Opinion ID: 731884
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Text: fiduciary duty concerning such compensation or payments, for 7 breach of fiduciary duty in respect of such compensation or payments paid by such registered investment company or by the security holders thereof to such investment adviser or person. 15 U.S.C. § 80a-35(b). A suit brought under Section 36(b) is similar to a derivative action in that it is brought on behalf of the investment company. Because the action is brought on behalf of the company, ―any recovery obtained in a § 36(b) action will go to the company rather than the plaintiff.‖ Daily Income Fund, Inc. v. Fox, 464 U.S. 523, 535 n.11 (1984) (citations omitted). Accordingly, ―[i]n this respect, a § 36(b) action is undeniably ‗derivative‘ in the broad sense of that word.‖ Id. (citations omitted). In the context of derivative suits governed by FED. R. CIV. P. 23.1, courts have imposed a requirement of continuous ownership.1 This requirement: 1 FED. R. CIV. P. 23.1(a) provides: This rule applies when one or more shareholders or members of a corporation or an unincorporated association bring a derivative action to enforce a right that the corporation or association may properly assert but has failed to enforce. The derivative action may not be maintained if it appears that the plaintiff does not 8 [D]erives from the first sentence of Rule 23.1, which refers to actions ‗brought by one or more shareholders to enforce a right of a corporation. . . .‘ The rule's provision that a ‗derivative action may not be maintained if it appears that the plaintiff does not fairly and adequately represent the interests of the shareholders . . . similarly situated in enforcing the right of the corporation . . . ,‘ has served as an anchor for the concept that ownership must extend throughout the life of the litigation. Lewis v. Chiles, 719 F.2d 1044, 1047 n.1 (9th Cir. 1983) (citations omitted). Section 36(b) plainly requires that a party claiming a breach of the fiduciary duty imposed by that legislative provision be a security holder of the investment company at the time the action is initiated. See, e.g., Dandorph v. Fahnestock & Co., 462 F. Supp. 961, 965 (D. Conn. 1979). Imposing a continuous ownership requirement throughout the pendency of the litigation assures that the plaintiff will fairly and adequately represent the interests of shareholders or members who are similarly situated in enforcing the right of the corporation or association. 9 adequately represent the interests of the security holders in obtaining a recovery for the benefit of the company. Participants assert that ―there is no basis upon which to impose a continuing ownership requirement on an ICA § 36(b) claim.‖ (Appellant‘s Br. at 33.) (citations omitted). Several arguments are advanced in support of Participants‘ position. First, citing two District Court decisions – In re American Mutual Funds Fee Litigation, cv-04-05593, 2009 WL 8099820, at  (C.D. Cal. Jul. 14, 2009), and In re Mutual Funds Investment Litigation, 519 F. Supp. 2d 580, 590 (D. Md. 2007) – Participants contend that FED. R. CIV. P. 23.1 does not apply to suits brought under Section 36(b). Participants also attempt to distinguish Siemers, 2007 WL 760750, at , the primary case relied upon by the District Court in dismissing the ICA section 36(b) claim. Participants assert that ―[Siemers] is distinguishable because [that] plaintiff did not have an interest in the investment fund when he filed his complaint. Here, Plaintiff Danielle Santomenno did, but the Poleys did not.‖ (Appellant‘s Br. at 35.) Participants further offer a policy argument: ―the imposition of a continuous-ownership requirement would effectively deter a plaintiff, who wishes to mitigate damages by selling his or her investment, from suing – a result at odds with the salutary goals of the ICA.‖ (Appellant‘s Br. at 35.) We disagree with Participants‘ contentions. First, we note that In re Mutual Funds Investment Litigation, one of two cases relied upon by Participants, did not concern the continuous ownership question. Instead, the District Court in that case addressed the contemporaneous ownership requirement rather than the continuous ownership requirement – the idea ―that, at the time of the alleged harm, 10 plaintiffs must have owned shares in the fund.‖ 519 F. Supp. 2d at 590 (emphasis added). There was no question in that case that the plaintiffs continued to hold shares in one of the mutual funds in question.2 This leaves Participants with In re American Mutual Funds Fee Litigation, an opinion that goes against the weight of authority on this topic,3 and is premised upon an overly 2 Notably, the District Court ruled that the plaintiffs did not have standing to assert claims under Section 36(b) on behalf of mutual funds in the same family of funds, i.e., funds sharing a common investment advisor, because Section 36(b) mandates that the plaintiff ―be a ‗security holder of‘ the entity on whose behalf he seeks to bring suit.‖ 519 F. Supp. 2d at 589. Thus, to this extent, the District Court acknowledged the derivative nature of a Section 36(b) claim. See also Kauffman v. Dreyfus Fund, Inc., 434 F.2d 727, 735-36 (3d Cir. 1970) (a shareholder of mutual funds who sues on behalf of those funds cannot sue derivatively on behalf of other similarly situated mutual funds because ―[s]tanding is justified only by this proprietary interest created by the stockholder relationship and the possible indirect benefits the nominal plaintiff may acquire qua stockholder of the corporation which is the real party in interest‖). 3 See, e.g., Siemers, 2007 WL 760750, at  (―For Section 36(b) standing purposes, it is important that the fund be continuously owned during the pendency of the action.