KORMAN, District Judge:
The Investment Company Act ("ICA") establishes a comprehensive federal regulatory framework applicable to mutual funds. See 15 U.S.C. § 80a-1 et seq. More specifically, it provides that a mutual fund's registration statement must recite all investment policies that can be changed only by shareholder vote. 15 U.S.C. § 80a-8(b). Deviation from policies so designated violates § 13(a) of the ICA. 15 U.S.C. § 80a-13(a)(3). This appeal arises out of a class action on behalf of investors who allege that the managers of the Schwab Total Bond Market Fund ("Fund") failed to adhere to two of the Fund's fundamental investment objectives; namely, that it seek to track a particular index and that it not over-concentrate its investments in any one industry. These objectives, which could only be changed by a vote of the shareholders, were adopted by a shareholder vote and subsequently incorporated in the Fund's registration statement and prospectuses.
On a previous interlocutory appeal, we rejected the argument that this conduct gave rise to an implied private right to enforce § 13(a) of the ICA. Northstar Fin. Advisors, Inc. v. Schwab Invs., 615 F.3d 1106 (9th Cir.2010). On this appeal from an order granting a motion to dismiss a Third Amended Complaint, the principal issues are whether the investors have stated valid causes of action for breach of contract, breach of fiduciary duty, and breach of an agreement to which the investors claim to be third-party beneficiaries.
Schwab Investments ("Schwab Trust") is an investment trust organized under Massachusetts law. Such a trust, which is often referred to generically as a "Massachusetts trust," even when not created under Massachusetts law, is an unincorporated business organization created by an instrument of trust by which property is to be held and managed by trustees for the benefit of persons who are or become the holders of the beneficial interests in the trust estate. See Hecht v. Malley, 265 U.S. 144, 146-47, 44 S.Ct. 462, 68 L.Ed. 949 (1924).
One of the significant features that distinguishes a Massachusetts trust from the ordinary or private trust "lies in the manner in which the trust relationship is created; investors in a business trust enter into a voluntary, consensual, and contractual relationship, whereas the beneficiaries of a traditional private trust take their interests by gift from the donor or settlor." Herbert B. Chermside, Jr., Modern Status of the Massachusetts or Business Trust, 88 A.L.R.3d 704, 720 (1978); see also Berry v. McCourt, 1 Ohio App.2d 172, 204 N.E.2d 235, 240 (1965) ("By an underlying contract, or in the provisions of a business trust instrument, or both, the parties agree on the operations of the venture."). Thus, the Agreement and Declaration of Trust at issue here states at the very outset that it was made "by the Trustees hereunder, and by the holders of shares of beneficial interest to be issued hereunder." Agreement and Declaration of Trust 1. Moreover, it continues that "[e]very Shareholder by virtue of having become a Shareholder shall be held to have expressly assented and agreed to the terms hereof and to have become a party hereto." Agreement and Declaration of Trust 4.
Because this case involves the relationship between investors and a mutual fund, the trust which created the fund and the investment adviser which manages the fund, it is helpful to have a clear understanding of the relationships among these parties. We begin with a useful, if oversimplified, description of a mutual fund:
Dukeminier, Sitkoff & Lindgren, Wills, Trusts, and Estates 556.
This simple description does not adequately discuss perhaps the most important party to this arrangement, namely, the investment adviser, whose "main role is to supervise and manage the fund's assets, including handling the fund's portfolio transactions." Clifford E. Kirsch, An Introduction to Mutual Funds, in Mutual Fund Regulation § 1:2.2 (Clifford E. Kirsch ed., 2d ed.2005). The investment adviser is not a mere employee, contractor, or consultant. Instead, it is "more often than not also the creator, sponsor, and promoter of the mutual fund." Charles E. Rounds, Jr. & Charles E. Rounds, III, Loring and Rounds: A Trustee's Handbook 955-56 (2012 ed.); see also Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 93, 111 S.Ct. 1711, 114 L.Ed.2d 152 (1991) (Mutual funds "typically are organized and underwritten by the same firm that serves as the company's `investment adviser.'"); Daily Income Fund, Inc. v. Fox, 464 U.S. 523, 536, 104 S.Ct. 831, 78 L.Ed.2d 645 (1984) (Mutual funds are "typically created and managed by a pre-existing external organization known as an investment adviser." (citing Burks v. Lasker, 441 U.S. 471, 481, 99 S.Ct. 1831, 60 L.Ed.2d 404 (1979))).
Thus, while "[i]n theory, the [trust] is able to choose any adviser it deems appropriate to invest the fund's portfolio, based
Consistent with this description of the structure of a mutual fund and its relationship with its investment adviser, the Schwab Trust selected Charles Schwab Investment Management, Inc. ("Schwab Advisor") as its investment adviser. Indeed, Charles R. Schwab is alleged to have been chairman and trustee of the Schwab Trust and a member of the board of the Schwab Advisor. Third Am. Compl. ¶ 38. The latter is a subsidiary of the Charles Schwab Corporation, of which Mr. Schwab has served as "CEO at various times, including from 2004 through October 2008." Third Am. Compl. ¶ 36. Moreover, the complaint alleges that all "[d]efendants and their affiliates held themselves out as one Schwab entity[.]" Third Am. Compl. ¶ 167.
The mutual fund at issue here, one of several operated by the Schwab Trust, is the Schwab Total Bond Market Fund. Reflecting the terms of a proxy statement proposed by the Schwab Trust in 1997, and subsequently adopted by the shareholders by majority vote, the prospectuses that the Fund issued during the relevant period stated that the Fund was "designed to offer high current income by tracking the performance of the Lehman Brothers [U.S.] Aggregate Bond Index [("Lehman Index")]" and was "intended for investors seeking to fill the fixed income component of their asset allocation plan." Specifically, the Lehman Index included "investment-grade government, corporate, mortgage-, commercial mortgage- and asset-backed bonds that [were] denominated in U.S. dollars and ha[d] maturities longer than one year." Northstar Fin. Advisors, Inc. v. Schwab Invs., 609 F.Supp.2d 938, 945 (N.D.Cal.2009).
The Fund disclosed in its registration statement, and reiterated in prospectuses issued thereafter, that its policy of tracking the Lehman Index was "fundamental," which means that it "cannot be changed without approval of the holders of a majority of the outstanding voting securities (as defined in the [ICA])." Schwab Investments, Registration Statement 5, 14 (Form N-1A) (Jan. 16, 1998), Prospectus 10 (Form N-1A, Part A) (Nov. 1, 1997, as amended Jan. 15, 1998); see also Michael Glazer, Prospectus Disclosure and Delivery Requirements, in Mutual Fund Regulation § 4:3.6 (Clifford E. Kirsch ed., 2d
Northstar Financial Advisors, Inc. ("Northstar") is a registered investment advisery and financial planning firm that manages discretionary and non-discretionary accounts on behalf of investors and had over 200,000 shares of the Fund under its management. In August 2008, Northstar filed this shareholder class action against the defendants, alleging that they deviated from the Fund's fundamental investment policies and exposed the Fund and its shareholders to tens of millions of dollars in losses.
Northstar has identified two classes of potential plaintiffs: (1) a "Pre-Breach" class, consisting of those who purchased shares of the Fund on or prior to August 31, 2007, and who continued to hold their shares as of August 31, 2007, and (2) a "Breach" class, consisting of those who purchased shares of the Fund during the period September 1, 2007 through February 27, 2009. Northstar alleges that August 31, 2007 was the last day of the fiscal year preceding the one during which the Fund first began deviating from its required fundamental investment policies, and that on February 27, 2009, the Fund reverted back to the required policies.
This case has a lengthy and complicated procedural history that includes the dismissal of successive amended complaints for failure to state a cognizable cause of action. Specifically, the Third Amended Complaint, which is based on the Fund's unauthorized deviation from its fundamental investment objectives, alleges five causes of action on behalf of each of the two identified classes, for a total of ten claims: breach of fiduciary duty against the Trustees
We review de novo the district judge's order granting a motion to dismiss. Manzarek v. St. Paul Fire & Marine Ins. Co., 519 F.3d 1025, 1030 (9th Cir.2008). On a motion to dismiss, "[w]e accept factual allegations in the complaint as true and construe the pleadings in the light most favorable to the non-moving party." Id. at 1031. "[W]e may consider materials incorporated into the complaint or matters of public record." Coto Settlement v. Eisenberg, 593 F.3d 1031, 1038 (9th Cir.2010).
