Halebian v. Berv

• Decision Date: 06 May 2011
• Docket Number: Docket No. 07–3750–cv.
• Parties: John HALEBIAN, Plaintiff–Appellant,v.Elliot J. BERV, Donald M. Carlton, A. Benton Cocanougher, Mark T. Finn, Stephen Randolph Gross, Diana R. Harrington, Susan B. Kerley, Alan G. Merten, R. Richardson Pettit, Defendants–Appellees,CitiFunds Trust III, Nominal Defendant–Appellee.*
• Court: U.S. Court of Appeals — Second Circuit

644 F.3d 122

John HALEBIAN, Plaintiff–Appellant,

v.Elliot J. BERV, Donald M. Carlton, A. Benton Cocanougher, Mark T. Finn, Stephen Randolph Gross, Diana R. Harrington, Susan B. Kerley, Alan G. Merten, R. Richardson Pettit, Defendants–Appellees,CitiFunds Trust III, Nominal Defendant–Appellee.*

Docket No. 07–3750–cv.

United States Court of Appeals, Second Circuit.

Argued: Feb. 5, 2009.Question Certified: Dec. 29, 2009.Certified Question Answered: Aug. 23, 2010.Decided: May 6, 2011.

Joel C. Feffer (Daniella Quitt, James G. Flynn, on the brief), Harwood Feffer LLP, New York, NY, for Plaintiff–Appellant.James S. Dittmar, Goodwin Procter LLP, Boston, MA (Michael K. Isenman, Matthew M. Hoffman, Goodwin Procter LLP, Washington, DC, on the brief), for Defendants–Appellees.

Before: SACK and B.D. PARKER, Circuit Judges, and STANCEU, Judge.^**

SACK, Circuit Judge:

Descriptions of the facts underlying this appeal have now been published in three different reported decisions—in the opinion of the United States District Court for the Southern District of New York, Halebian v. Berv (“ Halebian I ”), 631 F.Supp.2d 284, 287–91 (S.D.N.Y.2007); in this Court's previous opinion certifying a question of state law to the Supreme Judicial Court of Massachusetts, Halebian v. Berv (“ Halebian II ”), 590 F.3d 195, 199–203 (2d Cir.2009); and in the opinion of the Supreme Judicial Court answering our question on certification, Halebian v. Berv (“ Halebian III ”), 457 Mass. 620, 621–24, 931 N.E.2d 986, 987–89 (2010). We see no need to reiterate them here except insofar as we think it necessary to an understanding of our resolution of the narrow issues remaining before us.

BACKGROUND

Halebian's Complaint

On May 30, 2006, John Halebian, a holder of shares in one of six separate investment funds (the “Funds”) within CitiFunds Trust III (the “Trust”), a Massachusetts business trust, filed a complaint raising three claims in the United States District Court for the Southern District of New York against members of the Trust's board of trustees (the “Board”). The suit arose in connection with the June 23, 2005 corporate sale (the “Transaction”) of investment-adviser subsidiary companies that advised the six Funds. Pursuant to the Transaction, Citigroup, Inc., which owned the adviser subsidiaries, sold substantially all of its asset-management business to Legg Mason, Inc., automatically terminating, under federal law, the Funds' existing investment-advisory contracts. Following the sale and contract termination, the Trust's Board approved new investment-advisory agreements (the “New Agreements”) between the Trust and Legg Mason and then issued a proxy statement to Trust shareholders recommending that they vote to approve the New Agreements.

In his complaint, Halebian challenges two principal aspects of the Transaction. First, he questions the New Agreements' authorization of the payment of “soft dollars,” which permitted Legg Mason to hire broker-dealers that also perform research services—a combination that often results in higher commissions for the chosen broker-dealer than those paid to standard broker-dealers. Second, he challenges shareholder voting procedures permitting “echo voting,” which in this case allows Citigroup-affiliated service agents, as record holders of certain shares of the Funds, to vote their total number of shares in proportion to the votes they received from the shares' beneficial owners, even if the service agents had not received voting instructions from all of their customers. Halebian asserts, in sum, that the “defendants ... failed to avail themselves of the opportunity to negotiate lower fees or seek competing bids from other qualified investment advisers” and “utterly ignored their obligations of loyalty and good faith to CitiTrust and its beneficiaries.” Complaint ¶¶ 35, 40, Halebian I, No. 06 Cv 4099 (S.D.N.Y. May 30, 2006).

Halebian's Claim One, presented as a derivative claim on behalf of the Trust, alleges that the defendants breached their fiduciary duties to the Trust “in considering the ... [T]ransaction and in recommending the new advisory agreements.” Id. ¶ 54. Claims Two and Three, styled as direct claims, allege that the defendants violated federal and state law by issuing materially false and misleading statements and by omitting material information from the proxy statement as part of an effort to induce their shareholders to approve the Trust's New Agreements with Legg Mason. Id. ¶¶ 60–61, 64–65.

