Northstar Financial Advisors Inc. v. Schwab Investments

• Decision Date: 02 March 2011
• Docket Number: Case No. 08–CV–04119 LHK.
• Citation: 781 F.Supp.2d 926
• Parties: NORTHSTAR FINANCIAL ADVISORS, INC., on Behalf of Itself and All Others Similarly Situated, Plaintiff,v.SCHWAB INVESTMENTS; and 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 of Schwab Investments; and Charles Schwab Investment Management, Inc., Defendants.
• Court: U.S. District Court — Northern District of California

781 F.Supp.2d 926

NORTHSTAR FINANCIAL ADVISORS, INC., on Behalf of Itself and All Others Similarly Situated, Plaintiff,

v.SCHWAB INVESTMENTS; and 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 of Schwab Investments; and Charles Schwab Investment Management, Inc., Defendants.

Case No. 08–CV–04119 LHK.

United States District Court, N.D. California,San Jose Division.

March 2, 2011.

Christopher T. Heffelfinger, James Christopher Magid, Lesley Ann Hale, Anthony David Phillips, Joseph J. Tabacco, Jr., Berman DeValerio, San Francisco, CA, Marc J. Gross, Greenbaum Rowe Smith & Davis LLP, Roseland, NJ, Bryan D. Plocker, Greenbaum Rowe Smith & Davis LLP, Iselin, NJ, Robert C. Finkel, Wolf Popper LLP, New York, NY, Steve W. Berman, Hagens Berman Sobol Shapiro LLP, Seattle, WA, Peter E. Borkon, Hagens Berman Sobol Shapiro LLP, Berkeley, CA, for Plaintiffs.Arthur M. Roberts, John Mark Potter, Patrick C. Doolittle, Quinn Emanuel Urquhart & Sullivan, LLP, San Francisco, CA, Karin A. Kramer, Quinn Emanuel Urquhart & Sullivan, Redwood Shores, CA, Richard Allen Schirtzer, Quinn Emanuel Urquhart and Sullivan LLP, Los Angeles, CA, for Defendants.

CORRECTED ORDER GRANTING IN PART AND DENYING IN PART DEFENDANTS' MOTION TO DISMISS

LUCY H. KOH, District Judge.

The Court heard oral argument on defendants' Motion to Dismiss the Second Amended Complaint (Motion) in this matter on January 13, 2011. For the reasons set forth below, the Motion is GRANTED IN PART and DENIED IN PART. Plaintiffs are given leave to amend as specified in this Order.

I. Introduction and Procedural History

On August 28, 2008, Plaintiff Northstar Financial Advisors, Inc. (Northstar) filed this class action lawsuit on behalf of all persons who owned shares of the Schwab Total Bond Market Fund (the Fund) at any time from August 31, 2007 to the present. Compl. (Dkt. No. 1) ¶ 1. Northstar is a registered investment advisory and financial planning firm serving both institutional and individual clients. Id. ¶ 9. Northstar manages both discretionary and nondiscretionary accounts on behalf of investors in its role as an investment advisor. Id. Northstar traded through Charles Schwab's Institutional Advisor Platform, and purchased shares in the Fund for its clients. Id. ¶¶ 11–12.

Northstar alleged that defendants deviated from the Fund's investment objective to track the Lehman Brothers U.S. Aggregate Bond Index (the Index) in two ways. First, Northstar alleged that the Fund deviated from this objective by investing in high risk non-U.S. agency collateralized mortgage obligations (CMOs) that were not part of the Lehman Index and were substantially more risky than the U.S. agency securities and other instruments that comprised the Index. Id. ¶ 3. Second, Northstar alleged that the Fund deviated from its investment objectives which prohibited any concentration of investments greater than 25% in any industry by investing more than 25% of its total assets in U.S. agency and non-agency mortgage-backed securities and CMOs. Id. ¶ 4. Northstar alleged that defendants' deviation from the Fund's investment objective exposed the Fund and its shareholders to tens of millions of dollars in losses due to a sustained decline in the value of non-agency mortgage-backed securities. The Funds' deviation from its stated investment objective caused it to incur a negative total return of 1.09% for the period September 4, 2007 through August 27, 2008, compared to a positive return of 5.92% for the Index over that period. Id. ¶ 5.

Based on these allegations, Northstar asserted the following claims: (1) Violation of Section 13(a) of the Investment Company Act of 1940(ICA); (2) Breach of Fiduciary Duty; (3) Breach of Contract; and (4) Breach of Covenant of Good Faith and Fair Dealing. Defendants moved to dismiss the first complaint. See First MTD (Dkt. No. 33). Judge Illston, to whom this case was previously assigned, granted in part and denied in part defendants' motion. See Feb. 19, 2009 Order, 609 F.Supp.2d 938 (Dkt. No. 74).

