Northstar Fin. Advisors, Inc. v. Schwab Invs.

• Decision Date: 14 September 2018
• Docket Number: No. 16-15303,16-15303
• Citation: 904 F.3d 821
• Parties: NORTHSTAR FINANCIAL ADVISORS, INC., on behalf of itself and all others similarly situated, Plaintiff-Appellant, v. SCHWAB INVESTMENTS ; Mariann Byerwaler; 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; John F. Cogan; Charles Schwab Investment Management, Inc., Defendants-Appellees.
• Court: U.S. Court of Appeals — Ninth Circuit

904 F.3d 821

NORTHSTAR FINANCIAL ADVISORS, INC., on behalf of itself and all others similarly situated, Plaintiff-Appellant,

v.SCHWAB INVESTMENTS ; Mariann Byerwaler; 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; John F. Cogan; Charles Schwab Investment Management, Inc., Defendants-Appellees.

No. 16-15303

United States Court of Appeals, Ninth Circuit.

Argued and Submitted October 11, 2017, San Francisco, California

Filed September 14, 2018

Robert C. Finkel (argued), Wolf Popper LLP, New York, New York; Joseph J. Tabacco Jr. and Christopher T. Heffelfinger, Berman DeValerio, San Francisco, California; Marc J. Gross, Greenbaum Rowe Smith & Davis LLP, Roseland, New Jersey; for Plaintiff-Appellant.

Matthew L. Larrabee (argued), Joshua D.N. Hess, and Brian C. Raphel, Dechert LLP, San Francisco, California; Richard A. Schirtzer, Karin A. Kramer, and Arthur M. Roberts, Quinn Emanuel Urquhart & Sullivan LLP, San Francisco, California; for Defendants-Appellees.

Before: Sidney R. Thomas, Chief Judge, and Milan D. Smith, Jr. and Kathleen M. O’Malley,^* Circuit Judges.

Partial Concurrence and Partial Dissent by Chief Judge Thomas

O’MALLEY, Circuit Judge:

In this appeal, we consider whether the Securities Litigation Uniform Standards Act ("SLUSA") precludes class claims brought under state law by Northstar Financial Advisors, Inc. ("Northstar") against Schwab Investments, Charles Schwab Investment Management, Inc., and the trustees of the Schwab Trust (collectively, "defendants"). We conclude that SLUSA precludes all of Northstar’s claims, and that the district court therefore correctly dismissed them. The district court erred, however, in dismissing the claims with prejudice. We therefore affirm in part, reverse in part, and remand.¹

I

A

Northstar is a registered investment advisory and financial planning firm that manages accounts on behalf of investors. During the relevant time period, Northstar traded through Charles Schwab’s Institutional Advisor Platform, where it purchased shares in the Schwab Total Bond Market Fund ("Fund") for its clients. The Schwab Trust ("Trust") is a Massachusetts Business Trust having assets held by a group of trustees ("Trustees") who manage and supervise the Fund’s operations for the benefit of its shareholders, the Trust’s beneficiaries. Charles Schwab Investment Management, Inc. ("Schwab Advisor"), an investment advisory firm affiliated with the Trust, has acted as the manager of, and investment advisor to, the Trust in accordance with a June 1994 Investment Advisory Agreement ("IAA"). The Schwab Advisor oversees the day-to-day operations of the Fund, including selection of investments.

Northstar’s core allegations have remained the same across its five complaints. In a July 1997 Proxy Statement ("1997 Proxy Statement"), the Trustees sought a shareholder vote on two proposals relevant to this appeal. Proposal No. 2 would amend the Fund’s fundamental investment objective to track the investment results of the Lehman Brothers Aggregate Bond Index ("Index"). Proposal No. 3 would change the Fund’s "fundamental investment policies and investment restrictions" regarding the concentration of investments to incorporate the SEC’s interpretation of "concentration" from the Investment Company Act of 1940 ("ICA"), which was and is 25% of the available assets in a fund. A majority of Fund shareholders voted to approve the proposals. As a result, the Trust was obligated to "seek to track" the Index and to invest no more than 25% of the Fund’s total assets in any one industry.

From August 1997 through August 2007—which Northstar refers to as the "Pre-Breach period"—the Fund’s investments performed in a manner substantially consistent with the Index. During this period, the Fund continuously offered its shares to the public pursuant to annual prospectuses, which affirmed to potential and current shareholders that the Trust was following the fundamental investment objectives set forth in the 1997 Proxy Statement.

From August 2007 until February 2009—which Northstar refers to as the "Breach period"—the Trust continued to represent in Fund prospectuses and other public filings that the Fund would be managed conservatively and passively, and would be invested in the same securities as the Index, pursuant to its fundamental investment objective. In or about September 2007, however, the Trust caused the Fund to deviate from its fundamental investment policies by investing in collateralized mortgage obligations that were not part of the Index, and by concentrating more than 25% of the Fund’s total assets in mortgage-backed securities and collateralized mortgage obligations. The Fund deviated from its fundamental investment policies until about the end of February 2009. Fund shareholders suffered financial injury due to the Fund’s deviation, as the Fund underperformed the Index during this time.