Among the documents we consider pursuant to that doctrine are three sets of the Schwab Trust's filings with the Securities and Exchange Commission: (1) the Registration Statement of December 29, 1997; (2) the Registration Statement of January 16, 1998, which was filed with the Prospectus and Statement of Additional Information of November 1, 1997, as amended January 15, 1998; and (3) the Prospectus and Statement of Additional Information of November 15, 2004. While all of these documents are referred to in the complaint, the entire content of each document does not appear to be part of the record. Nevertheless, "[i]t is appropriate to take judicial notice of this information, as it was made publicly available by [the SEC], and neither party disputes the authenticity of the [documents] or the accuracy of the information displayed therein." Daniels-Hall v. Nat'l Educ. Ass'n, 629 F.3d 992, 998-99 (9th Cir.2010) (citing Fed. R.Evid. 201); see also Dreiling v. Am. Express Co., 458 F.3d 942, 946 n. 2 (9th Cir.2006) (We "may consider documents referred to in the complaint or any matter subject to judicial notice, such as SEC filings."). Indeed, defendants, who might otherwise be aggrieved by their use, created and filed them with the SEC. Under these circumstances, it is appropriate for us to consider them here. See 1 Christopher B. Mueller & Laird C. Kirkpatrick, Federal Evidence § 2:8 at 359-61 (4th ed.2013).
We pause before addressing the merits to discuss the issue of whether Northstar has standing. Northstar filed its initial class action complaint on behalf of investors in the Fund on August 28, 2008. Northstar owned no shares of the Fund, but it brought the action in its own name, without obtaining an assignment of claims from an investor in the Fund. Subsequently, in a comparable case brought by an asset management firm, the Second Circuit held that "the minimum requirement for injury-in-fact is that the plaintiff have legal title to, or a proprietary interest in, the claim." W.R. Huff Asset Mgmt. Co. v. Deloitte & Touche LLP, 549 F.3d 100, 108 (2d Cir.2008). On December 8, 2008, after W.R. Huff was decided, Northstar obtained an assignment of claim from a client-shareholder.
Defendants argue that because standing must be determined at the time a complaint is filed, and because Northstar did not obtain an assignment of claim until several months after the original complaint was filed, the assignment could not cure Northstar's original lack of standing. The district judge (Susan Illston, J.), to whom the case was then assigned, dismissed Northstar's complaint for lack of standing with a suggestion that this defect could be cured by filing an amended complaint. Northstar Fin. Advisors, Inc. v. Schwab Invs., 609 F.Supp.2d 938, 942 (N.D.Cal. 2009). Northstar followed her suggestion. After Schwab renewed its motion to dismiss the amended complaint, the district court judge to whom the case had been reassigned (Lucy Koh, J.) declined to order the dismissal of the complaint because
Rule 15(d) permits a supplemental pleading to correct a defective complaint and circumvents "the needless formality and expense of instituting a new action when events occurring after the original filing indicated a right to relief." Wright, Miller, & Kane, Federal Practice and Procedure: Civil 3d § 1505, pgs. 262-63. Moreover, "[e]ven though [Rule 15(d)] is phrased in terms of correcting a deficient statement of `claim' or a `defense,' a lack of subject-matter jurisdiction should be treated like any other defect for purposes of defining the proper scope of supplemental pleading." Id. at § 1507, pg. 273. Indeed, in Mathews v. Diaz, 426 U.S. 67, 96 S.Ct. 1883, 48 L.Ed.2d 478 (1976), the Supreme Court addressed the issue in a case in which an applicant for Medicare had failed to file his application until after an amended complaint had been filed joining him as an additional complainant in an as-yet uncertified class action. In holding that this jurisdictional defect could be cured by a supplemental pleading, the Supreme Court observed:
Id. at 75, 96 S.Ct. 1883 (internal citations omitted). This holding is consistent with Rockwell Int'l Corp. v. United States, in which the Supreme Court subsequently held that "when a plaintiff files a complaint in federal court and then voluntarily amends the complaint, courts look to the amended complaint to determine jurisdiction." 549 U.S. 457, 473-74, 127 S.Ct. 1397, 167 L.Ed.2d 190 (2007).
We add here a brief discussion of the thoughtful holding of the Court of Appeals for the Federal Circuit that summarizes the case law addressing supplemental pleadings. There, "[a]s an initial matter, the parties dispute[d] whether the allegations in [the plaintiff's] Amended Complaint that concern actions taken after the filing of the initial complaint can be used to establish subject matter jurisdiction." Prasco, LLC v. Medicis Pharm. Corp., 537 F.3d 1329, 1337 (Fed.Cir.2008). Relying on Rule 15(d) and Mathews v. Diaz, the Court of Appeals treated the complaint as a supplemental complaint and held that it was sufficient to cure the original complaint's jurisdictional defect:
Id. See also Feldman v. Law Enforcement Assocs. Corp., 752 F.3d 339, 347 (4th Cir. 2014) ("[W]e construe the present complaint as a supplemental pleading under Rule 15(d), thereby curing the defect which otherwise would have deprived the district court of jurisdiction under Rule 15(c)."); Black v. Sec'y of Health and Human Servs., 93 F.3d 781, 790 (Fed.Cir. 1996) ("Nonetheless, a defect in the plaintiff's case, even a jurisdiction defect, can be cured by a supplemental pleading under Rule 15(d) in appropriate circumstances."); United Partition Sys., Inc. v. United States, 59 Fed.Cl. 627, 644 (Fed.Cl.2004) ("The Supreme Court has interpreted Fed. R.Civ.P. 15(d) to permit supplemental pleadings in which a plaintiff may correct a jurisdictional defect in its complaint by informing the court of post-complaint events.").
Judge Koh's holding is also consistent with the approach to the Federal Rules of Civil Procedure taken by Judge Clark, "the principal architect of the Federal Rules of Civil Procedure." Zahn v. International Paper Co., 414 U.S. 291, 297, 94 S.Ct. 505, 38 L.Ed.2d 511 (1973). Thus, in Hackner v. Guaranty Trust Co. of New York, 117 F.2d 95 (2d Cir.1941), the complaint was subject to dismissal because the plaintiffs did not allege damages sufficient to satisfy the minimum amount required to invoke subject-matter jurisdiction on the basis of diversity of citizenship. An amended complaint was then filed which added a plaintiff, Eunice Eastman, whose alleged damages were "well over the requirement." Id. at 98. Speaking for the Second Circuit, Judge Clark wrote that subject-matter jurisdiction was proper notwithstanding the fact that it was first established by the addition of Eastman as a plaintiff in the amended complaint:
Id. (quotations and citations omitted); see also Fed.R.Civ.P. 1 (which provides that the Rules of Civil Procedure "should be construed and administered to secure the just, speedy, and inexpensive determination of every action and proceeding").
While Morongo does contain the broad statement that "subject matter jurisdiction must exist as of the time the action is commenced" and that a lack of subject-matter jurisdiction at the outset cannot be cured subsequently, it is now clear, if it was not then, that this rule is more nuanced than the inflexibility suggested by its language — both as it relates to curing jurisdictional defects through supplemental pleadings, see, e.g., Mathews, 426 U.S. 67, 96 S.Ct. 1883, and other circumstances in which defects in subject-matter jurisdiction were cured by the substitution, addition, or elimination of a party, see, e.g. Newman-Green, Inc. v. Alfonzo-Larrain, 490 U.S. 826, 830, 109 S.Ct. 2218, 104 L.Ed.2d 893 (1989); Mullaney v. Anderson, 342 U.S. 415, 72 S.Ct. 428, 96 L.Ed. 458 (1952); California Credit Union League v. City of Anaheim, 190 F.3d 997, 1000 (9th Cir.1999). Nevertheless, we need not belabor this issue because, in order to decide this case, it is enough to say that the rule as stated in Morongo does not extend to supplemental pleadings filed pursuant to Fed.R.Civ.P. 15(d).
The same is true of Righthaven LLC v. Hoehn, 716 F.3d 1166 (9th Cir.2013), which the dissent relies on for the "general principle that `jurisdiction is based on facts that exist at the time of filing.'" Dissent at 1068. Of course, a general principle, which Righthaven observed was subject to at least a few exceptions, is significantly different from the hard and fast rule that the language in Morongo suggested. Indeed, Righthaven acknowledged the possibility of additional exceptions and left open the question of whether "permitting standing based on a property interest acquired after filing" should be added to the list of exceptions. Righthaven, 716 F.3d at 1171 ("We need not decide whether the circumstances of this case call for a new exception to the general rule, however, because Righthaven lacked standing either way.").
