Green v. Fund Asset Mgmt.

• Decision Date: 16 March 2001
• Docket Number: No. 99-5734,99-5734
• Citation: 245 F.3d 214
• Parties: (3rd Cir. 2001) JACK GREEN, INDIVIDUALLY AND AS TRUSTEE; LAWRENCE P. BELDEN, TRUSTEE; STANLEY SIMON, TRUSTEE V. FUND ASSET MANAGEMENT, L.P.; MERRILL LYNCH ASSET MANAGEMENT, L.P.; MERRILL LYNCH & CO., INC.; MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED; PRINCETON SERVICES, INC.; ARTHUR ZEIKEL; TERRY K. GLENN; MUNIENHANCED FUND, INC.; MUNIVEST FUND II INC.; MUNIYIELD FUND, INC.; MUNIYIELD INSURED FUND, INC.; MUNIYIELD INSURED FUND II, INC.; MUNIYIELD QUALITY FUND, INC.; MUNIYIELD QUALITY FUND II, INC., JACK GREEN, LAWRENCE P. BELDEN, STANLEY SIMON, APPELLANTS
• Court: U.S. Court of Appeals — Third Circuit

Page 214

245 F.3d 214 (3rd Cir. 2001)

JACK GREEN, INDIVIDUALLY AND AS TRUSTEE; LAWRENCE P. BELDEN, TRUSTEE; STANLEY SIMON, TRUSTEE

V.

FUND ASSET MANAGEMENT, L.P.; MERRILL LYNCH ASSET MANAGEMENT, L.P.; MERRILL LYNCH & CO., INC.; MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED; PRINCETON SERVICES, INC.; ARTHUR ZEIKEL; TERRY K. GLENN; MUNIENHANCED FUND, INC.; MUNIVEST FUND II INC.; MUNIYIELD FUND, INC.; MUNIYIELD INSURED FUND, INC.; MUNIYIELD INSURED FUND II, INC.; MUNIYIELD QUALITY FUND, INC.; MUNIYIELD QUALITY FUND II, INC., JACK GREEN, LAWRENCE P. BELDEN, STANLEY SIMON, APPELLANTS.

No. 99-5734

UNITED STATES COURT OF APPEALS FOR THE THIRD CIRCUIT

Argued on June 27, 2000

Opinion filed March 16, 2001

Appeal from the United States District Court for the District of New Jersey District Judge: Honorable Dickinson R. Debevoise (D.C. Civil Action No. 97-CV-03502) [Copyrighted Material Omitted]

[Copyrighted Material Omitted]

Bruce I. Goldstein, Esquire Alberto G. Santos, Esquire Saiber, Schlesinger, Satz & Goldstein One Gateway Center Suite 1300 Newark, NJ 07102-5311, Lawrence M. Johnson, Esquire (Argued) Mahoney, Hawkes & Goldings 75 Park Plaza The Heritage on the Garden Boston, MA 02116, Attorneys for Appellants

Alan S. Naar, Esquire Paul A. Rowe, Esquire Greenbaum, Rowe, Smith, Ravin, Davis & Himmel LLP P.O. Box 5600 Woodbridge, NJ 07095, Attorneys for Appellees-Defendants Fund Asset Management, L.P., Merrill Lynch Asset Management, L.P., Merrill Lynch & Co., Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated, Princeton Services, Inc., Arthur Zeikel and Terry K. Glenn

James N. Benedict, Esquire (Argued) Mark Holland, Esquire James F. Moyle, Esquire Sean M. Murphy, Esquire Danielle A. Prill, Esquire Clifford Chance Rogers & Wells LLP 200 Park Avenue New York, NY 10166, Attorneys for Appellees Fund Asset Management, L.P., Merrill Lynch Asset Management, L.P., Merrill Lynch & Co., Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated, Princeton Services, Inc., Arthur Zeikel and Terry K. Glenn

Robert J. Del Tufo, Esquire Frank E. Derby, Esquire Skadden, Arps, Slate, Meagher & Flom LLP One Newark Center, 18th Floor Newark, NJ 07102, Attorneys for Appellees MuniEnhanced Fund, Inc., MuniVest Fund II, Inc., MuniYield Fund, Inc., MuniYield Insured Fund, Inc., MuniYield Insured Fund II, Inc., MuniYield Quality Fund, Inc., and MuniYield Quality Fund II, Inc.

Before: Roth and Garth, Circuit Judges, and STANTON,^* District Judge

OPINION OF THE COURT

Roth, Circuit Judge

The plaintiffs, shareholders in several investment companies, filed an interlocutory appeal of the District Court's dismissal of their state law claims for breach of fiduciary duty and deceit. They claim that the District Court erred in concluding that these claims are preempted by S 36(b) of the Investment Company Act of 1940, as amended (ICA). Because we conclude that the claims are not preempted, we will reverse their dismissal and remand this case to the District Court.

I. FACTS¹

The plaintiffs are shareholders in seven investment companies, the named defendants in this action: MuniEnhanced Fund, Inc., MuniVest Fund II, Inc., MuniYield Fund, Inc., MuniYield Insured Fund, Inc., MuniYield Insured Fund II, Inc., MuniYield Quality Fund, Inc., and MuniYield Quality Fund II, Inc. (the Funds). The plaintiffs invested more than $44,000 in the Funds between May 22 and October 18, 1995. The named plaintiff, Jack Green, has brought suit individually and in his capacity as a trustee of seven trusts that invested in the Funds. The other plaintiffs, Lawrence P. Belden and Stanley Simon, sue solely as trustees of trusts that invested in the Funds. Although not named in the caption, the complaint also identifies as plaintiffs seven trusts that allegedly purchased shares of the Funds. The plaintiffs have brought the case as a putative class action, seeking to represent more than 100,000 investors in the Funds.

