Laborers' Local 265 Pension Fund v. iShares Trust

Decision Date30 September 2014
Docket NumberNo. 13–6486.,13–6486.
Citation769 F.3d 399
PartiesLABORERS' LOCAL 265 PENSION FUND; Plumbers and Pipefitters Local No. 572 Pension Fund, Plaintiffs–Appellants, v. iSHARES TRUST et al., Defendants–Appellees.
CourtU.S. Court of Appeals — Sixth Circuit

ARGUED:C. Mark Pickrell, The Pickrell Law Group, P.C., Nashville, Tennessee, for Appellants. Seth M. Schwartz, Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York, for Appellees.ON BRIEF:C. Mark Pickrell, William G. Brown, The Pickrell Law Group, P.C., Nashville, Tennessee, James G. Stranch, III, J. Gerard Stranch IV, Michael G. Stewart, Michael J. Wall, Branstetter, Stranch & Jennings, PLLC, Nashville, Tennessee, Jenny L. Dixon, Robbins Arroyo LLP, San Diego, California, for Appellants. Seth M. Schwartz, Jeremy A. Berman, Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York, John R. Jacobson, Milton S. McGee, III, Riley Warnock & Jacobson, PLC, Nashville, Tennessee, Bruce H. Schneider, Stroock & Stroock & Lavan LLP, New York, New York, for Appellees.

Before: BOGGS, CLAY, and GILMAN, Circuit Judges.



An affiliate of the investment advisor for iShares mutual fund functions as a middleman between iShares and those who seek to borrow iShares's securities holdings, charging a fee of 35% for all net revenue received by iShares from such lending activity. The plaintiff shareholders challenge this fee as excessive under the Investment Company Act of 1940 (ICA), 15 U.S.C. § 80a–1 et seq. Their complaint was dismissed by the district court for failure to state a claim. For the reasons set forth below, we AFFIRM the judgment of the district court.

A. Factual background

Securities lending promotes market efficiency and liquidity by making securities readily available to a variety of borrowers, including short-sellers. The Second Circuit has described the practice as follows:

Securities lending is an important and significant business that describes the market practice whereby securities are temporarily transferred by one party (the lender) to another (the borrower). The borrower is obliged to return the securities to the lender, either on demand, or at the end of any agreed term. For the period of the loan the lender is secured by acceptable assets delivered by the borrower to the lender as collateral. Typically, the collateral—which, in the United States, often takes the form of cash—is valued at 102% [to] 105% of the market value of the loaned securities. The borrower of securities may be motivated by any number of factors, including the desire to cover a short position, to sell the borrowed securities in hopes of buying them back at a lower price before returning them to the lender, or to gain tax advantages associated with the temporary transfer of ownership of the securities.

United States v. Zangari, 677 F.3d 86, 88 (2d Cir.2012) (internal citations, footnotes, and quotation marks omitted).

The plaintiffs in this case are two pension funds that are shareholders in exchange-traded funds issued by iShares, Inc. and iShares Trust (collectively iShares). iShares, as part of its mutual-fund operations, lends its securities holdings to various borrowers. This lending activity generates substantial revenue for iShares because borrowers must post cash collateral and pay interest on their loans. BlackRock, Inc., which is not named as a defendant, is the corporate parent of iShares. Defendant BlackRock Institutional Trust Company, N.A. (BTC), a wholly owned subsidiary of BlackRock, serves as iShares's lending agent. BTC functions as a middleman between iShares and those who seek to borrow iShares's securities holdings. In exchange for its services as lending agent, BTC receives 35% of all securities-lending net revenue. The parties refer to this percentage as the “lending fee.”

Defendant BlackRock Fund Advisors (BFA) is a wholly owned subsidiary of BTC. BFA is the investment adviser for iShares and manages the funds' portfolios pursuant to an investment-advisory agreement. Under this agreement, BFA receives a separate fee that is not at issue in this case.

The plaintiffs allege, among other things, that BFA and BTC violated Section 36(a) and Section 36(b) of the ICA, 15 U.S.C. § 80a–35(a), (b), by charging an excessive lending fee. According to the plaintiffs, the fee charged by BTC bears no relationship to the actual services rendered.

B. Procedural background

The plaintiffs filed suit in federal district court against BFA, BTC, individual iShares directors, and several nominal defendants in January 2013. In response, the defendants moved under Rule 12(b)(6) of the Federal Rules of Civil Procedure to dismiss the complaint for failure to state a claim. The district court granted the defendants' motion and dismissed the complaint in August 2013. Although the district court granted the plaintiffs leave to amend their complaint, the plaintiffs instead filed this appeal following the entry of a final judgment.

