LUCY H. KOH, District Judge.
The Court heard oral argument on defendants' Motion to Dismiss the Third Amended Complaint (Third MTD) in this matter on August 4, 2011. For the reasons set forth below, the Motion is GRANTED.
On August 28, 2008, Plaintiff Northstar Financial Advisors, Inc. (Northstar) filed its first complaint in 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.
Although Northstar has amended its Complaint three times, its core allegations remain the same. Northstar alleges 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; Third Am. Compl. (TAC) ¶ 5. 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. Compl. ¶ 4; TAC ¶ 6. 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 4.80% for the period September 1, 2007 through February 27, 2009, compared to a positive return of 7.85% for the Index over that period. TAC ¶ 7.
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 (N.D.Cal.2009) (Dkt. No. 74).
Judge Illston 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.
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, Northstar
This Court dismissed the SAC on March 2, 2011, 781 F.Supp.2d 926 (N.D.Cal.2011). The Court found that all of Northstar's claims, as alleged, were precluded by the Securities Litigation Uniform Standards Act of 1998 (SLUSA), because all the claims alleged misrepresentations or omissions of material fact made in connection with the purchase or sale of the Fund's shares. 15 U.S.C. § 77p. The Court found that "the central theme of the SAC and all of Plaintiffs' claims is that defendants made misrepresentations about how investments in the fund would be managed, that Plaintiffs purchased Fund shares relying on these misrepresentations, and that Plaintiffs were injured when these statements turned out to be false." The one exception was the fiduciary duty claim. Under the Delaware carve-out, this claim was not subject to SLUSA preclusion if brought under the law of the state where the security issuer is organized (here, Massachusetts).
In addition to dismissing based on SLUSA preclusion, the Court found that Northstar had failed to allege a breach of contract claim, despite specific instructions from Judge Illston to "add more specific allegations regarding the language plaintiff relies on to allege the formation of a contract."
Northstar filed its TAC on March 28, 2011. In the TAC, Northstar identifies two classes of potential plaintiffs. TAC ¶ 65. First, a "Pre-Breach" class, consisting of "all persons or entities 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 were damaged thereafter." Id. Second, a "Breach Class," consisting of "all persons or entities who purchased shares of the Fund during the period September 1, 2007 through February 27, 2009 ... and were damaged thereafter." Id. The classes are divided between August 31 and September 1, 2007 because Northstar alleges that "August 31, 2007 is the last day of the fiscal year preceding the one during which the Fund first began deviating from its required fundamental investment policy to seek to track the Lehman Index through the use of an indexing strategy." Northstar alleges that the Fund "reverted back to its required fundamental investment policy" on February 27, 2009 (approximately). TAC ¶ 66. Northstar alleges five causes of action on behalf of each of the two classes, for a total of 10 claims. These are: (1) and (6) breach of fiduciary duty against the Trustees and the Trust; (2) and (7) breach of fiduciary duty against the Investment Advisor; (3) and (8) aiding and abetting breach of fiduciary duty against the Trustees; (4) and (9) aiding and abetting breach of fiduciary duty against the Investment Advisor; (5) and (10) breach of contract as third party beneficiary of the Investment Advisory Agreement against the Investment Advisor.
During oral argument on this Motion, the parties discussed the fact that certain Schwab defendants have entered into a settlement of claims, including Section 13(a) claims, brought by the Securities and Exchange Commission (SEC) based on management of the Fund at issue in this case as well as management of another fund. Northstar and the defendants both agreed that any recovery under the fiduciary duty breach claims asserted in this case would need to be reduced by the amount of recovery obtained by Fund investors through the SEC enforcement action. As Northstar's counsel put it, the fiduciary duty breach claims asserted here are "alter egos" of the Section 13(a) claims enforced by the SEC.
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
Northstar argues that the Trustees owed fiduciary duties directly to Fund investors as a matter of law, and that the rest of the defendants owed fiduciary duties to the investors as a matter of fact. The Court finds that Northstar has failed to successfully allege a breach of any duty owed directly to Fund investors, and that these claims would have to be asserted derivatively.
