On August 28, a federal district court in Tennessee dismissed two shareholders’ claims in a derivative lawsuit against BlackRock’s iShares Trust and iShares, Inc. (together, the Funds), Blackrock Fund Advisors (BFA), the Funds’ investment adviser, Blackrock Institutional Trust Company, N.A. (BRC), the Funds’ securities lending agent, and the directors of the Funds. The plaintiffs, two pension funds invested in the Funds, brought the suit seeking relief under various sections of the Investment Company Act of 1940 (the 1940 Act), including Section 36(b), in connection with the Funds’ securities lending transactions. Section 36(b) provides a right of action for excessive fund compensation to the investment adviser or any of its affiliates. The plaintiffs alleged that BFA and BTC received an excessive amount of compensation from securities lending revenue earned on the Funds’ securities lending transactions.
Funds that engage in securities lending typically contract with a lending agent to facilitate lending transactions with borrowers. The lending agent usually receives compensation by retaining a portion of the revenue generated from the securities lending transactions. Under the Funds’ securities lending agreement, BFA and BTC retained approximately 40 percent of the revenue created from the transactions, with the Funds receiving the remaining 60 percent. The plaintiffs argued that this compensation was grossly excessive and that more of the profit should have been returned to the Funds’ shareholders. The original complaint cited a 2012 Finadium survey showing that a majority of mutual funds using a non-affiliated lending agent had retained 90 percent of revenue. The complaint also stated that the securities lending arrangement among Vanguard Group, Inc. and the Vanguard Funds allowed those funds to retain 100 percent of securities lending revenue after costs.
The Court dismissed all of the plaintiffs’ claims, holding that the Section 36(b) claim was precluded by an exception within the statute. That exception, Section 36(b)(4), provides that transactions between entities that have obtained an exemptive order under Section 17 from the SEC are excepted from a Section 36(b) action. The Court pointed out that predecessors of BFA and BTC had received an exemptive order from the SEC under Section 17 of the 1940 Act permitting them to conduct the joint securities lending transactions among them and the Funds, and this exemption therefore removed the plaintiffs’ securities lending claim from the scope of Section 36(b). The Court gave the plaintiffs until September 17, 2013, to either amend the complaint or ask for a deadline extension.
A copy of the court’s opinion is available here.
A copy of the pension funds’ complaint is available here.