The plaintiffs do not object to the practice of securities lending in general, but they do object to the 35% lending fee that BTC charges. They specifically allege that:

66. BFA, acting as investment adviser to iShares and the Funds, has retained BTC, its parent company, to manage the lending of securities owned by iShares ETF's, including the Funds.


70. BTC's securities lending fees with respect to the Funds are set out in an Amended and Restated Securities Lending Agreement with iShares, Inc. and iShares Trust, among other entities. That agreement provides that BTC shall be provided a fee of 35% of the “net amount earned on securities lending activities.” This 35% fee is, standing alone, disproportionally large and far higher than would be negotiated with all unaffiliated agent[s] in an arms length transaction.


73. These securities lending fees charged to iShares investors are disproportionately large—“about three times more than what is typical in the industry.”

(Verif.Compl.¶¶ 66, 70, 73)

The plaintiffs' verified complaint contains three counts. In the first count, the plaintiffs assert derivative claims under Section 36(b) of the ICA against BFA, BTC, and the individual iShares directors. They allege that BTC's 35% lending fee is excessive and bears no relationship to the actual services rendered.

In the second count, the plaintiffs assert a claim under Section 47(b) of the ICA. They allege that the contracts “obligating iShares or any Fund to pay BTC or BFA or affiliates fees arising out of securities lending transactions ... were performed in violation of the [ICA] and are therefore unenforceable.” The plaintiffs contend that the contracts were made in “violation of at least four provisions of the [ICA]Sections 17(d), 17(e), 36(a) and 36(b).” They do not, however, appeal the district court's dismissal of this count.

In the third count, the plaintiffs assert a derivative claim under Section 36(a) of the ICA against BFA, BTC, and the individual iShares directors. They allege that the defendants breached their fiduciary duties to the shareholders by “using investor assets for the benefit of their hedge funds and short-selling operations, without compensating investors in line with compensation that would have been paid based on arm's length transactions.”

In response, the defendants argued that (1) the Section 36(b) claim is barred by the terms of a 2002 exemption order issued by the Securities and Exchange Commission (SEC) to BlackRock's predecessor-in-interest in which the SEC permitted the securities-lending operations at issue here, and (2) Section 36(a) of the ICA does not provide an implied private right of action. The district court, after agreeing with both of the defendants' arguments, dismissed the complaint for failure to state a claim. Although the dismissal was without prejudice, the plaintiffs chose not to amend their complaint. The district court then entered a final judgment against the plaintiffs in October 2013. This timely appeal followed.

A. Standard of review

We review de novo a district court's decision to grant a motion to dismiss for failure to state a claim. Lambert v. Hartman, 517 F.3d 433, 438–39 (6th Cir.2008). In reviewing the grant of such a motion, we construe the complaint in the light most favorable to the plaintiff and accept all factual allegations as true. Id. at 439. “To survive a motion to dismiss, a complaint must contain sufficient factual matter, accepted as true, to ‘state a claim to relief that is plausible on its face.’ Ashcroft v. Iqbal, 556 U.S. 662, 678, 129 S.Ct. 1937, 173 L.Ed.2d 868 (2009) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007) ).

B. The district court did not err in dismissing the Section 36(b) claim

The plaintiffs first contend that the district court erred in dismissing their Section 36(b) claim against BFA. They frame the relevant issue on appeal as whether Section 36(b) provides a remedy against the investment adviser, BFA, for excessive compensation paid to both it and its affiliate, BTC.” The plaintiffs argue that Section 36(b) permits a lawsuit against an investment adviser for excessive compensation even where (as is the case here) the SEC has blessed the securities-lending operations of an affiliated lending agent (BTC).

Section 36(b) of the ICA provides as follows:

For the purposes of this subsection, the investment adviser of a registered investment company shall be deemed to have a fiduciary duty with respect to the receipt of compensation for services, or of payments of a material nature, paid by such registered investment company, or by the security holders thereof, to such investment adviser or any affiliated person of such investment adviser. An action may be brought under this subsection by the Commission, or by a security holder of such registered investment company on behalf of such company, against such investment adviser, or any affiliated person

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    ...factual allegations as true," construing the complaint "in the light most favorable to the plaintiff." Laborers' Local 265 Pension Fund v. iShares Trust, 769 F.3d 399, 403 (6th Cir. 2014). To survive a motion to dismiss, plaintiffs must plead "sufficient factual matter, accepted as true, to......

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