The two main cases Northstar relies on for the ability of the Fund investors to sue directly for a breach of fiduciary duty are Fogelin v. Nordblom, 402 Mass. 218, 222, 521 N.E.2d 1007 (1988), and In re Great N. Iron Ore Properties, 263 N.W.2d 610, 620 (Minn.1978). Fogelin involved a Massachusetts Business Trust established in 1957 "for dealing in real estate." Fogelin, 402 Mass. at 220, 521 N.E.2d 1007. Robert C. Nordblom, one of three trustees, was initially the owner of all 500 shares of common stock of the trust. Id. In 1969, Nordblom amended the trust declaration to increase the number of common shares from 500 to 4,000, to create 6,000 preferred shares, and to give both common and preferred shareholders voting rights. Id. The 1969 Amendment also stated that no further amendment altering the rights of either class could be made without separate approval of two-thirds of each class. In 1972, the Trustees executed a further amendment which significantly decreased the liquidation value of preferred shares, and significantly increased the majority required for shareholders to make further amendments to the Trust. Fogelin, 402 Mass. at 221, 521 N.E.2d 1007. In response, the preferred shareholders (who were also all Nordblom's grandchildren) asked the Trustees not to ratify the 1972 Amendment. Fogelin, 402 Mass. at 222, 521 N.E.2d 1007. The Massachusetts Supreme Court held that the Amendment could not be ratified because, contrary to the 1969 Amendment, it benefited only trustee Nordblom himself, and prejudiced only the preferred shareholder grandchildren. In this context, the Massachusetts Supreme Court held that "[i]t is axiomatic that the BRT trustees stood in a fiduciary relationship to all of the beneficiaries of the trust and, therefore, had a duty not to favor one class of shareholders over another." Fogelin, 402 Mass. at 222-23, 521 N.E.2d 1007.
Although Northstar focuses exclusively on the first part of the quotation above, it is not clear that Fogelin stands for the broad rule Northstar urges—i.e., that trustees of all Massachusetts Business Trusts owe direct fiduciary duties to all beneficiaries of such trusts. As defendants argue, the source of the fiduciary duty in that case could have been based on the fact that the trust was a family trust administering gifts to minors. See Reply ISO Third MTD (Third Reply) at 3. Another possible explanation for the court's holding is the unequal treatment of shareholders. As the Ninth Circuit has held, it is proper to find a direct claim for breach of fiduciary duty when a trust beneficiary is injured in a way distinct from other beneficiaries. "A shareholder does not acquire standing to maintain a direct action
Northstar's other cited case, Great N. Iron Ore, is not very helpful.
As defendants point out, with one exception, the only cases cited by either party to consider whether a mutual fund trustee owes fiduciary duties directly to mutual fund investors under Massachusetts law have concluded either that no such duty is owed, or that the claim to assert a breach of fiduciary duty must be brought derivatively (because the duty is owed to the mutual fund rather than to individual investors).