Nor does the Supreme Court's holding in Grupo Dataflux v. Atlas Global Group, L.P., 541 U.S. 567, 124 S.Ct. 1920, 158 L.Ed.2d 866 (2004), compel a contrary result. There, diversity jurisdiction was lacking at the time the lawsuit was commenced because the plaintiff was a Texas-based limited partnership that included two Mexican citizens as members and the defendant was a Mexican corporation. Id. at 569, 124 S.Ct. 1920. After a verdict was rendered in favor of the plaintiff, the district court granted the defendant's motion to dismiss for lack of jurisdiction. Id. On appeal, the plaintiff partnership argued that the Mexican partners had left the partnership in a transaction consummated the month before the trial began. Id. A sharply divided Supreme Court held that this change in the composition in the membership of the partnership was insufficient to cure the initial jurisdictional defect. Specifically, it held that the time-of-filing rule "measures all challenges to subject-matter jurisdiction premised upon diversity of citizenship against the state of facts that existed at the time of filing — whether the challenge be brought shortly after filing, after trial, or even for the first time on appeal." Id. at 571, 124 S.Ct. 1920. Moreover, notwithstanding significant departures from the time-of-filing rule in diversity
Nevertheless, we do not regard that holding as dispositive here. First, the present case does not involve the issue of diversity jurisdiction. See Connectu LLC v. Zuckerberg, 522 F.3d 82, 92 (1st Cir. 2008) ("While the Court [in Grupo Dataflux] relied upon the time-of-filing rule to thwart an effort to manufacture diversity jurisdiction during the pendency of an action, the decision operates exclusively in the realm of diversity jurisdiction."). More significantly, unlike Grupo Dataflux, the present case involves the filing of a supplemental pleading that became the operative pleading in the case on which subject-matter jurisdiction must be based.
Nor we do not see any consideration of policy that would justify a rule, for which our dissenting colleague argues, that a party such as Northstar must file a new complaint instead of a supplemental pleading because of a post-complaint assignment from a party that had standing. The dissent does not dispute, nor can it, that the assignee of a cause of action stands in the shoes of the assignor, Hoffeld v. United States, 186 U.S. 273, 276, 22 S.Ct. 927, 46 L.Ed. 1160 (1902), and unquestionably has the same standing to file a complaint that the assignor could have filed. Sprint Communications Co. v. APCC Services, 554 U.S. 269, 271, 128 S.Ct. 2531, 171 L.Ed.2d 424 (2008). Indeed, the dissent concedes that "had Northstar accepted the dismissal without prejudice and then filed a new complaint after it obtained an assignment of rights, it would have had standing and a personal stake in the out-come of this litigation." Dissent at 1067 n. 5 (emphasis in original).
A rule that would turn on the label attached to a pleading is difficult for us to accept. As the Eleventh Circuit has observed in a case in which an amended complaint contained jurisdictional allegations that were based on post-complaint events, "[e]xcept for the technical distinction between filing a new complaint and filing an amended complaint, the case would have been properly filed.... We therefore hold that we have jurisdiction over this appeal and we will reach the merits." M.G.B. Homes, Inc. v. Ameron Homes, Inc., 903 F.2d 1486 (11th Cir. 1990).
Perhaps reflecting sensitivity to having a case turn on the technical distinction between a new complaint and a supplemental pleading, the dissent suggests a policy reason for the hypertechnical rule it advocates. Thus, it argues that permitting a plaintiff to proceed by supplemental pleading alleging a post-complaint assignment of the claim has adverse practical effects. Dissent at 1069. More specifically, "[u]ninjured parties, particularly those in search of class action lead plaintiff status, could sue first, then trawl for those truly and timely injured. Today the majority green-lights those who would race to the courthouse and bend Federal Rules of Civil Procedure and Article III standing requirements to gain an edge over other claimants who are not as fleet of foot." Id.
Under current law, however, the benefit that the dissent suggests goes to the winner of the race to the courthouse does not exist. Presumably, the dissent is referring to the fact that counsel for the lead plaintiff becomes class counsel. In 2003, however, Congress amended Fed.R.Civ.P. 23 to set out discrete standards for the appointment
More significantly, the present case was not one in which Northstar won a race to the courthouse and in which its attorneys were appointed lead counsel for that reason. Indeed, by the time it obtained the assignment from Henry Holz, over three months had passed since the complaint was filed. This was more than enough time for a competing plaintiff to file a complaint. No such complaint was filed. In sum, whatever merit there may be to the dissent's concern, it is not present in this case and has been substantially eliminated by the 2003 amendments to the Federal Rules of Civil Procedure. Moreover, that a supplemental pleading can only be filed with the permission of the district judge provides additional protection against the misuse of the pleading for strategic gamesmanship.
Thus, we agree that Judge Koh did not abuse her discretion in permitting Northstar to file a supplemental pleading after a post-complaint assignment from a party that clearly had standing. See Northstar, 781 F.Supp.2d at 931-33.
Before we review each of Northstar's claims, we give a brief overview of the case, and explain how the various claims relate to each other. We begin with the various governing documents of the Fund to which we have already made reference. The Agreement and Declaration of Trust, and its bylaws, establish the Trust and govern its internal affairs, and are governed by Massachusetts law. The Fund's prospectus is issued by the Schwab Advisor on behalf of the Fund on an annual basis. The Statement of Additional Information, or "SAI," produced at the same time as the prospectus, is made available to investors freely on demand, although it does not need to be mailed to them automatically. See Glazer, Prospectus Disclosure and Delivery Requirements, in Mutual Fund Regulation § 4:3.2 (citing Sec. & Exch. Comm'n, Form N-1A at 7, available at http://www.sec.gov/about/forms/ formn-1a.pdf (last visited Aug. 29, 2014)).
In 1997, a proxy statement was submitted to and approved by the Fund's investors. It included two relevant proposals which we have already described in detail. Briefly, Proposal 2 stated that the Trust would "seek[ ] to track the investment results of [the Lehman Index] through the use of an indexing strategy." Proposal 3 stated that the Trust would not invest more than 25% of the Fund's total assets in any industry. These fundamental investment objectives could be changed only by shareholder vote. Subsequent registration statements and prospectuses reflected these changes.
Northstar's original complaint alleged four causes of action arising from the Fund's alleged violations of the fundamental
On an interlocutory appeal, we rejected Northstar's theory that it had a private right of action under the Investment Company Act. Northstar Fin. Advisors, Inc. v. Schwab Invs., 615 F.3d 1106 (9th Cir.2010). Nevertheless, the district judge had allowed Northstar to replead its state law claims, specifying under which state's law they were asserted and on which documents they relied. Northstar Fin. Advisors, Inc. v. Schwab Invs., 609 F.Supp.2d 938, 945 (N.D.Cal.2009).
Northstar then filed an amended complaint that left those claims at risk of dismissal under the Securities Litigation Uniform Standards Act of 1998 ("SLUSA"), 15 U.S.C. §§ 77p, 78bb, because it contained allegations that suggested that its claims were based on misrepresentations. SLUSA bars certain state law class actions that allege "an untrue statement or omission of a material fact [or] the use[ ] of any manipulative or deceptive device or contrivance,"
SLUSA operates "wherever deceptive statements or conduct form the gravamen or essence of the claim." Freeman Invs., LP v. Pac. Life Ins. Co., 704 F.3d 1110, 1115 (9th Cir.2013). The district judge ruled that the "central theme" of the Second Amended Complaint was that the "defendants made misrepresentations about how investments in the Fund would be managed." Northstar, 781 F.Supp.2d at 934. In the district judge's view, the crux of Northstar's case was that the defendants' statements about how the shareholders' funds would be managed were false, or became false when the Fund deviated from the index in 2007. Id. at 933-36. The district judge also noted that the Second Amended Complaint contained one specific allegation that the Trust gave a false explanation for why the Fund underperformed its index in its May 2008 semi-annual report. Id. at 936; SAC ¶¶ 96-97. The district judge then dismissed the contract claims, with prejudice, for failure to state a claim on the ground that they were barred by SLUSA, and that they failed to allege a contract between the shareholders and the Fund. Northstar, 609 F.Supp.2d at 938-40. The district judge also rejected Northstar's breach of fiduciary duty causes of action under SLUSA, but gave Northstar leave to replead them under Massachusetts law. Id.
