Last week, the Second Circuit, in Bellikoff v. Eaton Vance Corporation, 2007 U.S. App. LEXIS 5951 (2d Cir. March 15, 2007), affirmed the district court’s dismissal of claims under certain provisions of the Investment Company Act of 1940 (“40 Act”). The Second Circuit agreed with the reasoning of several recent district court decisions and held that 40 Act Sections 34(b), 36(a) and 48(a) do not provide a private right of action.
In Bellikoff, a group of mutual fund investors brought a putative class action in the United States District Court in the Southern District of New York alleging violations of the 40 Act, the Investment Advisors Act and breach of fiduciary duty. Plaintiffs alleged that the Defendants improperly used fund money to make payments to brokers to encourage them to sell fund shares. These “shelf space” payments allegedly created more interest in the funds, which resulted in greater fund sales and increased fund assets. Plaintiffs argued that the increase in fund assets did not benefit the fund or its investors. Rather, the increase in assets was said to benefit the Investment Advisor and Distributor Defendants because their fees were calculated based on a percentage of assets under management. Plaintiffs further alleged that the advisory fees were disproportionately large.
Plaintiffs pursued ten causes of action in the trial court, of which the Second Circuit reviewed only four based on 40 Act Sections 34(b), 36(a), 48(a) and 36(b). Section 34(b) makes it unlawful for any person to make a material misstatement or omission in a registration statement or other document required by the 40 Act, 15 U.S.C. § 80a-33b, and Section 36(a) authorizes the SEC to bring an action to address breaches of fiduciary duties that involve “personal misconduct,” 15 U.S.C. § 80a-35(a). Section 48(a) provides for secondary liability on the part of any person who directly or indirectly causes another to do any act which would have been unlawful for that person to do himself or herself, 15 U.S.C. § 80a-47(a). Section 36(b) provides that “the investment adviser of a registered investment company shall be deemed to have a fiduciary duty with respect to the receipt of compensation for services, or of payments of a material nature, paid by such registered investment company, or by the security holders thereof, to such investment adviser . . . .” 15 U.S.C. § 80a-35(b).
The district court granted Defendants’ motion to dismiss, holding that under the 40 Act:
“(1) no private rights of action exist under §§ 34(b), 36(a), and 48(a);
(2) claims under §§ 36(a) and 48(a) must be brought derivatively, and plaintiffs lack standing to file derivative suits; and
(3) plaintiffs’ § 36(b) claims fail as a matter of law.”
Bellikoff, 2007 U.S. App. The Second Circuit reviewed the case and ultimately affirmed the district court’s holding.
In holding that Sections 34(b), 36(a), and 48(a) do not create a private right of action, the Second Circuit followed the course set by recent district court decisions. Many district courts have relied on the Supreme Court’s relatively new approach to implied rights of action adopted in Alexander v. Sandoval, 532 U.S. 275 (2001), to reject assertions of implied private rights of action. Prior to Sandoval, several courts had held that some 40 Act provisions contained private rights of action. Sandoval’s holding that congressional intent is determinative in assessing whether a statute creates private right and remedy severely limited situations where courts could imply a private right of action.
In Bellikoff, the Second Circuit held that “the text and the structure of the [40 Act] reveal no ambiguity about Congress’s intention to preclude private rights of action to enforce §§ 34(b), 36(a), and 48(a).” Relying heavily on Sandoval, the Court based its decision on four primary points:
(1) Neither Section 34(b), 36(a), nor 48(a) explicitly provide a private right of action.
(2) The 40 Act expressly provides another enforcement method, namely SEC civil suits and investigations, 15 U.S.C. § 80a-41. This suggests that Congress intended to preclude other methods of enforcement in favor of SEC action.
(3) The 40 Act explicitly provides private rights of action for other provisions which signals that the omission of a private right from Sections 34(b), 36(a), and 48(a) was intentional.
(4) The sections do not contain “rights creating language,” which indicates that Congress did not intend to imply a private right. Sections 34(b), 36(a), and 48(a) all focus on the regulated entity and not on the protected individual. This counsels against finding an implied private right of action.
The Second Circuit also affirmed the district court’s dismissal of Plaintiffs’ Section 36(b) claims. The Court reasoned that the Section 36(b) claim failed as to the Investment Advisor and Trustee Defendants because they did not receive the compensation or fees in question. The statute clearly specifies that claims may not be brought “against any person other than the recipient of such compensation payments.” 15 U.S.C. § 80a-35(b)(3) (emphasis supplied). Plaintiffs’ claim against the Distributor Defendant also failed because Plaintiffs did not meet Second Circuit pleading requirements that a Section 36(b) claim must allege that fees are excessive, not merely improper. The Court reiterated its prior holding in Gartenberg v. Merrill Lynch Asset Management, Inc., 694 F.2d 923 (2d Cir. 1982), that to properly state a claim “the complaint must specifically allege that the fees were so disproportionately large that they bore no relationship to the services rendered.”
Although many district courts have discussed this issue at great length, Bellikoff is the first Court of Appeals case to apply the Sandoval implied private rights of action approach to Sections 34(b), 36(a), and 48(a) of the 40 Act. Perhaps most notable about the decision is the Second Circuit’s reluctance to stray from recent district court jurisprudence. In the wake of Bellikoff, plaintiffs will no doubt face an even tougher uphill battle in arguing for implied private rights of action.