Defendants cite another case in which plaintiff mutual fund investors asserted a claim for breach of fiduciary duty based on the fund's trustees "carelessly or negligently fail[ing] to seek compensation from settlement of certain securities class action suits." Hamilton v. Allen, 396 F.Supp.2d 545, 560 (E.D.Pa.2005). The Hamilton court relied on the rule that there is no direct fiduciary relationship between corporate directors and shareholders and concluded that the plaintiffs could not bring a direct claim for the diminution in fund value resulting from the alleged breach of duty. Id., 396 F.Supp 2d at 552. Northstar criticizes Hamilton for relying on corporations law rather than trusts law, but the court stated that it did so because "there appear to be no cases in which Massachusetts or Ohio courts considered the applicability of these principles to claims filed by investors in mutual funds." Id. at 550. Likewise, in Forsythe v. Sun Life Fin., Inc., 417 F.Supp.2d 100, 112 (D.Mass.2006)
Several other district court decisions follow the reasoning of Hamilton, Stegall and Forsythe and conclude that when investors in Massachusetts business trust mutual funds bring fiduciary duty breach claims asserting a harm that affects all investors equally, no direct duty is owed to the investors and the claims are therefore derivative of duties owed to the trust. See Zucker v. Federated Shareholder Servs. Co., No. 06cv241, 2007 WL 709305, at *4, 2007 U.S. Dist. LEXIS 15186, at *11 (W.D.Penn. Mar. 5, 2007) (relying in part on Stegall); In re Blackrock Mut. Funds Fee Litig., No 04 Civ 164, 2006 WL 4683167 at *8-*9, 2006 U.S. Dist. LEXIS 13846 at *29-*30 (W.D.Penn. Mar. 29,
Northstar has failed to cite a single case finding a direct claim for breach of fiduciary duty against mutual fund trustees by trust beneficiaries.
Although Northstar alleges that the putative class was harmed through a change of the Fund's fundamental investment objective without the required shareholder vote, the Court finds that this does not convert the claims to direct claims, despite the Ninth Circuit's holding in Lapidus that a claim for violation of contractual shareholder voting rights "satisf[ies] the injury requirement for a direct action under Massachusetts law" and confers standing to pursue individual claims. Lapidus, 232 F.3d at 683. The Ninth Circuit's holding was based on the requirement that "a plaintiff must allege an injury distinct from that suffered by shareholders generally or a wrong involving one of his or her contractual rights as a shareholder, such as the right to vote." Id. (emphasis added). Here, the Court previously found that Northstar has failed to plead a contract
Northstar's other arguments as to why the fiduciary duty breach claims cannot be derivative are without merit. Northstar argues that its fiduciary duty breach claims must not be derivative because each shareholder was injured to a different degree depending on the number of shares purchased and their buy and sell dates. This argument is inconsistent with the holdings of all the cases cited herein finding no direct claim for damages affecting all shareholders by decreasing share values, including the holding in Lapidus. Northstar also argues that because a trust itself holds no property, the Trust could not have sustained any injury as a result of the alleged mismanagement. But, as defendants point out, the courts in both Hamilton and Forsythe explicitly found that diminution-of-value injuries were directly felt by the trusts at issue in those cases. See Hamilton, 396 F.Supp.2d at 552; Forsythe, 417 F.Supp.2d at 112. Indeed, this holding is implicit in all the cited decisions finding that claims against mutual fund trustees are derivative. Finally, Northstar argues that it would be inequitable to allow the defendants to benefit from their own wrongs. While this is true, it does not mean that there cannot be a derivative claim on behalf of the Trust. Any recovery would go to the Trust and therefore, ultimately, to the beneficiaries of the Trust.
Northstar claims that the defendants breached their fiduciary duty by failing to follow the Fund's fundamental investment objectives, and to comply with the 25% concentration policy, and caused the Fund to fail to track the Index as a result. Because the complained-of acts allegedly caused the Fund's shares to diminish in value equally for all shareholders, the Court finds that Northstar's fiduciary duty claim must be asserted derivatively. In light of Lapidus, which holds that diminution-in-value claims alleged by mutual fund shareholders are derivative under Massachusetts law, the Court finds that Northstar's fiduciary duty claims against the defendants are derivative.