Northstar repled the fiduciary duty causes of action in its Third Amended Complaint and also amended its allegations in an effort to remove their supposed focus on misrepresentations. Indeed, the Schwab defendants conceded in their motion to dismiss the Third Amended Complaint
As we discuss in detail below, we reverse the district court's dismissal of the breach of contract claims for failure to allege a contract between the shareholders and the Fund. We also reverse the district court's dismissal of the fiduciary duty and third-party beneficiary claims. We do not, however, reach the question of whether any of Northstar's claims are barred by SLUSA. The district court has not yet had the need to determine whether the allegations in the Third Amended Complaint can survive under SLUSA, and should do so in the first instance. See, e.g., Haskell v. Harris, 745 F.3d 1269, 1271 (9th Cir.2014) ("[W]e are a court of review, not first view.").
With this as a backdrop, we proceed to discuss the merits of Northstar's complaint.
Northstar argues that, once the shareholders approved the proposals regarding the fundamental investment objectives of the Schwab Trust, which were described in the proxy statement, the Schwab Trust was contractually obligated to comply with them in managing the Fund. Moreover, Northstar argues that the subsequent dissemination of the fundamental investment objectives in the registration statement and prospectuses formed a contract between the Schwab Trust and the "existing investors [who] retained shares and new investors [who] purchased shares in consideration for Schwab's contractual obligations." Appellant's Br. at 21; see also Appellant's Reply Br. at 7 n.8.
The Restatement (Second) of Contracts provides that "[a] promise may be stated in words either oral or written, or may be inferred wholly or partly from conduct." Restatement (Second) of Contracts § 4 (1981). While contracts are often spoken of as express or implied, "[t]he distinction involves ... no difference in legal effect, but lies merely in the mode of manifesting assent." Id. cmt. a. "Just as assent may be manifested by words or other conduct, sometimes including silence, so intention to make a promise may be manifested in language or by implication from other circumstances, including course of dealing or usage of trade or course of performance." Id. "The distinction between an express and an implied contract, therefore, is of little importance, if it can be said to exist at all." 1 Joseph M. Perillo, Corbin on Contracts § 1.19 at 57 (rev. ed.1993); see also 1 Richard A. Lord, Williston on Contracts § 1:5 at 37-38 (4th ed.2007) ("An implied-in-fact contract requires proof of
While it is not necessary to characterize the contract here as either express or implied, a particularly instructive discussion of the concept of implied contracts, in circumstances analogous to those present here, appears in Trustees of Dartmouth College v. Woodward, 17 U.S. (4 Wheat.) 518, 4 L.Ed. 629 (1819), one of the earliest cases applying Article I, Section 10 of the Constitution, which provides that "[n]o State shall ... pass any ... Law impairing the Obligation of Contracts." The case arose out of an effort by the State of New Hampshire to alter the terms of a corporate charter that had provided certain guarantees as to the structure and governance of Dartmouth College. As Professor Tribe succinctly describes it, the Supreme Court "held that New Hampshire could not pack the Dartmouth College board of trustees and alter its faculty so as to change the college into a public institution in violation of its 1769 charter from George III." Laurence H. Tribe, American Constitutional Law 614 (2d ed.1988). Of particular relevance here is the concurring opinion of Justice Story, who began his discussion of this issue by describing the creation of the corporation and the terms of its charter. Specifically, he observed:
Dartmouth College, 17 U.S. (4 Wheat.) at 689.
Justice Story then identified two implied contracts in this circumstance. First, "there was an implied contract on the part of the crown, with every benefactor, that if he would give his money, it should be deemed a charity protected by the charter, and be administered by the corporation, according to the general law of the land. As, soon, then, as a donation was made to the corporation, there was an implied contract... that the crown would not revoke or alter the charter, or change its administration, without the consent of the corporation." Id. Second, "[t]here was also an implied contract between the corporation itself, and every benefactor, upon a like consideration, that it would administer his bounty according to the terms, and for the objects stipulated in the charter." Id. at 689-90, 17 U.S. 518.
The fundamental investment objectives of the Schwab Total Bond Market Fund can be analyzed in the same manner. Indeed, when they were adopted by the shareholders, they added a structural restriction on the power conferred on the Trustees in the Agreement and Declaration of Trust that can only be changed by a vote of the shareholders. This created a "contract between the [Trustees themselves], and every [investor]" — that the Schwab Trust "would administer his [investment] according to the terms, and for the objects stipulated in the" two restrictions
The defendants argue that undertakings in SEC filings themselves cannot reflect contractual obligations that can be enforced in a suit for breach of contract. This argument cannot be reconciled with Lapidus v. Hecht, 232 F.3d 679 (9th Cir. 2000), where the plaintiffs sought "to recover losses sustained by the mutual funds as a result of short sales made without shareholder approval, allegedly in violation of the registration statement filed with the Securities and Exchange Commission." Id. at 680. Specifically, the defendant, a Massachusetts business trust, had filed a "prospectus ... with the SEC [that] provided that the trust could engage in short sales of securities with a value of up to 25% of the value of the mutual fund's total assets."
On appeal, we addressed whether the plaintiffs could bring their action for violations of the ICA directly against the defendant or whether the action had to be brought derivatively. We held that the Lapidus plaintiffs had adequately alleged an injury "predicated upon a violation of [the] shareholder's voting rights," id. at 683 (citing cases), and that those "allegations are sufficient to satisfy the injury requirement for a direct action under Massachusetts law," id. Significantly, the violation held to be adequately alleged was of the plaintiffs' "contractual rights as shareholders to vote on proposed changes to the short sale and senior security restrictions." Id. (emphasis added). These restrictions were spelled out in the registration statement, id., and in the "prospectus filed with the SEC," id. at 681. Lapidus's holding is directly applicable here because Northstar's breach of contract cause of action rests on the deviation by defendants from two fundamental investment objectives, which required a shareholder vote to be changed, without first obtaining shareholder approval. Until the fundamental investment objectives were amended by shareholder vote, the investors had a contractual right to have the Fund managed in accordance with those objectives.
McKesson HBOC, Inc. v. New York State Common Retirement Fund, Inc., 339 F.3d 1087 (9th Cir.2003), upon which the
Id. at 1089. McKesson sought recovery for unjust enrichment, which was potentially available only if there was no governing contract between the parties. Id. at 1089, 1091. While McKesson HBOC ultimately held that there was no recovery for unjust enrichment, even if there were no governing contract, it first addressed whether the Merger Agreement or the relevant Proxy Statement/Prospectus ("Prospectus") was a contract that governed McKesson's claims against the shareholders.
First, McKesson HBOC held that "it is clear from the text and the signatories to the agreement that the only parties to the Merger Agreement were the corporations themselves." Id. at 1091. Second, it held that "the Prospectus was not an offer by McKesson to the HBOC shareholders to enter into a bilateral contract separate and apart from the Merger Agreement." Id. at 1092. Specifically, McKesson HBOC explained that, although the "Prospectus references the Merger Agreement, advising shareholders that `[t]he merger cannot be completed unless the stockholders of both companies approve the merger agreement and the transactions associated with it,'" such "references do not ... convert McKesson's solicitation of the shareholders' vote into a contractual offer." Id. Thus, McKesson HBOC concluded that "the Prospectus did not serve as the basis for a contract between McKesson and the shareholders." Id. at 1093.
Significantly, McKesson HBOC distinguished the scenario it addressed from a "tender offer situation, where the courts have found a contract between the corporation and an individual shareholder who tenders shares[.]" Id. at 1092; see also 6A Fletcher Cyc. Corp. § 2841.10 at 358 (rev. ed.2013) ("A binding contract is created when the shareholder tenders his or her securities in accordance with the terms of the offer."). Unlike a tender offer, "the shareholders [in McKesson] did not tender their shares." McKesson HBOC, 339 F.3d at 1092-93. Moreover, "shareholders who objected to the merger could not separately opt out or contract out of the merger. Individual shareholders were not in a position of contracting with McKesson, and shareholder ratification did not convert the Prospectus into a contract." Id at 1093.
This case is clearly distinguishable from McKesson HBOC. First, the parties to the contract at issue in this case are the Trustees and the shareholders of the Fund. Second, the breach of contract cause of action is predicated, in part, on the approval of the fundamental investment objectives by the shareholders. Once those objectives were adopted, they significantly restricted the discretion which the Agreement and Declaration of Trust conferred on the Schwab Trust to manage the Fund. Moreover, the Fund's registration statement and prospectuses reflected the adoption of those restrictions. The acquisition of the securities constituted an acceptance of the offer.
