Opinion ID: 511960
Heading Depth: 1
Heading Rank: 2

Heading: investment company act claims

Text: 14 As the Supreme Court has noted, [t]he relationship between investment advisers and mutual funds is fraught with potential conflicts of interest. Burks v. Lasker, 441 U.S. 471, 481, 99 S.Ct. 1831, 1838, 60 L.Ed.2d 404 (1979) (quoting Galfand v. Chestnutt Corp., 545 F.2d 807, 808 (2d Cir.1976)). [A] typical fund is organized by its investment adviser which provides it with almost all management services.... [A] mutual fund cannot, as a practical matter sever its relationship with the adviser. Therefore, the forces of arm's-length bargaining do not work in the mutual fund industry in the same manner as they do in other sectors of the American economy. Id. (quoting S.Rep. No. 184, 91st Cong. at 5 (1969)). In enacting the Investment Company Act of 1940, Congress was aware of this potential conflict of interest and was also concerned by reports of 'fantastic abuse of trust by investment company management and wholesale victimizing of security holders.'  United States v. Smolar, 557 F.2d 13, 20 (1st Cir.) (quoting United States v. Deutsch, 451 F.2d 98, 108 (2d Cir.1971), cert. denied, 404 U.S. 1019, 92 S.Ct. 682, 30 L.Ed.2d 667 (1972)), cert. denied, 434 U.S. 866, 966, 971, 98 S.Ct. 203, 508, 523, 54 L.Ed.2d 143, 453, 461 (1977). The Act was designed primarily to correct [such] abuses of self-dealing which had produced injury to stockholders of investment companies. Id. 15 The regulatory scheme embodied in the Investment Company Act scheme carefully controls the relationship between investment advisers and investment companies. It limits the number of persons affiliated with the adviser who may serve on the investment company's board of directors, 15 U.S.C. Sec. 80a-10, it requires that fees for investment advice and other services be governed by a written contract approved both by the directors and the shareholders of the investment company, 15 U.S.C. Sec. 80a-15, and it strictly regulates most transactions between investment companies and their advisers. 15 U.S.C. Sec. 80a-17. See Daily Income Fund, Inc. v. Fox, 464 U.S. 523, 536-37, 104 S.Ct. 831, 838-39, 78 L.Ed.2d 645 (1984). Lessler's claim that he and other shareholders were harmed by self-dealing on behalf of Management Company thus falls squarely within the scope of concerns addressed by the Investment Company Act. 16 Nevertheless, raising an issue not addressed by the magistrate, the defendants assert a threshold defense to Lessler's invocation of the Investment Company Act, at least with regard to sections other than 36(b). 5 They argue that the Investment Company Act generally may not be enforced by private parties like Lessler. Relying principally on Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 100 S.Ct. 242, 62 L.Ed.2d 146 (1979), defendants point to Congress' failure explicitly to create private rights under sections like 17(a)(2) while at the same time providing for administrative enforcement and criminal penalties, see 15 U.S.C. Secs. 80a-35(a), 80a-41, 80a-48, and urge that this legislative scheme conclusively illustrates Congress' intent not to create a private cause of action. We do not agree. 17 At the outset, we must express our surprise that none of the defendants has cited, let alone discussed, this court's decision in Levitt v. Johnson, 334 F.2d 815 (1st Cir.1964), cert. denied, 379 U.S. 961, 85 S.Ct. 649, 13 L.Ed.2d 556 (1965), where an implied private cause of action under the Investment Company Act was found, at least in the context of a shareholder derivative suit. See also Moses v. Burgin, 445 F.2d 369, 373 & n. 7 (1st Cir.) (finding an implied private cause of action under section 36 of the Investment Company Act as it existed prior to the 1970 amendments in which Congress made explicit that such a private cause of action exists), cert. denied, 404 U.S. 994, 92 S.Ct. 532, 30 L.Ed.2d 547 (1971). We recognize, of course, that Levitt and Moses were decided before Cort v. Ash, 422 U.S. 66, 95 S.Ct. 2080, 45 L.Ed.2d 26 (1975), and later cases in which the Supreme Court imposed new constraints on the implication of private causes of action. E.g., Transamerica, 444 U.S. 11, 100 S.Ct. 242; Touche Ross & Co. v. Redington, 442 U.S. 560, 99 S.Ct. 2479, 61 L.Ed.2d 82 (1979). But two post-Cort court of appeals decisions have both distinguished Transamerica and held that causes of action implied under the Investment Company Act survive that decision. Bancroft Convertible Fund, Inc. v. Zico Investment Holdings, Inc., 825 F.2d 731 (3d Cir.1987); Fogel v. Chestnutt, 668 F.2d 100 (2d Cir.1981), cert. denied, 459 U.S. 828, 103 S.Ct. 65, 74 L.Ed.2d 66 (1982). The defendants also have failed to cite or discuss these cases whose reasoning we find compelling. 