The US District Court for the District of New Jersey denied a defendant’s motion to dismiss a pending action under Section 36(b) of the 1940 Act, holding that a participant in a variable annuity program has standing to bring the action. Section 36(b) limits those who may pursue a claim to the SEC or a security holder on behalf of a mutual fund that is allegedly charged excessive fees. The term “security holder” is not defined in the 1940 Act.
Plaintiff is a participant in a variable annuity program that entitles her to receive certain insurance benefits. Plaintiff’s variable annuity contributions, together with those of other program participants, are placed in a separate account and plaintiff is credited with units of the separate account. The defendant insurance company is the legal owner of the assets in the separate account and invests those assets in the shares of underlying mutual funds selected by program participants. Plaintiff alleges that the underlying mutual funds incurred excessive fees because the investment adviser, which contracted with sub-advisers to provide portfolio management services, maintained most of the investment management fees while providing only supervisory input.
Rather than addressing the issue of whether or not the fees paid by the mutual funds are excessive for Section 36(b) purposes, defendants argued that plaintiff does not have standing to bring the case. Specifically, since plaintiff owns units of the separate account, rather than shares of an underlying mutual fund, she is not the legal or record owner of the fund and therefore is not a “security holder” for purposes of Section 36(b). Plaintiff argued that the term “security holder” refers to the equitable or beneficial owner of a security.
The court referenced the broad definition of “security” in the securities laws and said that it makes little sense to construe “security” broadly while limiting the “reach of ‘holders’ to entities that lack any economic interest or stake in the transaction.” The court found that, because plaintiff and similarly situated variable annuity investors have all the incidents of ownership of the underlying fund shares, and accordingly all the economic stake in the investment, plaintiff has standing to bring a Section 36(b) case on behalf of underlying mutual funds in which a separate account invests. The court distinguished this from a fund-of-funds case, in which the plaintiffs did not enjoy the incidents of ownership in the underlying funds.
Sivolella v. AXA Equitable Life Insurance Co., No. 3:11-cv-04194 (D.N.J. Sept. 25, 2012)