Nor does In re Charles Schwab Corp. Securities Litigation, No. C 08-01510 WHA, 2009 WL 1371409 (N.D.Cal. May 15, 2009) [hereinafter "Charles Schwab"], on which defendants rely, and which involved
We find equally unpersuasive the argument that "the prospectuses ... here at issue are not contracts but rather are mandatory regulatory disclosure documents." Charles Schwab, 2009 WL 1371409, at *3. The prospectus, which is the primary selling document, offers to sell shares to investors in a mutual fund which will invest the proceeds in the manner described in the prospectus, unless shareholders approve a proposal to do otherwise. Indeed, the Securities and Exchange Commission urges investors to "request and read the fund's prospectus before making an investment decision." Mutual Fund Prospectus, Sec. & Exch. Comm'n, http://www.sec.gov/answers/mfprospectustips.htm (last visited Sept. 5, 2014). The mere fact that Congress has chosen to ensure that investors are fully informed of the fundamental investment objectives of mutual funds hardly provides a license to ignore the objectives, enshrined by shareholder approval, which a mutual fund has obligated itself to pursue. Nor does it alter the fact that the purchase of those shares constitutes an acceptance of the offer by the investor. Indeed, as previously observed, this is precisely how the shareholders became parties to the Agreement and Declaration of Trust. Agreement and Declaration of Trust 4 ("Every Shareholder by virtue of having become a Shareholder shall be held to have expressly assented and agreed to the terms hereof and to have become a party hereto.").
Moreover, the district judge in Charles Schwab did not cite any authority for his suggestion that a "mandatory regulatory disclosure document" cannot form the basis for an implied contract. Lapidus holds otherwise and the district judge in Charles Schwab acknowledged that, "in certain circumstances prospectuses can constitute a contract." Charles Schwab, 2009 WL 1371409, at *5. Indeed, even before the enactment of the Securities Act of 1933, "the term `prospectus' was well understood to refer to a document soliciting the public to acquire securities from the issuer." Gustafson v. Alloyd Co., Inc., 513 U.S. 561, 575, 115 S.Ct. 1061, 131 L.Ed.2d 1 (1995) (citing Black's Law Dictionary 959 (2d ed.1910)).
In sum, we conclude that the mailing of the proxy statement and the adoption of the two fundamental investment policies after the shareholders voted to approve them, and the annual representations by the Fund that it would follow these policies are sufficient to form a contract between the shareholders on the one hand and the Fund and the Trust on the other. The Fund offered the shareholders the right to invest on these terms, and the shareholders accepted by so investing. The consideration for the contract was the shareholders' investment, or continued investment, in the Fund, and the parties' object was
We are aware that Judge Koh held that, under the particular circumstances of this case, Northstar failed to successfully allege the formation and breach of a contract. 781 F.Supp.2d at 939. She reasoned that:
Id. at 940.
We are not persuaded. Northstar alleged that the SAI's statement that "the funds have determined that mortgagebacked securities issued by private lenders are not part of any industry for the purposes of the funds' concentration policies," Northstar Fin. Advisors, Inc. v. Schwab Invs., No. 5:08-cv-04119-LHK (N.D. Cal.), Statement of Additional Information (Sept. 1, 2006) at 8, Doc. No. 152-2, was an improper attempt to circumvent the Fund's concentration policy that limited investment in one industry to 25% of its assets because no vote was taken to approve it. This position was supported by a complaint filed by the Securities and Exchange Commission, which alleged "that the Schwab trust deviated from its policy on concentration for the Schwab Total Bond Market Fund ... by deciding to not treat mortgage-backed securities as an industry without shareholder approval." Appellees' Br. 13 (citing SEC v. Charles Schwab Inv. Mgmt. Inc., No. 11-cv-00136 (N.D. Cal.), Compl. ¶¶ 24-28, Doc. No. 1).
Specifically, the SEC charged that before August 2006, the 25% concentration policy stated that "[b]ased on characteristics of mortgage-backed securities, [the Total Bond Fund] has identified mortgage-backed securities issued by private lenders and not guaranteed by the U.S. government agencies or instrumentalities as a separate industry for purposes of [the] fund's concentration policy." SEC v. Charles Schwab Inv. Mgmt. Inc., No. 11-cv-00136 (N.D. Cal.), Compl. ¶ 25, Doc. No. 1; see also Schwab Investments, Statement of Additional Information (Form N-1A, Part B) 9 (Nov. 15, 2004). The position of the SEC was that, because Schwab had identified mortgage-backed securities issued by private lenders as an industry, "the Total Bond Fund could not invest more than 25% of [its] assets in non-agency MBS without obtaining shareholder approval under Section 13(a)" of the ICA. SEC v. Charles Schwab Schwab Inv. Mgmt. Inc., No. 11-cv-00136 (N.D. Cal.), Compl. ¶ 25.
Judge Koh's reliance on the September 1, 2006 SAI, even if correct, overlooks the fact that the Fund's concentration policy was only one of the two fundamental investment objectives from which the defendants could not depart without shareholder approval. The primary violation was "causing the Fund to deviate from its fundamental investment objective to `seek to track the investment results' of the Lehman Brothers U.S. Aggregate Bond Index... `through the use of an indexing strategy.'" The complaint then goes on to allege that the "Fund also deviated from its stated fundamental investment objective by investing more than 25% of its total assets
The SAI did not provide any notice that the defendants intended to depart from the first of the fundamental objectives which obligated the Fund to "seek to track the investment results" of the Lehman Index. Thus, even if Judge Koh was correct in her analysis with respect to the breach of the second investment objective, as to which notice was provided in the SAI, the complaint still sufficiently states a claim for breach of contract. This is true with respect to those who purchased before September 1, 2006 and held on to their shares afterward, and those who purchased after that date.
Particularly as to those who purchased before September 1, 2006 and held onto their shares, we are not prepared to assume that the SAI itself was sufficient to provide adequate notice. An SAI, "affords the Fund an opportunity to expand discussions of the matters described in the prospectus by including additional information that the Fund believes may be of interest to some investors." Glazer, Prospectus Disclosure and Delivery Requirements, in Mutual Fund Regulation § 4:3.2 (quoting Sec. & Exch. Comm'n, Form N-1A at 7, available at http://www.sec.gov/about/forms/formn-1a.pdf (last visited Sept. 5, 2014)). "The SAI is not automatically provided investors but must be available free of charge upon request." Id. Moreover, the SAI may be specifically incorporated "by reference into the prospectus without delivering the SAI with the prospectus." Id. § 4:3.1[D]. While there may be sophisticated shareholders who make the effort to ask for an SAI or read it with the care necessary to digest the relevant parts of a long and multifaceted document, we think it is reasonable to assume that there are many ordinary shareholders who do not do so. Indeed, even if a mutual fund could alter a fundamental investment objective by the vehicle of an SAI, it should provide current shareholders with clear and unambiguous notice of the alteration that it wishes to make.
Northstar alleged that the Schwab defendants breached their fiduciary duties by failing to ensure that the Fund was managed in accordance with the fundamental investment objectives and by changing the Fund's fundamental investment objectives without obtaining required shareholder authorization. The district judge held that Northstar "failed to successfully allege a breach of any duty owed directly to Fund investors, and that these claims would have to be asserted derivatively." Northstar Fin. Advisors, Inc. v. Schwab Invs., 807 F.Supp.2d 871, 876 (N.D.Cal.2011).
Defendants conceded at oral argument that the allegations in the operative complaint are sufficient to state a cause of action for breach of fiduciary duty. They argue, however, that the Trustees did not owe a fiduciary duty to the beneficiaries of the Schwab Trust — namely, the shareholders. Instead, they argue that because of the "close resemblance of a mutual fund operated as a Massachusetts Business Trust to a corporation," the Trustees should be treated in the same way as corporate directors, who "owe fiduciary duties to the corporation rather than to its shareholders." Appellees' Br. at 48. This argument provides the predicate for the claim that Northstar was required to proceed by way of a derivative action.
There are several deficiencies in this argument. First, it simply ignores the plain terms of the Agreement and Declaration of Trust.
The document states expressly that:
Agreement and Declaration of Trust 1. We are not aware of any Massachusetts case that holds that agreements of this kind cannot be enforced directly by the beneficiaries of a trust.