18 In Fogel, stockholders of a mutual fund brought a derivative action against an investment adviser and several affiliated directors based on the failure of the adviser to take action to recapture certain brokerage commissions. The district court dismissed the stockholders' suit on the merits, but the Second Circuit, assuming that there was a private cause of action under the Investment Company Act, reversed and remanded for a computation of damages. Fogel v. Chestnutt, 533 F.2d 731 (2d Cir.1975) (Fogel I ), cert. denied, 429 U.S. 824, 97 S.Ct. 77, 50 L.Ed.2d 86 (1976); see Schwartz v. Eaton, 264 F.2d 195, 198 n. 5 (2nd Cir.1959) (finding a private cause of action under the Investment Company Act); Brown v. Bullock, 294 F.2d 415 (2d Cir.1961) (same). After remand, the case returned to the Second Circuit where the defendants claimed, among other things, that cases like Transamerica compelled the conclusion that no implied private causes of action exist under the statute. In a thoughtful and thorough opinion by Judge Friendly, the Second Circuit rejected that argument. Fogel v. Chestnutt, 668 F.2d 100 (2d Cir.1981) (Fogel II ), cert. denied, 459 U.S. 828, 103 S.Ct. 65, 74 L.Ed.2d 66 (1982). Judge Friendly distinguished Transamerica, which dealt with a companion statute, the Investment Advisers Act, from the Investment Company Act on the following basis. 19 In contrast to the three court of appeals decisions, all of very recent date, see [Transamerica,] 444 U.S. at 14 n. 4 [100 S.Ct. at 244 n. 4], sustaining the availability of a private cause of action under the Investment Advisers Act, the cases in the courts of appeals upholding the private cause of action for damages for violation of the [Investment Company Act] go back to our decision in Brown v. Bullock, supra, in 1961, and include the Third Circuit's 1963 decision in Taussig v. Wellington Fund, Inc., 313 F.2d 472, 476, cert. denied, 374 U.S. 806 [83 S.Ct. 1693, 10 L.Ed.2d 1031] (1963); the First Circuit's 1964 decision in Levitt v. Johnson, 334 F.2d 815 (1964), cert. denied, 379 U.S. 961 [85 S.Ct. 649, 13 L.Ed.2d 556] (1965); the Tenth Circuit's 1968 decision in Esplin v. Hirschi, 402 F.2d 94, 103 (1968), cert. denied, 394 U.S. 928 [89 S.Ct. 1194, 22 L.Ed.2d 459] (1969), and numerous other decisions of the courts of appeals.... 20 Fogel II, 668 F.2d at 110. Judge Friendly found it significant that this line of cases had survived subsequent amendment of the statute in 1970, and refuted convincingly the notion that the express right of action created in 1970 under section 36(b) reasonably could be interpreted to negate the implied causes of action previously found by the courts of appeals. Id. at 111-12. 21 Building on Fogel II, the Third Circuit in Bancroft reached a similar conclusion. Its treatment of the issue is instructive. 22 We need not repeat Judge Friendly's Fogel v. Chestnutt analysis here. We do note, however, that it is consistent with the analysis made a short time later by the Supreme Court in Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Curran, 456 U.S. 353 [102 S.Ct. 1825, 72 L.Ed.2d 182] (1982). In Curran, the Court considered whether there is an implied private right of action for enforcement of the Commodities Exchange Act (CEA). After many courts of appeals had so held, Congress amended the CEA in 1974 and 1978, but neither the original act nor the amendments addressed the subject of private judicial remedies. The Curran Court, stating that the crucial issue was whether Congress, in amending the CEA, intended to preserve pre-existing implied remedies, reasoned: 23 In determining whether a private cause of action is implicit in a federal statutory scheme when the statute by its terms is silent on that issue, the initial focus must be on the state of the law at the time the [amending] legislation was enacted. More precisely, we must examine Congress' perception of the law that it was shaping or reshaping. When Congress enacts new legislation, the question is whether Congress intended to create a private remedy as a supplement to the express enforcement provisions of the statute. When Congress acts in a statutory context in which an implied private remedy has already been recognized by the courts, however, the inquiry is logically different. Congress need not have intended to create a new remedy, since one already existed; the question is whether Congress intended to preserve the existing remedy. 24 Id. at 378-79 [102 S.Ct. at 1839] (footnote omitted). Noting that prior to the amendments, federal courts routinely and consistently recognized an implied cause of action under the CEA, the Curran Court concluded that an implied cause of action under the CEA was, therefore, part of the contemporary legal context in which Congress acted in amending the Act. See id. at 381 [102 S.Ct. at 1840].... Therefore, the Curran Court held, the prior law on implied causes of action for enforcement of the statute survived. 25 We find Fogel v. Chestnutt persuasive authority and Curran controlling. 26 825 F.2d at 731. See also Krinsk v. Fund Asset Management, Inc., 654 F.Supp. 1227, 1230-34 (S.D.N.Y.1987) (relying on Fogel II to imply a cause of action under the Investment Company Act); Saylor v. Bastedo, 100 F.R.D. 44, 52-53 (S.D.N.Y.1983) (same). The Third Circuit noted that the implied private cause of action under the Investment Company Act had survived two sets of extensive congressional amendments, the first in 1970 and the second in 1980. In the case of the latter amendments, the legislative history accompanying the amendments explicitly stated that Congress intended the courts to continue implying private causes of action under the Investment Company Act where the plaintiff falls within the class of persons protected by the statutory right in question. Id. at 735-36 (quoting H.Rep. No. 1341, 96th Cong., 2d Sess. 28-29, reprinted in 1980 U.S.Code Cong. & Admin.News 4800, 4810-11). 