The Defendants' Motion to Dismiss

On October 24, 2006, the defendants' counsel moved to dismiss Halebian's complaint pursuant to, inter alia, Federal Rule of Civil Procedure 12(b)(6). Regarding Claims Two and Three, the defendants asserted that Federal Rules 12(b)(6) and 23.1, and various provisions of the Investment Company Act (the “ICA”), 15 U.S.C. §§ 80a–15(a), 80a–20(a), required dismissal of the two claims because these claims were derivative in nature, not direct, and as such failed as a matter of law. Specifically addressing their requested dismissal of Claim One, the defendants relied in part on a then-recently enacted provision of Massachusetts law codifying the business-judgment rule permitting a corporation's directors to move to dismiss a derivative lawsuit as to the prosecution of which the leadership concluded would not be in the corporation's best interest.¹ See Mass. Gen. Laws ch. 156D, § 7.44(a).

Our Prior Panel Opinion

In Halebian II, we agreed with the defendants and the district court, classifying the second and third claims asserted in the plaintiff's complaint as derivative by looking to Massachusetts law, which all agree is applicable. Halebian II, 590 F.3d at 210. We saw the gravamen of the second and third claims as Halebian's challenge to the use of echo voting. We then reasoned:

There is no indication that the alleged unlawfulness of echo voting under section 15(a) of the ICA or Massachusetts law was called to the attention of the Board by Halebian or anyone else prior to the institution of this lawsuit. And the Board has consistently and strenuously denied that echo voting violates these laws. Since the Board was apparently not of the view, nor had it been told, that using a Citigroup-affiliated service agent other than a broker-dealer to echo vote shares violated the ICA or Massachusetts law, or indeed any law, its failure to inform shareholders to the contrary does not appear to us to have been potentially false and misleading so as to be cognizable under Massachusetts or federal law.

Id. (footnotes omitted). We thus expressed our inclination to affirm the judgment of the district court (Naomi Reice Buchwald, Judge ) dismissing Halebian's second and third claims, but declined to resolve them at that time. We reserved decision on those claims so that we could consider any commentary or analysis that the Supreme Judicial Court of Massachusetts might offer in answering our certified question regarding Halebian's first claim. Id.

As to Halebian's undisputedly derivative first claim, which alleges a breach of fiduciary duty for failure to investigate alternatives to the New Agreements between the Trust and Legg Mason, we first rejected the district court's reliance on Federal Rule of Civil Procedure 23.1 in dismissing the claim. We were of the view that Halebian's complaint satisfied this federal pleading rule for derivative claims and, accordingly, that the claim thus “stands or falls on whether it was properly dismissed pursuant to Massachusetts substantive law.” Id. at 211. On the state-law question, the district court had ruled that despite language in the state derivative-suit dismissal provision indicating that it applies only to derivative proceedings “commenced after the rejection of a demand,” Mass. Gen. Laws ch. 156D, § 7.44(a) (emphasis added), the defendants could rely on the provision irrespective of the fact that the plaintiff had filed suit before the Board's rejection of the demand, provided they rejected the plaintiff's demand “after a good faith review.” Halebian I, 631 F.Supp.2d at 294.

Proffering an alternative reading,² but “declin[ing] to resolve [the issue] in the first instance,” Halebian II, 590 F.3d at 210, we certified to the Supreme Judicial Court of Massachusetts the following question: “Under Massachusetts law, can the business judgment rule, established under Mass. Gen. Laws ch. 156D, § 7.44, be applied to dismiss a derivative complaint filed timely under section 7.42 but prior to a corporation's rejection of the demand that serves as the basis for the suit?” ³ Id. at 214.

Supreme Judicial Court's Response

On August 23, 2010, the Supreme Judicial Court issued an opinion answering our certified question in the affirmative. Halebian III, 457 Mass. at 621, 931 N.E.2d at 987. The court reasoned, inter alia:

If we were to adopt the plaintiff's assertion that the Legislature's inclusion of the phrase, “commenced after rejection of a demand,” was intended to deny a corporation the benefit of the business judgment doctrine where it failed to reject a shareholder's demand before the filing of a derivative complaint, we would be giving § 7.44 an interpretation that would be in direct conflict with other language in the same section and that would be inconsistent with the statutory scheme embodied in the Act and reflected in the commentary of its drafters. For these reasons, despite the statute's unfortunate inclusion of a phrase that, when read in isolation, would suggest that § 7.44(a) was intended to limit dismissals under the business judgment doctrine to derivative proceedings “commenced after rejection of a demand,” we conclude that the Legislature did not intend such a limitation. Rather, we conclude that the Legislature intended that a derivative action must be dismissed under § 7.44 following a corporation's independent determination, made in good faith and after reasonable inquiry, that maintenance of the derivative proceeding is...