Second, the Supreme Judicial Court of Massachusetts has held that "[i]t is axiomatic that the ... trustees [stand] in a fiduciary relationship to all the beneficiaries of the trust." Fogelin v. Nordblom, 402 Mass. 218, 521 N.E.2d 1007, 1011 (1988); see also Dukeminier, Sitkoff & Lindgren, Wills, Trusts, and Estates 556 ("In managing the portfolio, [the trustee] is subject to a fiduciary obligation to" the investors in the mutual fund); John H. Langbein, The Secret Life of the Trust: The Trust as an Instrument of Commerce, 107 Yale L.J. 165, 166 (1997) ("The familiar standards of trust fiduciary law protect trust beneficiaries of all sorts, regardless of whether the trust implements a gift or a business deal (unless, of course, the terms of the transaction expressly contraindicate)."). While the Supreme Judicial Court of Massachusetts has acknowledged similarities between corporations and business trusts, it has held that business trusts "are not corporations, nor are they entities apart from the trustees." Swartz v. Sher, 344 Mass. 636, 184 N.E.2d 51, 53 (1962). Under these circumstances, there is no logical basis for the argument that the trustees of a mutual fund organized as a Massachusetts business trust owe a fiduciary duty to the trust, rather than the shareholders, and that for this reason they are limited to a derivative action on behalf of the trust.
Lapidus v. Hecht, 232 F.3d 679 (9th Cir.2000), upon which defendants rely, does not support their position. Lapidus involved two discrete claims of wrongdoing. The first, which is comparable to the cause of action here, was based on deviations from the investment objectives of the mutual fund and the issuance of senior securities without shareholder approval. Id. at 681 (citing 15 U.S.C. § 80a-13(a)(2)-(3)). The second cause of action involved the issuance of senior securities in violation of section 15 U.S.C. § 80a-18(f).
Lapidus first addressed the issue of whether a direct action could be brought for the departure from the mutual fund's investment objectives and the issuance of senior securities without shareholder approval. Lapidus, 232 F.3d at 683. We held that, "[t]o bring a direct action under Massachusetts law, a plaintiff must allege an injury distinct from that suffered by shareholders generally or a wrong involving one of his or her contractual rights, such as the right to vote." Lapidus, 232 F.3d at 683 (emphasis added). We then went on to observe that the plaintiffs alleged "violations of their contractual rights as shareholders to vote on proposed changes to the short sale and senior security restrictions." Id. Such claims could be brought directly. Id.
Lapidus then addressed the second cause of action based on "the allegedly improper issuance of senior securities," id. at 683, in violation of federal law, id. at 681 n. 3. This action could not be brought directly because it failed both parts of the disjunctive test. First, the injury was not distinct from the injury to all shareholders holding the same series of stock because the alleged improper "issuance of senior securities ... would be an injury to the trust generally." Id. at 683. Second, the alleged improper issuance was "unconnected to any violation of voting rights" or any other contractual right. Id.
Moreover, even if that prong survived the holding in Tooley, a direct action in this case would be appropriate under the second prong of the disjunctive test applied in Lapidus because the plaintiffs allege "a wrong involving one of [their] contractual rights as ... shareholder[s]." 232 F.3d at 683. Northstar's breach of contract cause of action rests on the deviation by defendants from two fundamental investment objectives, which required a shareholder vote change, without first obtaining shareholder approval. The right to vote, however, is not the only contractual right at issue. Instead, it is inextricably intertwined with the restrictions placed on the power of the Trustees to invest the assets of the Fund. Until the fundamental investment objectives were amended by shareholder vote, the investors had a contractual right to have the Fund managed in accordance with those objectives.
The third deficiency in defendants' argument that this action must be brought derivatively is that the distinction between direct and derivative actions has little meaning in the context of mutual funds, at least on the facts present here. A publicly held corporation, in contrast to a mutual fund, engages in a business, e.g., the buying and selling of widgets, in which the accretion of share price is generally the byproduct of business success, and the depletion of share price can be the by-product of either unsuccessful business decisions or misconduct by fiduciaries. The particular facts in the latter scenario will determine whether claims against corporate officers are derivative or direct in nature (or both). See Tooley, 845 A.2d 1031. In a mutual fund, however, there is no business other than acquiring investment instruments for the purpose of increasing the net asset value "for the pro rata benefit of the holders ... of Shares in this Trust." Agreement and Declaration of Trust 1. Any decrease in a mutual fund's share price flows directly and immediately to the shareholders. This is particularly true when such an injury results from the failure to comply with a fund's fundamental investment objectives. Thus, such misconduct supports a direct action.
There may be scenarios where a mutual fund trustee can be sued only derivatively — for example, if he embezzles assets held by the fund, the injury may be first to the mutual fund and only secondarily to the investors in the fund. But that is not this case. Rather, this case alleges a failure to follow trading restrictions, the very essence of the Fund's business, which, accepting the allegations as true, caused a diminution in shareholder value. The claim supports a direct action because the impact is directly on the investors in the Fund and a recovery would not be dependent on demonstrating an injury to the Schwab Trust. Cf. Tooley, 845 A.2d at 1039 (holding that a corporate stockholder who brings a direct action "must demonstrate
Even if we were to accept defendants' attempt to analogize the Fund to a publicly held corporation, their argument that Northstar may only sue derivatively would fail. Significantly, the Principles of Corporate Governance promulgated by the American Law Institute ("ALI") recognize that in circumstances comparable to this case, a direct action may be appropriate. Thus, in a comment to § 7.01, the section that is captioned "Direct and Derivative Actions Distinguished," the ALI observes:
American Law Institute, Principles of Corporate Governance § 7.01, cmt. c (1994).
The present case involves the same kind of structural relationship of shareholders to the Schwab Trust that the foregoing comment addresses. Of course, we deal here with an agreement and declaration of trust rather than a certificate of incorporation. The adoption by the shareholders of the fundamental investment objectives of the Fund effectively imposed a restraint on the structural relationship in the Agreement and Declaration of Trust comparable to an amendment of a certificate of incorporation. The allegations in the complaint, although not in haec verba, are sufficient to support an argument that the Trustees "violat[ed] both specific restraints imposed by the shareholders and the official[s'] duty of care." ALI, Principles of Corporate Governance § 7.01, cmt. c. Thus, even if the same rules that apply to corporations are applied to the Schwab Trust, this is the kind of case in which "the plaintiff may opt to plead either a direct or a derivative action[.]" Id.
Moreover, there is another reason, directly rooted in Massachusetts case law, which provides a basis for permitting a direct action even against a corporation. While Massachusetts cases generally preclude direct actions "where corporate recovery for misdeeds by a corporate fiduciary
This case is one in which a recovery by the Schwab Trust "would not provide a just measure of relief to the complaining shareholder." Diamond, 2009 WL 1539792, at *7. Any recovery in a derivative action would simply increase the net asset value of the Fund at the time any damages were recovered. Consequently, as defendants conceded at oral argument, if a derivative suit is successfully prosecuted, all current shareholders would participate in the recovery by the Schwab Trust even if they were not shareholders during the relevant time period, and injured former shareholders would not necessarily participate in the recovery at all.
Significantly, the remedy agreed to in an enforcement action by the SEC avoids such "a[n] [un]just measure of relief to the complaining [shareholders]." Crowley, 573 N.E.2d at 1004. The action, as we have previously observed, was based on the allegation "that the Schwab Trust improperly deviated from its policy on concentration for the [Fund] ... by deciding to not treat mortgage-backed securities as an industry without shareholder approval." Appellees' Br. at 13 (citing SEC v. Charles Schwab Inv. Mgmt. Inc., No. 11-cv-00136 (N.D. Cal.), Compl. ¶¶ 24-28, Doc. No. 1). A consent judgment was entered requiring the Schwab Trust to disgorge profits and prejudgment interest. Appellees' Br. at 13-14 (citing SEC v. Charles Schwab Inv. Mgmt. Inc., No. 11-cv-00136 (N.D. Cal.), Consent to Enter J. ¶ 2, Doc. No. 2). The Schwab Trust, however, did not share in the recovery. Instead, the settlement proceeds were deposited by the defendants into "a fund for distribution to adversely affected investors, including investors in the [Fund.]" Appellees' Br. at 14 (citing SEC v. Charles Schwab Inv. Mgmt. Inc., No. 11-cv-00136 (N.D. Cal.), Order Approving Distribution Plan with Modification, Doc. No. 37). This kind of remedy could be obtained if this direct class action is successful.
