisors, Inc., a registered investment advisery and financial planning firm that managed accounts on behalf of investors and had over 200,000 shares of the Fund under its management. The panel held that Northstar had standing because it filed a supplemental pleading under Federal Rule of Civil Procedure 15(d) after obtaining an assignment of claim from an investor in the Fund.
The panel reversed the district court's dismissal of breach of contract claims. It held that the Fund shareholders' adoption of the investment objectives added a structural restriction on the power conferred on the Fund trustees that could only be changed by a vote of the shareholders, and was subsequently reflected in the Fund's registration statements and prospectuses, and thus created a contract between the trustees and Fund investors.
Vacating the dismissal of fiduciary duty claims, the panel held that the operative complaint stated a claim that the Schwab defendants breached their fiduciary duties by failing to ensure that the Fund was managed in accordance with the fundamental investment objectives and by changing the Fund's fundamental investment objectives without obtaining required shareholder authorization. The panel held that the trustees owed a fiduciary duty to the shareholders, rather than the Fund, and so Northstar was not required to proceed by way of a derivative action.
The panel reversed the dismissal of a third-party beneficiary breach of contract claim. It held that Northstar adequately alleged that the investors were third-party beneficiaries of the Investment Advisory and Administration Agreement between Schwab Trust and Schwab Advisor.
The panel declined to address the effect of the Securities Litigation Uniform Standards Act on the various common law causes of action. It remanded the case to the district court.
Dissenting, Judge Bea wrote that Northstar lacked standing because, at the commencement of the action, it did not own any fund shares, nor did it own any claims of others who had suffered losses the defendants had allegedly caused.
The Investment Company Act (" ICA" ) establishes a comprehensive federal regulatory framework applicable to mutual funds. See 15 U.S.C. § 80a-1 et seq. More specifically, it provides that a mutual fund's registration statement must recite all investment policies that can be changed only by shareholder vote. 15 U.S.C. § 80a-8(b). Deviation from policies so designated violates § 13(a) of the ICA. 15 U.S.C. § 80a-13(a)(3). This appeal arises out of a class action on behalf of investors who allege that the managers of the Schwab Total Bond Market Fund (" Fund" ) failed to adhere to two of the Fund's fundamental investment objectives; namely, that it seek to track a particular index and that it not over-concentrate its investments in any one industry. These objectives, which could only be changed by a vote of the shareholders, were adopted by a shareholder vote and subsequently incorporated in the Fund's registration statement and prospectuses.
On a previous interlocutory appeal, we rejected the argument that this conduct gave rise to an implied private right to enforce § 13(a) of the ICA. Northstar Fin. Advisors, Inc. v. Schwab Invs., 615 F.3d 1106 (9th Cir. 2010). On this appeal from an order granting a motion to dismiss a Third Amended Complaint, the principal issues are whether the investors have stated valid causes of action for breach of contract, breach of fiduciary duty, and breach of an agreement to which the investors claim to be third-party beneficiaries.
Schwab Investments (" Schwab Trust" ) is an investment trust organized under Massachusetts law. Such a trust, which is often referred to generically as a " Massachusetts trust," even when not created under Massachusetts law, is an unincorporated business organization created by an instrument of trust by which property is to be held and managed by trustees for the benefit of persons who are or become the holders of the beneficial interests in the trust estate. See Hecht v. Malley, 265 U.S. 144, 146-47, 44 S.Ct. 462, 68 L.Ed. 949, 1924-1 C.B. 489, T.D. 3595 (1924).1 Thus, the Schwab Trust's Agreement and Declaration of Trust states that " the Trustees hereby declare that they will hold all cash, securities and other assets, which they may from time to time acquire in any manner as Trustees hereunder IN TRUST to manage and dispose of the same . . . for the pro rata benefit of the holders from time to time of Shares in this Trust." Schwab Investments, Registration Statement (Form N-1A), Agreement and Declaration of Trust 1 (Ex. 1) (Dec. 29, 1997) [hereinafter " Agreement
and Declaration of Trust" ]. Such a " trust today is a preferred form of organization for mutual funds and asset securitization." Dukeminier, Sitkoff & Lindgren, Wills, Trusts, and Estates 556.
One of the significant features that distinguishes a Massachusetts trust from the ordinary or private trust " lies in the manner in which the trust relationship is created; investors in a business trust enter into a voluntary, consensual, and contractual relationship, whereas the beneficiaries of a traditional private trust take their interests by gift from the donor or settlor." Herbert B. Chermside, Jr., Modern Status of the Massachusetts or Business Trust, 88 A.L.R.3d 704, 720 (1978); see also Berry v. McCourt, 1 Ohio App.2d 172, 204 N.E.2d 235, 240 (Ohio Ct.App. 1965) (" By an underlying contract, or in the provisions of a business trust instrument, or both, the parties agree on the operations of the venture." ). Thus, the Agreement and Declaration of Trust at issue here states at the very outset that it was made " by the Trustees hereunder, and by the holders of shares of beneficial interest to be issued hereunder." Agreement and Declaration of Trust 1. Moreover, it continues that " [e]very Shareholder by virtue of having become a Shareholder shall be held to have expressly assented and agreed to the terms hereof and to have become a party hereto." Agreement and Declaration of Trust 4.
Because this case involves the relationship between investors and a mutual fund, the trust which created the fund and the investment adviser which manages the fund, it is helpful to have a clear understanding of the relationships among these parties. We begin with a useful, if oversimplified, description of a mutual fund:
T, an investment professional, approaches A, B, C, and others like them and agrees to pool certain of their assets in a common fund to be managed by T. A, B, C, and the other investors each receive tradable shares in the fund in an amount proportional to their investment. By structuring their collective investment in this way, A, B, C, and the others are able to take advantage of economies of scale, obtain professional portfolio management, and achieve a more diversified portfolio than each could have individually. In managing the portfolio, T is subject to a fiduciary obligation to A, B, C, and the other investors in the fund.
Dukeminier, Sitkoff & Lindgren, Wills, Trusts, and Estates 556.
This simple description does not adequately discuss perhaps the most important party to this arrangement, namely, the investment adviser, whose " main role is to supervise and manage the fund's assets, including handling the fund's portfolio transactions." Clifford E. Kirsch, An Introduction to Mutual Funds, in Mutual Fund Regulation § 1:2.2 (Clifford E. Kirsch ed., 2d ed. 2005). The investment adviser is...
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