A federal court recently decided that a registered investment company’s independent trustees owed fiduciary duties to shareholders that required the disclosure of attorney-client communications to a shareholder plaintiff in a 36(b) litigation despite the trustees’ efforts to withhold those communications on the basis of the attorney-client privilege. The court’s decision could have far-reaching implications for the confidentiality of all communications between independent trustees and their legal counsel.

Background

A mutual fund shareholder sued the fund’s investment adviser and subsidiary distributor for breaching their fiduciary duties when they charged the fund excessive fees and failed to pass on economies of scale. As part of the litigation, the shareholder issued subpoenas to the independent trustees, who were not parties to the case, for documents pertaining to the lawsuit. The independent trustees provided some documents, but withheld over 200 documents containing legal advice about the fund. The shareholder sought a court order to compel the trustees to produce the withheld documents.

Court’s Decision

While the parties agreed that the documents squarely fell within the attorney-client privilege, the shareholder argued that a “fiduciary exception” applied because the trustees were seeking legal advice to guide the administration of the fund, and not legal advice for their own personal matters. The shareholder further reasoned that the attorney-client privilege in this instance belonged to the trust’s beneficiaries – i.e., the shareholders – rather than to the trustees.

The independent trustees responded that piercing the attorney-client privilege “would destabilize the mutual fund industry to the detriment of all shareholders.”[1] The investment adviser further added that independent trustees and their counsel would not be able to speak freely to one another if their communications were opened to the public.

Ruling in the shareholder’s favor, the U.S. District Court for the Western District of Washington observed that the independent trustees owed fiduciary duties to the fund’s shareholders that required disclosure of the documents. The court reasoned that the documents at issue contained legal advice for managing the fund and were not sought in anticipation of any litigation. The court further noted that the fund paid legal counsel’s fees, and that legal advice concerning the fund was ultimately for the shareholders’ benefit. Therefore, the independent trustees and the defendants failed to show why the plaintiff shareholder was not entitled to the documents he requested. However, the court ordered the independent trustees to produce the documents to the shareholder pursuant to a protective order that shielded the documents from public disclosure.

Outlook

The attorney-client privilege is a fundamental principle of the U.S. legal system. The court’s decision threatens the free flow of communications between independent trustees and their counsel, allowing previously privileged communications regarding contract renewals, compliance, compensation and other governance matters to be publicly disclosed under the pretense of shareholder interest.

Although this decision’s impact is yet to be seen, and an appeal remains a possibility, trustees should be cautioned that the attorney-client privilege is not absolute, and that issues of a particularly sensitive nature are best discussed in person or through oral communications. Despite the court’s intention to serve the shareholder’s interests, in the long run, its decision will be detrimental to shareholders if fund trustees become hesitant to seek legal advice from counsel regarding the fund’s management out of fear their confidences will not be protected.