Halebian v. Berv, 457 Mass. 620, 931 N.E.2d 986 (2010), upon which defendants rely, does not compel a contrary result. The defendants correctly argue that Halebian held, in an appropriate case, a shareholder of a mutual fund may be forced to resort to making a demand on the Trustees to file a derivative action. Nevertheless, Halebian did not address the circumstances under which such a course of action would be required. Instead, it held that "the statute regulating derivative actions [Mass. Gen. Laws ch. 156D, §§ 7.40-7.47] applies to a shareholder bringing such a claim against a corporation or a business trust." Id. at 988 n. 4. Because the plaintiff had filed a derivative action, Halebian went on to address the narrow issue of "whether the Legislature intended that the provisions for dismissal under § 7.44 apply only to derivative proceedings that are `commenced after rejection
Moreover, the allegations in that case were quite unlike the misconduct alleged here. In Halebian, the plaintiff claimed that the trustees failed to engage in competitive bidding in their selection of an investment adviser. Id. at 988. A derivative suit was arguably appropriate in the case because the injury to the shareholders was the attenuated result of an improper trust expenditure (the investment adviser's fee).
Nor are we persuaded by the policy arguments defendants rely on to support treating this case as a derivative action. Defendants argue that "[b]y requiring shareholders to demand that a corporation bring a claim before filing a derivative action, derivative action rules allow disinterested directors to halt suits that are meritless or contrary to the corporation's interest and allow them to exercise their judgment and oversee litigation in the best interest of the company." Appellees' Br. at 46-47 (citing Mass. Gen. Laws ch. 156D, § 7.42; Daily Income Fund, 464 U.S. at 533, 104 S.Ct. 831; Halebian, 457 Mass. at 626, 931 N.E.2d 986). Moreover, they go on to argue that, "applying derivative action rules in this context ... ensures that disinterested trustees remain primarily responsible for management of a trust's litigation." Appellees' Br. at 47. This argument is particularly unpersuasive in light of the manner in which Massachusetts business trusts that operate mutual funds conduct business. The Supreme Court has recognized that mutual funds are "typically organized and underwritten by the same firm that serves as the company's `investment advisor.'" Kamen, 500 U.S. at 93, 111 S.Ct. 1711. They are essentially puppets of the investment adviser.
Moreover, although fund boards have been required to include a percentage of independent directors, "the definition of `independent' is fairly loose when it comes to fund board members[.]" Shipman, So Who Owns Your Mutual Fund?, Wall St. J., May 5, 2003, at R1. As one commentator has observed:
Id. Indeed, notwithstanding the requirement that a percentage of the members of the mutual fund board be "independent" from the adviser, Congress required that the shareholders of the Fund annually approve the adviser contract. 15 U.S.C. § 80a-15. This requirement reflected the fact that the trustees of a mutual fund "cannot seriously be expected to induce arm's-length bargaining. As the SEC long ago recognized, any so-called independent directors would `obviously have to be satisfactory to the dominating stockholders who are in a position to continue to elect a responsive board.'" Fox v. Reich & Tang, Inc., 692 F.2d 250, 259 (2d Cir.1982) (quoting In re Petroleum & Trading Corp., 11 S.E.C. 389, 393 (1942)). Under these circumstances, it is wrong to suggest that "applying derivative action rules in this context ... ensures that disinterested trustees remain primarily responsible for management of a trust's litigation." Appellees' Br. at 47. This is particularly true here because one of the principal defendants,
There are, of course, other "reasons ... commonly advanced for distinguishing between a derivative action, which is brought on the corporation's behalf against either corporate fiduciaries or third persons, and a direct action, which is brought on a shareholder's own behalf against either corporate fiduciaries or the corporation itself." Eisenberg & Cox, Corporations and Other Business Organizations 1064. The first has been described as "theoretical: Since a corporation is a legal person separate from its shareholders, an injury to the corporation is not an injury to its shareholders. This proposition is somewhat dubious, because every injury to a corporation must also have an impact, however slight, on the shareholders as well." Id. The other, and more compelling, reasons of policy are summed up in Watson v. Button as follows: "(1) to avoid a multiplicity of suits by each injured shareholder, (2) to protect the corporate creditors, and (3) to protect all the stockholders since a corporate recovery benefits all equally." 235 F.2d 235, 237 (9th Cir.1956); see also Eisenberg & Cox, Corporations and Other Business Organizations 1064. Significantly, two of these three policy objectives, which defendants also put forward here, are ameliorated by the very nature of the class action, which is designed to avoid a multiplicity of suits by shareholders and which contain procedural mechanisms to ensure that all members of the class are treated equally. Moreover, to the extent that one of the reasons for favoring a derivative suit is a concern for the protection of creditors, it is enough to say here that the defendants do not argue that the concern is at issue in this case.
The Schwab Trust entered into an agreement with the Schwab Advisor to serve as its investment adviser and administrator of the Fund. The Schwab Advisor expressly agreed to "use the same skill and care in providing such services as it would use in providing services to fiduciary accounts if it had investment responsibilities for such accounts." The principal duty of the Schwab Advisor, as prescribed in the IAA with the Schwab Trust, was to "determine from time to time what securities and other investments [would] be purchased, retained, or sold by the [Fund]." This agreement with the Schwab Advisor was expressly approved by the shareholders of the Fund. Northstar alleges that the Schwab Advisor breached the IAA by managing the Fund in a manner inconsistent with the Fund's fundamental investment objectives, and that the shareholders may hold the Schwab Advisor liable for such a breach as third-party beneficiaries of the IAA.
The IAA expressly states that it "shall be governed by the laws of the State of California." Under California Civil Code § 1559, a critical element of a third-party cause of action is a showing that the contract was "made expressly for the benefit of a third person." The phrase, however, has been held not to mean "exclusively," Hartman Ranch Co. v. Associated Oil Co., 10 Cal.2d 232, 73 P.2d 1163, 1170 (1937), "solely," Le Ballister v. Redwood Theatres, Inc., 1 Cal.App.2d 447, 36 P.2d 827, 827 (Cal.Dist.Ct.App.1934), or "primar[il]y," Montgomery v. Dorn, 25 Cal.App. 666, 145 P. 148, 151 (Cal.Dist.Ct.App.1914), for the benefit of a third person. Similarly, the term has been construed not to require that performance be rendered "directly" to the beneficiary, Lucas v. Hamm, 56 Cal.2d 583, 15 Cal.Rptr. 821, 364 P.2d 685, 688 (1961), or that the beneficiary be specifically named or identified in the contract, Garratt v. Baker, 5 Cal.2d 745, 56 P.2d 225, 226 (1936).
Under these circumstances, the critical issue is "`[w]hether the third party is an intended beneficiary.'" Balsam v. Tucows Inc., 627 F.3d 1158, 1161 (9th Cir. 2010) (quoting Prouty v. Gores Tech. Grp., 121 Cal.App.4th 1225, 18 Cal.Rptr.3d 178, 184 (2004)). The resolution of this issue, in turn, "`involves construction of the intention of the parties, gathered from reading the contract as a whole in light of the circumstances under which it was entered.'" Id. (quoting Prouty, 18 Cal. Rptr.3d at 184); Restatement (Second) of Contracts § 302, reporter's note ("A court in determining the parties' intention should consider the circumstances surrounding the transaction as well as the actual language of the contract." (citing cases)). "Insofar as intent to benefit a third person is important in determining his right to bring an action under a contract, it is sufficient that the promisor must have understood that the promisee had such intent." Lucas, 15 Cal.Rptr. 821, 364 P.2d at 689.
Northstar has adequately alleged an "intent to benefit a third person." Northstar has also plausibly alleged that the Schwab Advisor understood that it was the intent of the Schwab Trust to benefit the shareholders of the Fund. Moreover, compelling evidence lending plausibility to the third-party beneficiary cause of action, based on the premise that the shareholders are intended beneficiaries of the IAA, is that Congress has required "that the contract between the adviser and the company be approved by a majority of the company's shareholders." Kamen, 500 U.S. at 93, 111 S.Ct. 1711 (citing 15 U.S.C. § 80a-15(a)); see also Navellier v. Sletten, 262 F.3d 923, 944 (9th Cir.2001); David A. Sturms & Renee M. Hardt, Regulation of the Advisory Contract, in Mutual Fund Regulation § 6:2.2 (Clifford E. Kirsch ed., 2d ed.2005).