At the hearing on this Motion, Northstar first argued that it would not have standing to bring a derivative claim, and then argued that if the fiduciary duty breach claims were found to be derivative, it could amend its complaint to assert demand futility. However, Northstar's fiduciary duty breach claim is brought under Massachusetts law. As of July 1, 2004, Massachusetts law requires that a written demand be made before a derivative suit may be brought. Mass. Gen. Laws ch. 156D, § 7.42. There are no exceptions (such as futility of demand) to this requirement. See ING Principal Prot. Funds Derivative Litig., 369 F.Supp.2d 163, 170 (D.Mass.2005) (dismissing derivative claims against a mutual fund organized as a Massachusetts business trust based on the fact that plaintiffs had failed to make a demand). Because Northstar admittedly
In addition to its breach of fiduciary duty claims, Northstar has asserted several claims for aiding and abetting in the asserted breaches of fiduciary duty. See 4AC Claims 3, 4, 8 and 9. In order to state a claim for aiding and abetting in the breach of fiduciary duty, a plaintiff must allege an underlying breach of fiduciary duty. Arcidi v. Nat'l Ass'n of Gov't Emps., Inc., 447 Mass. 616, 856 N.E.2d 167, 174 (2006). Because the Court has concluded that Northstar's fiduciary duty claims are derivative claims, the aiding and abetting claims must also be brought derivatively. Therefore, the Court DISMISSES Northstar's aiding and abetting breach of fiduciary duty claims with prejudice.
Northstar's fifth and tenth claims are for breach of the Investment Advisor Agreement (IAA)
As the Court previously noted, under California law, a contract must be clear in its intention to benefit a third party in order for that party to establish beneficiary status. Id.; Cal. Civil Code § 1559 ("a contract, made expressly for the benefit of a third person, may be enforced by him at any time before the parties
The IAA does not expressly mention Fund investors, but it does mention the Fund. Northstar argues that because investors are the beneficial owners of the Fund, the Fund is a "class for whose express benefit the contract was made." However, the Fund and the investors are legally separate, and Northstar has cited no authority holding that they should be considered indistinct for these purposes. Therefore, the Court must determine if Northstar has successfully stated a claim that investors should be entitled to enforce the IAA even though they are not expressly mentioned in it (neither specifically, nor as members of a class).
Northstar cites a recent California appellate decision finding that an excess insurance provider was a third-party beneficiary to a contract between an employer and a claims administrator. Nat'l Union Fire Ins. Co. of Pittsburgh, PA v. Cambridge Integrated Servs. Grp., Inc., 171 Cal.App.4th 35, 51, 89 Cal.Rptr.3d 473 (2009). The excess insurance provider (National Union) insured workers' compensation claims over $250,000. Id. The Cambridge contract provided that the claims administrator, Cambridge, must notify any excess insurer of certain claims, as specified by the excess insurance policy. Id. In addition, any claim covered by National Union would continue to be administered by Cambridge. Id. The court concluded that National Union was a third party beneficiary to the Cambridge contract for two "interrelated" reasons. First, if Cambridge performed its duties as required and limited worker's compensation claims, this would directly benefit National Union by reducing what it must pay out in excess insurance. Id. Second, Cambridge was obligated to perform claims administration directly for National Union if the claims exceeded $250,000. Id. Northstar relies on the court's statement that the benefit to National Union was not incidental because it "flow[ed] directly from one of the purposes of the contracting parties, which was to limit the Bank's liability for workers' compensation claims," and argues that likewise, the benefit to investors under the IAA was not incidental because the value of the Fund's shares would directly rise or fall depending on the investment decisions made by the Investment Advisor.
Northstar also cites Escalante v. Minn. Life Ins. Co., No. 09cv1843-L(BLM), 2010 WL 4975658, at *2, 2010 U.S. Dist. LEXIS 127463, at *6 (S.D.Cal. Dec. 2, 2010). In this case, the plaintiff had entered into a life insurance contract. Id. Under a contract between the plaintiff's mortgage lender and the life insurer, plaintiff could make payments on the life insurance policy together with her mortgage payments, and the lender would forward the life insurance premiums to the insurer. Id. Plaintiff alleged that coverage under the life insurance policy was denied because the lender failed to forward payments to the insurer. Id. Although the court provided limited analysis of the agreement between the lender and the insurer, it appears that
Finally, Plaintiffs submitted supplemental authority finding that partners were third-party beneficiaries to an agreement between the partnership and an auditor. Tuttle v. Sky Bell Asset Mgmt., LLC, No. C-10-3588, 2011 WL 2519235 (N.D.Cal. June 16, 2011). This result was based on the agreements themselves and on allegations that that "[t]he engagement letters reflect an understanding and agreement that the audit reports would be sent to the Limited Partners. The Auditors Defendants understood and agreed that their audit reports would be sent to the Limited Partners." Id. at 2.