The Funds are closed-end investment companies, which are registered with the Securities and Exchange Commission (SEC) and publicly traded on the New York Stock Exchange. All of the Funds are incorporated under the laws of Maryland and have their principal places of business in Plainsboro, New Jersey. By investing in long- term tax-exempt municipal bonds, the Funds' aim is to provide shareholders with income that is exempt from federal income taxes and to increase return to shareholders through the use of leverage. The Funds gain leverage by issuing shares of preferred stock that pay dividends based upon prevailing short-term interest rates and investing the proceeds from the sale of this preferred stock in longer- term obligations that, under normal market conditions, pay higher rates. As long as there is a spread between the short-term rates paid by the Funds to holders of the preferred stock and the longer-term rates received by the Funds from investments, the fund managers are able to provide the shareholders with higher yields.

Defendant Fund Asset Management, L.P., (FAM) serves as the Funds' investment adviser and is responsible for managing the Funds' investment portfolios and providing administrative services to the Funds. Pursuant to written investment advisory agreements, the Funds pay FAM a fee for its services based upon a percentage of the Funds' weekly net assets. The MuniEnhanced Fund, Inc., prospectus describes its advisory fee as follows:

For the services provided by the Investment Adviser [FAM] under the Investment Advisory Agreement, the Fund will pay a monthly fee at an annual rate of.50 of 1% of the Fund's average weekly net assets (i.e., the average weekly value of the total assets of the Fund, minus the sum of accrued liabilities of the Fund and accumulated dividends on the shares of preferred stock). For purposes of this calculation, average weekly net assets is determined at the end of each month on the basis of the average net assets of the Fund for each week during the month. Green v. Fund Asset Management, 19 F. Supp. 2d 227, 229 (D.N.J. 1998) (Green I).²

Defendant Merrill Lynch Asset Management, L.P., (MLAM) is an affiliate of FAM. MLAM and FAM are organized under the laws of Delaware and have their principal places of business in Plainsboro, New Jersey. Defendant Princeton Services, Inc., (PSI), a Delaware corporation with its principal place of business in Plainsboro, New Jersey, is the general partner of FAM and MLAM. PSI has a 1% interest in FAM and MLAM. Defendant Merrill Lynch and Co., Inc., is FAM's and MLAM's sole limited partner and has a 99% interest in FAM and MLAM. Merrill Lynch is a publicly traded holding company that provides global investment, financing, insurance, and related services through its subsidiaries and affiliates. Merrill Lynch is a Delaware corporation with corporate headquarters in New York City.

Defendant Arthur Zeikel is the President and a director of each of the Funds, President and Chief Investment Officer of MLAM and FAM, President and a director of PSI, and an Executive Vice President of Merrill Lynch. Defendant Terry Glenn is the Executive Vice President of each of the Funds and Executive Vice President of FAM and MLAM.

Defendant Merrill Lynch, Pierce, Fenner & Smith Incorporated (MLPFS), a securities broker-dealer and investment bank, is a wholly owned subsidiary of Merrill Lynch. MLPFS served as the principal underwriter for the offerings of the Funds' common stock. MLPFS has also entered into auction agent agreements with the Funds to sell the Funds' preferred stock. The 1994 MuniYield Insured Fund, Inc., annual statement describes the fees generated by the preferred stock auctions as follows:

The Fund pays commissions to certain broker -dealers at the end of each auction at an annual rate ranging from 0.25% to 0.375%, calculated on the proceeds of each auction. For the year ended October 31, 1994, MLPFS, an affiliate of FAMI [FAM's predecessor], received $591,736 as commissions.

Id.³ MLPFS is a Delaware corporation and maintains its corporate headquarters in New York City.

The plaintiffs brought this action seeking to remedy alleged violations of state law and of S 36(b) of the Investment Company Act of 1940 (the ICA), codified at 15 U.S.C. S 80a-35(b).⁴ In their complaint, plaintiffs allege that defendants breached their disclosure obligations and fiduciary duties under the ICA and under state law. The plaintiffs contend that the defendants "failed to explicitly or sufficiently disclose" that the calculation of FAM's management fee would include assets purchased with the proceeds from the sale of preferred stock. They claim that because the advisory fee is measured as a percentage of the Funds' capitalization, including leverage, there is a strong financial incentive for FAM to keep the Funds fully leveraged at all times, even when it would be in the best interest of shareholders to reduce or eliminate leverage. The plaintiffs contend that FAM would lose approximately one-third of its advisory compensation if it eliminated leverage. They argue that the fee arrangement creates an inherent conflict of interest, which was not disclosed in the Funds' prospectuses, the Funds' filings with the SEC, or the Funds' periodic reports to the shareholders. The plaintiffs also allege that the defendants failed to disclose that the issuing of the preferred stock was subject to a conflict of interest; they find this conflict in the fact that FAM's affiliate, MLPFS, received fees from the sale of the preferred stock. In addition, plaintiffs claim that the defendants have continually misled investors with respect to the advisory fees, which are ultimately paid by the Funds' shareholders.

The plaintiffs seek both compensatory damages and injunctive relief. They ask for an order permanently enjoining the defendants from entering into any compensation arrangement between the Funds and any investment adviser under which "the compensation payable to such investment advisor is...