First, Judge Illston found that Northstar, as lead plaintiff, had no standing to sue regarding securities it had not itself invested in, but that an assignment of claim from one of its client investors “would ... cure this deficiency.” Feb. 19, 2009 Order, 609 F.Supp.2d at 942. Northstar had submitted such an assignment, dated December 8, 2008, to the Court in support of its opposition to the First MTD. See Finkel Decl. (Dkt. No. 39) at Ex. F. Judge Illston also granted leave to amend so that Northstar could state a claim on its own behalf. Id. Judge Illston also found that there was an implied private right of action under Section 13(a) of the ICA, and that Plaintiffs had stated a claim for violation of shareholders' voting rights under this section. Feb. 19, 2009 Order, 609 F.Supp.2d at 944, 945–48. Regarding the asserted state law causes of action, Judge Illston granted Plaintiffs leave to amend their breach of fiduciary duty and breach of contract claims. Regarding the breach of fiduciary duty claim, Judge Illston did not decide whether Massachusetts or California law would apply to determine whether the defendants owed investors a duty, but that the defendant's admission that “some person or entity” owed a duty to the fund's investors supported granting Plaintiffs leave to amend. Judge Illston ordered the Plaintiffs to “carefully examine whether each of the defendants named in this claim can in fact be named in such a claim, and under which state's law such a claim is properly brought.” She further held that “[a]fter review of the amended complaint, defendants may renew their motion to dismiss this claim.” Feb. 19, 2009 Order, 609 F.Supp.2d at 950. Judge Illston likewise concluded that it was unclear whether or not Plaintiffs could state a breach of contract claim based on Proxy statements and prospectuses relating to the Fund. Plaintiffs were given leave to amend to “add more specific allegations regarding the language plaintiff relies on to allege the formation of a contract, as well as each defendants' involvement.” Id. at 950. Finally, Judge Illston found that the Plaintiffs had stated a claim for breach of the covenant of good faith and fair dealing. Id. at 950.

On March 2, 2009, Plaintiffs filed a First Amended Complaint (FAC). On March 5, 2009, defendants sought and were granted leave to appeal Judge Illston's Order finding a private right of action under the ICA § 13(a), and a stay of this action pending the appeal. See Dkt. No. 108. Thus, the case was stayed from April 27, 2009 through August 13, 2010 while the appeal was pending. In the interim, the case was reassigned, first to Judge Seeborg, and then to the undersigned. See Dkt. Nos. 115, 117. On August 13, 2010, the Ninth Circuit reversed Judge Illston's Order, holding that there is no private right of action under Section 13(a). Northstar Fin. Advisors, Inc. v. Schwab Invs., 615 F.3d 1106, 1122 (9th Cir.2010).

In light of this, Plaintiffs filed a Second Amended Complaint (SAC) removing their Section 13(a) claim on September 28, 2010. The SAC named Schwab Investments (the Trust), its Trustees ¹, and Charles Schwab Investment Management, Inc. (the Investment Advisor) as defendants. According to the SAC, the Trust is an investment trust organized under Massachusetts law, and “consists of a series of mutual funds, including the Fund.” SAC ¶ 16. The Trust is managed by the Trustees. SAC ¶ 19. Pursuant to a contractual agreement between the Trust and the Investment Advisor, the Investment Advisor serves as the investment manager for the Fund. SAC ¶ 23, 154. The SAC alleges claims based on breach of fiduciary duty (against all defendants), breach of contract (against the Trust), breach of the covenant of good faith and fair dealing (against the Trust and the Investment Advisor), and a claim for third party beneficiary status to the agreement between the Trust and the Investment Advisor (against the Investment Advisor).

II. Legal Standard

Under Federal Rule of Civil Procedure 12(b)(6), a district court must dismiss a complaint if it fails to state a claim upon which relief can be granted. To survive a motion to dismiss, the plaintiff must allege “enough facts to state a claim to relief that is plausible on its face.” Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007). This “facial plausibility” standard requires the plaintiff to allege facts that add up to “more than a sheer possibility that a defendant has acted unlawfully.” Ashcroft v. Iqbal, 556 U.S. 662, 129 S.Ct. 1937, 1949, 173 L.Ed.2d 868 (2009). In deciding whether the plaintiff has stated a claim, the Court must assume the plaintiff's allegations are true and draw all reasonable inferences in the plaintiff's favor. Usher v. City of Los Angeles, 828 F.2d 556, 561 (9th Cir.1987). However, the court is not required to accept as true “allegations that are merely conclusory, unwarranted deductions of fact, or unreasonable inferences.” In re Gilead Scis. Sec. Litig., 536 F.3d 1049, 1055 (9th Cir.2008). Leave to amend must be granted unless it is clear that the complaint's deficiencies cannot be cured by amendment. Lucas v. Dep't. of Corr., 66 F.3d 245, 248 (9th Cir.1995).

III. Application

a. Standing

Defendants argue that all of Plaintiffs' claims must be dismissed for lack of standing. Defendants argue that because standing must be determined at the time a complaint is filed, and because Northstar did not obtain an assignment of claims until several months after the original complaint was filed, the assignment cannot cure Northstar's original lack of standing. ² Plaintiffs respond that Judge Illston's dismissal considered the assignment of claim that Plaintiffs now rely upon, held that this assignment would “cure this [standing] defi...