B

This case has a lengthy procedural history that includes the dismissal of successive amended complaints for failures to state claims. In June 2015, Northstar filed its Fourth Amended Complaint. In that complaint, Northstar asserted claims on behalf of Fund shareholders who purchased shares during the Breach period ("Breach class"), as well as those who purchased shares during the Pre-Breach period but held them during the Breach period ("Pre-Breach class"). The complaint alleges fourteen causes of action: seven pertaining to the Pre-Breach class, and seven pertaining to the Breach class. With respect to each class, Northstar alleged breach of fiduciary duties against both the Trust and the Trustees; breach of fiduciary duty against the Schwab Advisor; aiding and abetting breach of fiduciary duty against the Trustees and the Schwab Advisor; breach of contract as third-party beneficiary to the IAA against the Schwab Advisor; breach of contract against the Trust; and breach of the covenant of good faith and fair dealing against the Schwab Advisor and the Trustees. Northstar alleged that its claims, if barred by SLUSA, are nonetheless preserved by the "Delaware carve-out."

The district court granted in part and denied in part the defendants’ motion to dismiss. Northstar Fin. Advisors Inc. v. Schwab Invs. , 135 F.Supp.3d 1059 (N.D. Cal. 2015). In particular, the court granted the motion to dismiss, with prejudice, Northstar’s claims for breach of contract and breach of the covenant of good faith and fair dealing, concluding that SLUSA barred those claims and that they did not fall within the Delaware carve-out. The district court also granted the motion to dismiss, with prejudice, Northstar’s breach of fiduciary duty claims "insofar as these claims pertain to an alleged breach of fiduciary duty by the Trust." Id. at 1089. The district court reasoned that any such duties were owed by the Trustees, rather than by the Trust itself. The district court further granted the motion to dismiss, with prejudice, Northstar’s third-party beneficiary claims, breach of contract claims, and breach of the covenant of good faith and fair dealing claims, concluding that SLUSA also barred those claims and that they did not fall within the Delaware carve-out. Id. at 1080–89.

The district court denied the motion to dismiss the remaining claims, however, which alleged breaches of fiduciary duties by the Trustees and the Schwab Advisor, and aiding and abetting such breaches. Id. at 1077–80. The district court reasoned that the defendants could not assert a SLUSA defense to these claims in a Rule 12(b)(6) motion, but that they could raise such a defense by filing a motion for judgment on the pleadings. Id. at 1071. The defendants subsequently moved for judgment on the pleadings, arguing that the breach of fiduciary duty and aiding and abetting claims were barred by SLUSA, and the district court granted the motion. Northstar Fin. Advisors Inc. v. Schwab Invs. , No. 08-CV-04119-LHK, 2016 WL 706018 (N.D. Cal. Feb. 23, 2016). This appeal timely followed.

II

A

We review de novo a district court’s order granting a motion to dismiss, Proctor v. Vishay Intertechnology Inc. , 584 F.3d 1208, 1218 (9th Cir. 2009), as well as a grant of a motion for judgment on the pleadings, Harris v. Cty. of Orange , 682 F.3d 1126, 1131 (9th Cir. 2012). In evaluating Northstar’s claims, we "accept factual allegations in the complaint as true and construe the pleadings in the light most favorable to the nonmoving party." Manzarek v. St. Paul Fire & Marine Ins. Co. , 519 F.3d 1025, 1031 (9th Cir. 2008).

B

SLUSA was enacted to stem the shift of class-action securities lawsuits from federal courts to state courts after passage of the Private Securities Litigation Reform Act of 1995 ("PSLRA"). Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit , 547 U.S. 71, 82, 126 S.Ct. 1503, 164 L.Ed.2d 179 (2006). In order to avoid PSLRA’s heightened pleading requirements for class-action securities lawsuits, plaintiffs began asserting what were essentially federal securities law claims as state law causes of action in state courts. Id. Congress sought to end this practice by enacting SLUSA.

SLUSA bars a plaintiff class from bringing (1) a covered class action (2) based on state law claims (3) alleging that the defendants made a misrepresentation or omission or employed any manipulative or deceptive device (4) in connection with the purchase or sale of (5) a covered security. Freeman Invs., L.P. v. Pac. Life Ins. Co. , 704 F.3d 1110, 1114–15 (9th Cir. 2013). Here, the only element at issue is whether the plaintiff class alleged that the defendants made a misrepresentation or omission.

Several basic principles about SLUSA govern our analysis of Northstar’s claims. First, the Supreme Court has made clear that SLUSA’s requirement that fraudulent statements be made in connection with the purchase or sale of a covered security must be construed broadly. See Dabit , 547 U.S. at 86, 126 S.Ct. 1503....