The U.S. Court of Appeals for the Ninth Circuit has overturned a District Court decision that recognized an implied private right of action under Section 13(a) of the 1940 Act. Section 13(a) requires shareholders to approve an investment company’s deviations from its investment policy. The court, in Northstar Financial Advisors Inc. v. Schwab Investments, rejected the implied cause of action, stating that “[n]either the language of § 13(a), the structure of the [1940 Act], nor the statute’s legislative history, including the addition of § 13(c), the [Sudan Accountability and Divestment Act of 2007 (SADA)], reflect any congressional intent to create, or recognize a previously established, right of action to enforce § 13(a).”
The Ninth Circuit heard the case on an interlocutory appeal after a California district court found a private cause of action under Section 13(a). Plaintiff Northstar had alleged that the Schwab Total Bond Market Fund had deviated from its investment objective in violation of Section 13(a) of the1940 Act in two ways. First, although its disclosed objective was to track a specific index, the fund made sizeable investments in nonagency collateralized mortgage obligations (CMOs) that were substantially riskier than the securities in the index. Second, although the fund’s stated investment objective prohibited industry concentrations greater than 25 percent of total fund assets, it invested over 25 percent in CMOs. The district court held that whether investments in non-agency CMOs were inconsistent with the fund’s index-tracking objective and whether mortgage-backed securities are properly considered an “industry” were factual questions that could not be resolved on the pleadings. The district court also held that the fund’s reclassification of mortgage-backed securities may have violated its disclosed industry concentration policy. Proceedings on these issues were stayed during Schwab’s appeal of the district court’s ruling.
The Ninth Circuit opinion in Northstar v. Schwab examined Section 13(a) for “rightscreating language” that would imply Congressional intent “to confer upon shareholders the right to sue an investment company for violating the statute’s requirements.” Finding none, it noted that the Second Circuit’s examination of private causes of action under other sections of the 1940 Act was instructive in assessing whether private suits could be maintained under Section 13(a). The court agreed with the Second Circuit “that the structure of the [1940 Act] does not indicate that Congress intended to create an implied private right to enforce the individual provisions of the Act.” The opinion also emphasized that the 1940 Act’s “thorough delegation of authority to the SEC to enforce” it “strongly suggests Congress intended to preclude other methods of enforcement.” The court rejected Northstar’s argument that SADA created a private right of action, stating that SADA barred actions far beyond the scope of Section 13 and that subsequent amendment by Congress in the Comprehensive Iran Sanctions, Accountability and Divestment Act of 2010, indicated legislative intent that no such right of action be created. The remaining issues in Northstar v. Schwab were remanded to the district court for further proceedings.