In our October 7, 2015 Investment Management Update, we reported that the U.S. Supreme Court had announced on October 5, 2015 that it would not grant certiorari to review the March 2015 decision of the Ninth Circuit in Northstar Financial Advisors Inc. v. Schwab Investments (“Northstar”). On the same day that the U.S. Supreme Court denied the Northstar defendants’ petition for certiorari, the U.S. District Court for the Northern District of California issued its opinion resulting from the Ninth Circuit’s remand in Northstar. As a reminder, in Northstar, the Ninth Circuit ruled that three novel state law claims were validly pled by a plaintiff seeking to represent a class of mutual fund shareholders. The state law claims were based on theories of breach of contract against the fund, breach of fiduciary duty against the trustees and adviser, and breach of the investment advisory agreement against the adviser. Most notably, the Ninth Circuit permitted all three state law claims to be brought directly, rather than derivatively.
On remand, the district court granted the defendants’ motion to dismiss with respect to the third-party beneficiary claims for breach of the advisory agreement against the adviser and the claims for breach of contract against the trust based on statements made in the fund’s proxy statement and prospectus. In each case, the court found the substance of the claim was essentially based on a misrepresentation or omission – namely, that the defendants “stated that they would do one thing, and ended up doing another.” As a result, the district court concluded that these claims fell within the scope of the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”) preclusion, which bars the filing of what are essentially federal securities laws misrepresentation claims as state law causes of action. The court also dismissed the breach of fiduciary duty claims against the trust, finding that the fiduciary duties owed to the shareholders are owed by those responsible for managing the trust (i.e., the trustees and the adviser) rather than the trust itself.
However, the district court found that the trustees and the adviser could not raise a SLUSA defense as to the breach of fiduciary duty claims because they had failed to assert the defense in their motion to dismiss the plaintiff’s earlier third amended complaint. Therefore, the breach of fiduciary duty claims against the trustees and the adviser survived the defendants’ motion to dismiss.
We expect that the district court’s opinion to be appealed to the Ninth Circuit sometime in 2016.
In our view, while the district court’s opinion is favorable to funds and their advisers and board members, it does not diminish the potential risks posed by the Ninth Circuit’s Northstar decision. SLUSA preclusion is very fact specific, turning on the allegations of a given complaint. Although the district court held that certain of the plaintiff’s allegations sounded in misrepresentation, plaintiffs in other cases may assert alternative claims that a court concludes do not sound in misrepresentation (and, therefore, were not precluded by SLUSA)