27 We agree with the Second and Third Circuits that it is consistent with congressional intent and with governing law to imply a private cause of action under the Investment Company Act. Moreover, as already stated, we think it clear that Lessler is within the class of persons intended to be protected by the Investment Company Act in general, and particularly section 17(a)(2) upon which he principally relies. We therefore reject the defendants' threshold argument and move on to consider the merits of Lessler's claims under the Investment Company Act. 28 Section 17(a)(2), in essence, prohibits investment advisers and persons affiliated with such advisers from purchasing the assets of a registered investment company. See note 1 supra. Lessler argues that Management Company and the individual defendants, who are affiliated persons, have purchased such assets, at least indirectly, by arranging for the sale of Narragansett to Monarch in conjunction with an arrangement whereby Management Company obtained a twenty percent interest in the profits to be made on former Narragansett assets now owned by Monarch. Defendants would have us reject this claim by adopting the overly technical analysis of the magistrate which segregated the Monarch-Management Company fee arrangement from the Narragansett-Monarch sale. This distorts the complaint. There is no basis in Lessler's complaint for the magistrate's conclusion that the two transactions are independent. To the contrary, the gist of the complaint is that, while the two transactions are separate on their faces, they are in fact components of a single deal. 29 Especially in light of section 48(a), which makes it unlawful to do indirectly that which one could not do directly, we believe that if Lessler can prove that the two transactions are related in the way he alleges, he will have a valid claim under section 17(a)(2). To hold otherwise would elevate form over substance and ignore the broad remedial purposes of the Act; it would allow the defendants, simply by structuring a deal in two parts, to immunize their plan from judicial scrutiny under the Investment Company Act. See United States v. Smolar, 557 F.2d 13, 20 (1st Cir.) (rejecting an unduly restrictive interpretation of section 17(a) because it would make the task of regulation impossible), cert. denied, 434 U.S. 866, 966, 971, 98 S.Ct. 203, 508, 523, 54 L.Ed.2d 143, 453, 461 (1977). Since it is prohibited by the Act for Management Company directly to purchase Narragansett assets, we fail to see why the Act could not also reach Management Company's attempt to achieve the same result through the more circuitous route of selling Narragansett to a third party while itself retaining an interest (in the form of an excessive contingent advisory fee) in Narragansett assets. 30 Of course, in order to succeed, Lessler will also need to prove that the twenty percent contingent fee (in addition to the two to three percent annual management fee) is indeed, under the circumstances, so excessive as an investment advisory fee as to constitute an ownership interest by Management Company in the assets managed. 6 But Lessler is entitled to his day in court to attempt to prove exactly that. Accordingly, the district court's dismissal of Lessler's section 17(a)(2) claim must be reversed and the issue remanded for further proceedings. 31 Section 36(b)(4) of the Investment Company Act makes it clear that rights and remedies under section 17 and section 36(b) are intended to be mutually exclusive. It provides that section 36(b) shall not apply to compensation or payments made in connection with transactions subject to section 80a-17.... 15 U.S.C. Sec. 80a-35(b)(4). Since we have held that Lessler's complaint does state a claim under section 17(a)(2), it therefore follows that his complaint does not also state a claim under section 36(b). In addition, even if the transaction involved here was not subject to section 17, Lessler's section 36(b) claim would fail for another reason. Section 36(b) provides shareholders with a cause of action for compensation paid to an investment adviser in violation of the adviser's fiduciary duty. See note 2 supra. Here, however, the disputed compensation is the twenty percent contingent fee, and Lessler does not allege that any part of that fee has yet been paid by Monarch to Management Company. Lessler therefore can point to no cognizable loss under section 36(b) upon which to sue. The district court's dismissal of Lessler's section 36(b) claim is affirmed. 32 Lessler's final Investment Company Act claim is his request for rescission of the Narragansett-Monarch sale contract under section 47(b)(1), and his related request for unjust enrichment recovery under section 47(b)(3). In this claim, Lessler appears to have overlooked the plain language of the very statutory section he invokes. Section 47(b)(1) declares that contracts entered into in violation of the other provisions of the Investment Company Act are unenforceable by either party. 15 U.S.C. Sec. 80a-46(b)(1) (emphasis added). Lessler is not a party to the Narragansett-Monarch contract, nor does his complaint assert a derivative action on behalf of Narragansett, which is a party. Lessler proceeds solely on his own behalf as a shareholder and on behalf of others similarly situated. As our previous decisions have made clear, a shareholder such as Lessler lacks standing to pursue on his own claims properly belonging to the corporation. E.g., In re Dein Host, Inc., 835 F.2d 402, 405-06 (1st Cir.1987). The dismissal of Lessler's section 47 claim was proper.