The agreements in Northstar's cited cases are distinguishable from the IAA on several grounds. First, at least regarding the agreement in National Union, it is clear that the agreement expressly mentioned an excess insurer. Although National Union itself was not named in the agreement, the agreement named a class of persons (excess insurers) to which National Union belonged. Likewise, although the opinion is somewhat unclear, it appears that the plaintiff in Escalante was a member of a class (insured mortgagors) mentioned specifically in the relevant contract. And in Tuttle, the court concluded that the agreements "reflected the understanding" that audit reports would be sent to partners. Second, all of the agreements in question benefitted the plaintiff third parties directly. Cambridge's claims administration would reduce National Union's exposure to claims, and National Union received claims administration directly from Cambridge once claims exceeded $250,000; Escalante was able to pay her mortgage and insurance premium in one convenient step; and the partners in Tuttle received copies of the auditors' reports.
As summarized in the Court's March 2, 2011 Order, if a contract does not clearly evince the intent to benefit a third party, that party is not a beneficiary of the contract. It is not enough for a plaintiff to identify a benefit he will receive if the contract is performed; the plaintiff must show that the contracting parties intended that he, specifically, receive this benefit. For example, in Jones v. Aetna Cas. and Sur. Co., 26 Cal.App.4th 1717, 1722, 33 Cal.Rptr.2d 291 (1994), the plaintiff leased property for his restaurant. The lease agreement required the lessor to obtain rental income insurance coverage for damage to the property, to be paid by the lessee. In the case of damage, the lease stated that plaintiff's rent would be reduced by the amount of any insurance recovery. Jones, 26 Cal.App.4th at 1721, 33 Cal.Rptr.2d 291. Despite the fact that the plaintiff would benefit in case of an insurance payout, the court found that plaintiff was not a third-party beneficiary to the insurance agreement between the lessor and the insurer. The insurance agreement itself did not mention the plaintiff, and did not demonstrate that the lessee and the insurer intended to benefit the plaintiff by entering it. Id. at 1725, 33 Cal.Rptr.2d 291.
Northstar asks the Court to expand the third-party beneficiary concept beyond the outlines set forth by the California appellate courts, described above. None of
It is undisputed that the IAA does not explicitly mention the Fund investors, and the Court finds that its references to the Fund do not equate to referencing a class of beneficiaries to which the Fund investors belong. Based on the language of the IAA itself, the Fund's intention in entering the agreement was to "retain the Investment Adviser to furnish investment advisory, administrative, and certain accounting and record-keeping services to the investment portfolios of the Trust [including the Fund at issue here]." See IAA (Dkt. No. 152, Ex. D). Although, as the Court previously noted, the Fund's share values (and therefore the Fund investor's investment values) would change depending on the Investment Advisor's actions, the benefit to Fund investors was incidental to the purposes of the IAA. As Northstar argues, a finding that investors enjoy third-party beneficiary status to enforce this contract would mean that investors could enforce any third-party contracts if the execution of such contracts affected the value of the Fund. This rule would be overbroad, likely encompassing employment agreements between the Investment Advisor and its employees. The Court previously ordered Northstar to amend its third party beneficiary claims, and deferred ruling on the question of whether Fund investors could claim third party beneficiary status based on the IAA. In light of the parties' additional briefing on this issue, the Court concludes that Fund investors are not third party beneficiaries to the IAA. Accordingly, these claims are hereby DISMISSED with prejudice.
For the reasons set forth above, Northstar's claims are DISMISSED with prejudice. The Clerk shall close the file.
