Monday, September 13, 2010

Ninth Circuit Court of Appeals Rejects Private Cause of Action Under Section 13(a) of the Investment Company Act

On August 12, 2010, the Ninth Circuit Court of Appeals issued a decision in which it found that there is no private cause of action to enforce the provisions of Section 13(a) of the Investment Company Act of 1940 ("ICA"), 15 U.S.C. Section 80a-13a. Section 13(a)(3) prohibits an investment company from deviating from its investment policies recited in its registration statement unless authorized by the vote of a majority of its outstanding voting securities.


The court of appeals began its analysis of the case before it by noting that Congress enacted the ICA in 1940 to provide comprehensive regulation of investment companies and the mutual fund industry. The ICA was the counterpart in the area of mutual fund regulation to the Securities Act of 1933 and the Securities Exchange Act of 1934, which were designed to regulate corporate securities. Section 8 of the ICA states that once an investment company registers with the SEC, it must file a registration statement that contains a recital of certain types of investment policies adopted by the company, including the company’s policy with respect to concentration of investments in a particular industry or group of industries; any policy that is only changeable through a shareholder vote; and any policy the company deems “fundamental.” 15 U.S.C. § 80a-8(b).

To ensure compliance with the requirements of the ICA, the court noted that Congress gave the SEC broad authority to police violations of the ICA. Only one section of the ICA as originally enacted authorized anyone other than the SEC to sue for violations of the Act. Section 30(f) of the 1940 Act incorporated a remedy under the 1934 Act. The Supreme Court has said that by incorporating the provisions of § 16(b) of the Securities Exchange Act of 1934 into § 30(f) of the ICA, Congress expressly authorized private suits for damages against closed-end investment company insiders who make short-swing profits. Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 20 & n.10 (1979). Later, the 1970 amendments to the ICA included a change to Section 36 of the ICA, which authorized the security holders of a registered investment company to bring a derivative suit against the company's investment advisor and its affiliates for breach of the advisor's fiduciary duty. 15 U.S.C. Section 80a-35(b).

In 2007, Congress imposed economic sanctions on two Sudanese government officials and thirty-one Sudanese companiesas a result of their involvement with the genocide in Darfur. These sanctions barred the companies from doing business within the US financial system or with US companies. To facilitate the efforts of state and local governments and private asset fund managers to divest from companies involved in business sectors in Sudan, Congress enacted the Sudan Accountability and Divestment Act ("SADA") in 2007. As a part of SADA, Congress added subsection (c) to Section 13 of the ICA. Subsection (c) expressly barred any kind of civil, criminal, or administrative action against an investment company to challenge the company's divestment from the securities of companies conducting the affected business operations in Sudan.


The litigation involved in the case before the Ninth Circuit involved claims by investors that a large investment trust operating a series of mutual funds unlawfully deviated from the investment policies set forth in its registration statement, to the detriment of the fund's shareholders and in violation of Section 13(a) of the ICA. The plaintiff brought a claim against the defendant alleging that defendant violated Section 13(a) when it allegedly deviated from the defendant fund's fundamental investment policies. The plaintiff alleged that the deviations exposed the fund and its shareholders to tens of millions of dollars in losses stemming from a sustained decline in the value of non-agency mortgage-backed securities.

The defendant moved to dismiss for failure to state a claim under ICA Section 13(a), asserting that there is no private right of action to enforce that section's terms. The district court denied this motion, declining to adopt the Second Circuit's reasoning in Olmsted. Pruco Life Ins. Co. of New Jersey, 283 F.3d 429 (2d. Cir. 2002), because Olmsted predated the 2007 amendment of Section 13 by SADA. Relying on the language of subsection (c) added to Section 13 by the SADA, the district court held that Congress recognized a private right to enforce Section 13(a) when it enacted Section 13(c) - i.e., there was no basis for Congress to bar actions based on Sudanese divestments if the statute did not authorize other private causes of action.


The court of appeals noted that a statute must explicitly or implicitly contain a private right of action. In the case before it, the parties agreed that Section 13(a) did not expressly create a right of action. Therefore, if Section 13(a) implicitly contained a private right of action, it had to be determined from the statute's language, structure, context, and legislative history. In. re Digimarc Corp. Derivative Litig., 549 F.3d 1223, 1229 (9th Cir. 2008).

The court of appeals first found that Section 13(a)'s language contains no "rights creating language." Alexandar v. Sandoval, 532 U.S. 275, 290 (2001). Instead, Section 13(a) merely contains the types of actions an investment company can take without first obtaining shareholder approval.

The court next found that the structure of the ICA did not suggest any congressional intent to allow private enforcement of Section 13(a). The Court noted that in both Bellikoff v. Eaton Vance Corp., 481 F.3d 110 (2nd Cir. 2007) and Olmsted v. Pruco Life Ins. Co. of New Jersey, 283 F.3d 429 (2nd Cir. 2002), the Second Circuit focused on the fact that the ICA authorizes SEC enforcement and that there is a private right of action for certain breaches of fiduciary duties of investment advisors in Section 36(b). The Ninth Circuit noted additionally that in Lewis, 444 U.S. at 20 & n.10, the Supreme Court found that Section 30(f) provides for a private right of action for short-swing profits made by insiders of closed-end investment companies. The court agreed with the Second Circuit that this leads to the conclusion that Congress did not intend to imply a private right of action in the ICA to enforce Section 13(a).

The court further found that the legislative history of amendments to the ICA did not evince a clear congressional intent to allow private lawsuits to enforce the statute's provisions. The court first noted that the 1970 amendments dealt with the need for shareholder votes to change investment policy. The court found that the language and legislative history reflected that purpose and that purpose only.

The court found that the 2007 amendment by the SADA, which added Section 13(c), while a stronger argument, was unpersuasive. Section 13(a) is a bar to actions any person or goverment agency might file to challenge divestment from Sudanese investments. The court of appeals noted that the district court focused on the fact that Section 13(c) referred to actions that a "person" could file. The court of appeals found that this would have some validity if the bar applied only to causes of action to enforce the other provisions of Section 13. But it extends to any civil, criminal, or administrative action brought under any state or federal law. Thus, Congress included the term "person" to describe the entities restricted from bringing the types of actions barred by Section 13(c). The court further noted that the legislative history revealed that a primary purpose of the SADA was to permit public and private asset managers to adopt Sudanese divestment measures without fear of legal reprisals.


Based on its analysis, the Ninth Circuit Court of Appeals concluded that the neither the language of Section 13(a), the structure of the ICA, nor the statute's legislative history, including the addition of Section 13(c) by the SADA, reflected any congressional intent to create, or recognize a previously established, private right of action to enforce Section 13(a). Therefore, the court of appeals reversed the order of the district court and remanded the matter with instructions to grant the defendant's motion to dismiss the plaintiff's federal ICA claims.

A complete copy of the Ninth Circuit's opinion can be found here.

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