‖); In re Lord Abbett Mut. Funds Litig., 407 F. Supp. 2d 616, 633 (D.N.J. 2005) (plaintiffs cannot bring a Section 36(b) claim ―on behalf of Funds in which they have no ownership interest‖ because such a claim is derivative, i.e., brought on 11 expansive reading of the Supreme Court‘s decision in Daily Income Fund. The District Court in In re American Mutual Funds Fee Litigation viewed Daily Income Fund as dispensing with a continuous ownership standing requirement because such a requirement was recognized in the context of cases arising under FED. R. CIV. P. 23.1, and that rule does not apply to Section 36(b) claims. Id. at . Daily Income Fund, however, addressed only the pre-suit demand requirement of a common derivative action to which Rule 23.1 applies, i.e., that before bringing suit a shareholder must make demand upon the corporation‘s directors to take appropriate action with respect to a right ―the corporation could itself have enforced in court.‖ 464 U.S. at 529 (citations omitted). Because the right created by Section 36(b) could not be read as one belonging to the company itself, the Court held that there was no basis for imposing a pre-suit demand requirement. Id. at 542. Daily Income Fund did not address the question of whether a securities holder must maintain that status throughout the pendency of the litigation. Participants mistakenly assume that the root of the continuous ownership requirement is Rule 23.1. Instead, the prerequisite arises from the fact that Congress directed that behalf of the Funds), partially vacated on other grounds, 463 F. Supp. 2d 505 (D.N.J. 2006); Brever v. Federated Equity Mgmt. Co. of Pa., 233 F.R.D. 429, 431 (W.D. Pa. 2005) (plaintiff who sold his shares after filing suit ―divested himself of standing‖ to bring suit under Section 36(b)); In re Franklin Mut. Funds Fee Litig., 388 F. Supp. 2d 451,468 n.13 (D.N.J. 2005) (plaintiffs may only bring a Section 36(b) claim ―against the . . . funds they owned‖). 12 only the Securities and Exchange Commission and securities holders, acting on behalf of the investment company, could bring an action to enforce the rights created by Section 36(b). As the Court recognized in Daily Income Fund, any recovery in an action brought under Section 36(b) belongs to the investment company. 464 U.S. at 535 n.11. When a plaintiff disposes of his or her holdings in the company, that plaintiff no longer has a stake in the outcome of the litigation because any recovery would inure to the benefit of existing securities holders, not former ones. A continuous ownership requirement gives effect to this ―undeniably ‗derivative‘‖ nature of a Section 36(b) claim. Id. Stated otherwise, a continuous ownership requirement ―reflects a shareholder's real interest in obtaining a recovery for the corporation which increases the value of his holdings.‖ Chiles, 719 F.2d at 1047 (citing Lewis v. Knutson, 669 F.2d 230, 238 (5th Cir. 1983); Schilling v. Belcher, 582 F.2d 995, 1002 (5th Cir. 1978)). As Participants no longer own John Hancock funds, they lack any real interest in securing a recovery. Participants‘ policy argument – that a continuous ownership requirement deters a plaintiff from mitigating damages by preventing him or her from selling shares during the pendency of litigation – is unconvincing. First, because the recovery belongs to the company, not the security holder, see Daily Income Fund, 464 U.S. at 535 n.11, it would not seem appropriate to impose a duty to mitigate damages on individual security holders. Moreover, it has long been recognized that only those parties who would actually benefit from a suit may continue to prosecute the action, a rationale that we explicitly adopted in Kauffman: 13 Standing is justified only by this proprietary interest created by the stockholder relationship and the possible indirect benefits the nominal plaintiff may acquire qua stockholder of the corporation which is the real party in interest. Without this relationship, there can be no standing, ―no right in himself to prosecute this suit.‖ 434 F.2d at 735-36 (citations omitted). Furthermore, we note that even if continuous ownership were not a requirement of Section 36(b), Participants‘ claim under that Section still fails. As observed above, a plain reading of Section 36(b) indicates that ownership when the suit is first filed is an indisputable prerequisite. The Poleys‘ interests in the John Hancock funds were terminated prior to the filing of the original complaint. Therefore, they cannot be classified as ―security holder[s]‖ under Section 36(b). Santomenno, meanwhile, still owned John Hancock funds when the case was first initiated, but no longer had any interest in the funds when the Second Amendment Complaint was filed on October 22, 2010. It is the Second Amended Complaint that is the operative pleading for standing purposes. As the Supreme Court observed in Rockwell International Corp. v. United States, 549 U.S. 457 (2007): The state of things and the originally alleged state of things are not synonymous; 14 demonstration that the original allegations were false will defeat jurisdiction. So also will the withdrawal of those allegations, unless they are replaced by others that establish jurisdiction. Thus, when a plaintiff files a complaint in federal court and then voluntarily amends the complaint, courts look to the amended complaint to determine jurisdiction. Id. at 473-74 (citations omitted). Even if we were to hold that continuous ownership is not required by the statute, Participants‘ Section 36(b) claim would fail because their interests in the John Hancock funds were terminated prior to the filing of the Second Amended Complaint. As a result, they are not security holders entitled to bring an action on behalf of the investment company. Accordingly, dismissal of Participants‘ Section 36(b) claim was proper.