Thus, the agreement between the Schwab Trust and the Schwab Advisor explicitly provides "that it has been approved by a vote of a majority of the outstanding voting securities of such Schwab Fund, in accordance with the requirements under the [ICA]." This suffices to establish that the shareholders have more than a "remote" relationship to the contract between the Schwab Trust and the Schwab Advisor. Rather, it indicates the direct relationship that the shareholders have with the IAA and the fact that they are the actual beneficiaries of the IAA. Indeed, as we have held, the requirement for shareholder approval, which is imposed by the ICA, "reflect[s] the judgment of Congress that stockholders of the investment company have a substantial interest in evaluating the new owners of an investment manager." Zell v. InterCapital Income Sec., Inc., 675 F.2d 1041, 1047 (9th Cir.1982) (citing 15 U.S.C. § 80a-15(a)(4)).
The sufficiency of the complaint is also supported by a number of California cases. Specifically, in Gilbert Financial Corp. v. Steelform Contracting Co., 82 Cal.App.3d 65,
Applying the reasoning of Gilbert, the Fund's shareholders are comparable to the property owners, the Schwab Trust is comparable to the general contractor, and the Schwab Advisor is comparable to the subcontractor. The Schwab Trust engaged the Schwab Advisor to manage and operate the Fund in accordance with the fundamental investment objectives that the shareholders had adopted. In this situation, the Schwab Advisor's management of the Fund directly affected whether the Fund achieved its stated goal of tracking the Lehman Index. Thus, the "ultimate beneficiary" of the Schwab Advisor's contractual duties were the shareholders.
A more recent case, Spinks v. Equity Residential Briarwood Apartments, 171 Cal.App.4th 1004, 90 Cal.Rptr.3d 453 (2009), is similarly analogous. In Spinks, an employer had contracted with a landlord to provide housing for an employee. Sometime thereafter, the employer terminated the employee and directed the landlord to change the locks on the employee's apartment, which the landlord did. The employee brought suit against the landlord as a third-party beneficiary of the contract between the employer and the landlord. The California Court of Appeal held that the employee had adequately alleged that she was an intended third-party beneficiary. See id. at 475. In so holding, the court noted that "the most basic aspect of [the landlord's] performance is its obligation to supply [the employer] with a place for its staff to live." Id. at 472. In the present case, "the most basic aspect" of the Schwab Advisor's performance — properly managing the Fund — is for the benefit of the shareholders.
Nor does the fact that the IAA contained an inurement clause providing that it "shall be binding upon and shall inure to the benefit of the parties hereto and their respective successors," preclude a third-party beneficiary action in the context of this case. The defendants cite cases holding that, because the parties specified one particular beneficiary in the contract, other beneficiaries are excluded. These cases are not dispositive. The cases upon which the defendants rely do not speak to this issue or are not controlling. For instance, Klamath Water Users Protective Ass'n v. Patterson, 204 F.3d 1206 (9th Cir.1999), involved a governmental contract, not a private contract. "Parties that benefit from a government contract are generally assumed to be incidental beneficiaries, and may not enforce the contract absent a clear intent to the contrary." Id. at 1211. Arista Films, Inc. Emp. Profit Sharing Plan v. Gilford Sec., Inc., 43 Cal.App.4th 495, 51 Cal.Rptr.2d 35 (1996), the only California case the defendants cite, concerned an arbitration contract, where the "overwhelming weight of authority" was against third-party enforcement, and which was governed by New York law, not California law. Id. at 38.
The other cases on which the defendants rely are all from courts outside California and this circuit. At this stage in the case — a motion to dismiss — we follow
Under California law, as the district judge recognized, a plaintiff may be a third-party beneficiary of a contract if he alleges that he is a member of a class named or referred to in the contract, or if the contract discharges a contractual duty owed to the plaintiff. Northstar, 781 F.Supp.2d at 942-43. We hold, contrary to the district judge, that Northstar has adequately alleged the existence of a contract between the Trust and the investors. Northstar has also alleged that the IAA was designed to discharge the Trust's duties to the shareholders under this contract. Therefore, Northstar's allegations that the shareholders are third-party beneficiaries of the IAA survive the motion to dismiss.
Therefore, we hold that Northstar's allegations that the shareholders are third-party beneficiaries of the IAA survive the motion to dismiss.
To summarize:
1. We hold that by filing a supplemental pleading alleging a post-complaint assignment from a party that clearly had standing, Northstar has standing to prosecute this case.
2. We reverse the district judge's dismissal of Northstar's breach of contract claim and hold that Northstar adequately alleged the formation of a contract between the investors and the Schwab Trust.
3. We vacate the district judge's dismissal of the fiduciary duty claims and remand for the district judge to "address the other arguments raised by the parties regarding [Northstar's] claims for breach of fiduciary duty[.]" Northstar, 807 F.Supp.2d at 881.
4. We reverse the district judge's dismissal of Northstar's third-party beneficiary breach of contract claim and hold that Northstar adequately alleged that the investors are third-party beneficiaries of the IAA.
5. We decline to address the effect of SLUSA on the various common law causes of action. We leave that to the district court in the first instance.
BEA, Circuit Judge, dissenting:
When Northstar Financial Advisors, Inc. ("Northstar") commenced this action by filing its complaint, it did not own, nor had it ever owned any Schwab Total Bond Market fund ("Fund") shares. Likewise, at the commencement of this action, Northstar did not own any claims of anyone who had owned any of such shares during the period when the defendants are alleged improperly to have lowered the share value of the Fund.
Defendants moved to dismiss Northstar's complaint for lack of standing, because Northstar failed to allege it had suffered an injury in fact.
The district court quite properly granted defendants' motion and dismissed the complaint without prejudice,
Northstar then filed an amended complaint that alleged Holz's assignment of claims to Northstar. Defendants again moved to dismiss on the ground that Northstar still had not alleged facts sufficient to establish Northstar's standing to sue, only to have the district court deny the motion upon an original — but nonetheless erroneous — theory. The district court noted that "in light of [the] previous holding that [an] assignment [of claims] would cure the [Northstar's] lack of standing, and direction to the [Northstar] to file an amended complaint based on the assignment, it would be unfair to [Northstar] to punish them for relying on the [prior district judge's] specific instructions." Northstar, 781 F.Supp.2d at 932.
Thankfully, there is no exception to the requirement of standing based on earlier district court error.
The first district court judge did not have jurisdiction to grant leave to amend, and the second judge could not — out of considerations of "fairness" — allow an amendment or a supplement to an original
The majority and the district court opinion examine the law of other circuits "because there is no published Ninth Circuit authority" as to whether "parties may cure standing deficiencies through supplemental pleadings." Northstar, 781 F.Supp.2d at 933. In dicta,
Nevertheless, the majority cites to limited exceptions where courts have allowed the cure of jurisdictional defects other than standing through additional pleadings. In short, the district court and the majority argue that if a supplemental pleading can cure defects in the original complaint, and if that supplemental pleading can be tacked onto the original complaint, then Northstar would retroactively have standing as of its original complaint, even though "subject-matter jurisdiction depends on the state of things at the time of the action brought." Rockwell Intern. Corp. v. U.S., 549 U.S. 457, 473, 127 S.Ct. 1397, 167 L.Ed.2d 190 (2007) (internal quotations and citation omitted). This argument misses one crucial point: "[t]he state of things and the originally alleged state of things are not synonymous." Id. Therefore, even if our circuit allowed supplemental pleadings to cure standing deficiencies, those supplemental pleadings must allege facts necessary to establish standing only as those facts existed at the time of the original complaint. This is not a novel concept in our circuit. See Wilbur v. Locke, 423 F.3d 1101 (9th Cir.2005), abrogated on other grounds by Levin v. Commerce Energy, Inc., 560 U.S. 413, 130 S.Ct. 2323, 176 L.Ed.2d 1131 (2010) ("[S]tanding is determined as of the date of the filing of the complaint.... [t]he party invoking the jurisdiction of the court cannot rely on
If all an uninjured party need do to get around pesky Article III standing requirements is to file a complaint, then ask for liberal leave to supplement under Fed. R.Civ.P. 15(d) to allege after-acquired rights of those who were timely injured, the long-standing general rule which requires injury-in-fact at commencement of the action for standing to exist quickly would lose all force. Uninjured parties, particularly those in search of class action lead plaintiff status, could sue first, then trawl for those truly and timely injured. Today the majority green-lights those who would race to the courthouse and bend Federal Rules of Civil Procedure and Article III standing requirements to gain an edge over other claimants who are not as fleet of foot. I respectfully dissent.
