Northstar Financial Advisors v. Schwab Investments

• Decision Date: 19 February 2009
• Docket Number: No. C 08-4119 SI.,C 08-4119 SI.
• Citation: 609 F.Supp.2d 938
• Court: U.S. District Court — Northern District of California
• Parties: NORTHSTAR FINANCIAL ADVISORS, INC., Plaintiff, v. SCHWAB INVESTMENTS, et al., Defendants.

609 F.Supp.2d 938

NORTHSTAR FINANCIAL ADVISORS, INC., Plaintiff, v. SCHWAB INVESTMENTS, et al., Defendants.

No. C 08-4119 SI.

United States District Court, N.D. California.

February 19, 2009.

COPYRIGHT MATERIAL OMITTED

Christopher T. Heffelfinger, James Christopher Magid, Lesley Ann Hale, 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, for Plaintiff.

Darryl Paul Rains, Morrison & Foerster LLP, Palo Alto, CA, for Defendants.

ORDER GRANTING IN PART AND DENYING IN PART MOTION TO DISMISS WITH LEAVE TO AMEND

SUSAN ILLSTON, District Judge.

On January 23, 2009, the Court heard argument on defendants' motion to dismiss the complaint. For the reasons stated below, the Court GRANTS IN PART AND DENIES IN PART the motion and GRANTS leave to amend.

BACKGROUND

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. Complaint ¶ 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 trades through Charles Schwab's Institutional Advisor Platform, and purchased shares in the Fund for its clients. Id. ¶¶ 11-12.

Northstar alleges that defendants violated the Section 13(a) of the Investment Company Act of 1940 ("ICA") by deviating from the Fund's investment objective to track the Lehman Brothers U.S. Aggregate Bond Index (the "Index") in two ways. First, Northstar alleges 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 alleges 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 alleges 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.

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. The question presented by a motion to dismiss is not whether the plaintiff will prevail in the action, but whether the plaintiff is entitled to offer evidence in support of the claim. See Scheuer v. Rhodes, 416 U.S. 232, 236 94 S.Ct. 1683, 40 L.Ed.2d 90 (1974), overruled on other grounds by Davis v. Scherer, 468 U.S. 183, 104 S.Ct. 3012, 82 L.Ed.2d 139 (1984).

In answering this question, the Court must assume that the plaintiff's allegations are true and must draw all reasonable inferences in the plaintiffs favor. See 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." St. Clare v. Gilead Scis., Inc. (In re Gilead Scis. Sec. Litig.), 536 F.3d 1049, 1055 (9th Cir.2008). To survive a Rule 12(b)(6) 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, 127 S.Ct. 1955, 1974, 167 L.Ed.2d 929 (2007). While courts do not require "heightened fact pleading of specifics," a plaintiff must provide "more than labels and conclusions, and a formulaic recitation of the elements of a cause of action will not do." Id. at 1965. Plaintiff must allege facts sufficient to "raise a right to relief above the speculative level." Id.

If the Court dismisses the complaint, it must then decide whether to grant leave to amend. The Ninth Circuit has "repeatedly held that a district court should grant leave to amend even if no request to amend the pleading was made, unless it determines that the pleading could not possibly be cured by the allegation of other facts." Lopez v. Smith, 203 F.3d 1122, 1130 (9th Cir.2000) (citations and internal quotation marks omitted).

DISCUSSION

I. Standing

Defendants contend that because Northstar is an investment advisor that only purchased shares for its clients and not for itself, Northstar lacks constitutional standing. Defendants note that although the complaint is brought as a class action on behalf of "persons who owned shares of the Schwab Total Bond Market Fund," Northstar never actually owned shares of the Fund and instead only purchased them on behalf of its clients. Defendants rely on W.R. Huff Asset Management Company, LLC v. Deloitte & Touche LLP, 549 F.3d 100 (2d Cir.2008), in which an investment advisor alleged it had constitutional standing to sue on behalf of its clients as both their investment advisor and "attorney-in-fact." Id. at 104. The investment advisor did not allege in the complaint that it suffered any direct injury; instead, all of the alleged injury was suffered by the advisor's clients. Id. at 107. The Second Circuit held that the investment advisor lacked standing as an investment advisor because "the investment advisor-client relationship is not the type of close relationship courts have recognized as creating a `prudential exception' to the third-party standing rules" and because the advisor "failed to demonstrate that, absent a recognition of its standing claim, there is a `hindrance' to the [clients'] ability to protect their own interests." Id. at 110. The court rejected the advisor's standing based on its status as "attorney-in-fact" because the advisor's "power-of-attorney permits it to serve as an agent of its clients and to conduct litigation on behalf of its clients as their attorney-in-fact, but ... is not purported to be a valid assignment and does not confer a legal title to the claims Huff brings." Id. at 109.

In response, Northstar argues that Huff is distinguishable because Northstar has suffered a direct financial injury because "Northstar operates under a fee-based structure based on the total value of assets under management." Complaint ¶ 12. Northstar also has obtained an assignment of claims from one of its clients, Finkel Decl. Ex. F, and states that it can amend the complaint to allege the assignment.

The Court finds that the complaint does not allege that Northstar has suffered an injury in fact sufficient to confer constitutional standing, but that Northstar could amend the complaint to cure these deficiencies. As defendants note, the complaint alleges that it is brought on behalf of a class of persons who owned shares of the Fund. Complaint ¶ 1. Under Huff, which this Court finds persuasive, Northstar cannot bring claims on behalf of its clients simply by virtue of its status as an investment advisor.¹ The assignment of claims from one of Northstar's clients would, however, cure this deficiency. The Court also finds that Northstar would likely have standing to sue in its own right due to the direct financial injury it alleges that it suffered due to the decline in total value of assets under management. See Miller v. Dyadic Int'l Inc., No. 07-80948-CIV, 2008 WL 2465286, at *10 (S.D.Fla. Apr.18, 2000) (investment advisor had alleged injury sufficient to meet the constitutional injury in fact requirement because it was compensated based on the performance and value of the portfolios under its management). However, the complaint as currently framed is not brought on behalf of Northstar directly, but on behalf of Northstar's clients, and thus does not seek to redress Northstar's injuries.

Accordingly, the Court GRANTS defendants' motion to dismiss for lack of standing, and GRANTS plaintiff leave to amend to cure the deficiencies noted above. Because the Court finds that Northstar can cure the standing deficiency by amendment, the Court addresses defendants' other arguments in favor of dismissal.

II. Private right of action under Section 13(a)

Section 13(a) of the ICA provides:

(a) No registered investment company shall, unless authorized by a vote of a majority of its outstanding voting securities—

(1) change its subclassification as defined in section 80a-5(a)(1) and (2) of this title or its subclassification from a diversified to a non-diversified company;

(2) borrow money, issue senior securities, underwrite securities issued by other persons, purchase or sell real estate or commodities or make loans to other persons, except in each case in accordance with the recitals of policy contained in its registration statement in respect thereto;

(3) deviate from its policy in respect of concentration of investments in any particular industry or group of industries as recited in its registration statement, deviate from any investment policy which is changeable only if authorized by shareholder vote, or deviate from any policy recited in its registration statement pursuant to section 80a-8(b)(3) of this title; or

(4) change the nature of its business so as to cease to be an investment company.

15 U.S.C. § 80a-13(a). Section 13(a) does not explicitly provide for a private remedy, and the burden is on plaintiff to show that a private right of action...