Court Opinion

ID: 4436548
Source: CourtListenerOpinion
Date Created: 2019-09-09 15:00:13.367535+00
Date Added: 2024-06-11T14:51:16.825008
License: Public Domain

18‐3467‐cv
Edwards v. Sequoia Fund, Inc.

                                UNITED STATES COURT OF APPEALS
                                    FOR THE SECOND CIRCUIT

                                       August Term 2018

              (Argued: June 13, 2019               Decided: September 9, 2019)

                                     Docket No. 18‐3467‐cv

THOMAS EDWARDS AND MICHAEL FORTUNE, individually and on behalf of all
                    others similarly situated,

                                                    Plaintiffs‐Appellants,

                                              v.

                     SEQUOIA FUND, INC., A Maryland Corporation,

                                                    Defendant‐Appellee.

                  ON APPEAL FROM THE UNITED STATES DISTRICT COURT
                      FOR THE SOUTHERN DISTRICT OF NEW YORK

Before:
                           LEVAL, POOLER, AND CHIN, Circuit Judges.

                Appeal from a judgment of the United States District Court for the

Southern District of New York (Daniels, J.) dismissing claims against defendant‐
appellee mutual fund pursuant to Federal Rule of Civil Procedure 12(b)(6).

Plaintiffs brought a putative class action on behalf of shareholders alleging that

the mutual fund breached a contractual obligation not to concentrate its

investments in a single industry. The district court granted the motion to

dismiss, holding that there was no enforceable contract and, even assuming there

was a binding contract, there was no breach. Plaintiffs appeal, contending that

the district court erred in both respects. We agree with the district courtʹs

alternative holding.

             AFFIRMED.

                          FELICIA S. ENNIS (Alan M. Pollack, on the brief), Robinson
                                Brog Leinwand Greene Genovese & Gluck, P.C.,
                                New York, New York, and Raymond Farrow and
                                Mark A. Griffin, Keller Rohrback L.L.P., Seattle,
                                Washington, on the brief, for Plaintiffs‐Appellants.

                          ROBERT A. SKINNER (Amy D. Roy and Lee S. Gayer, on
                               the brief), Ropes & Gray LLP, Boston,
                               Massachusetts, and New York, New York, for
                               Defendant‐Appellee.
                                              ___________

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CHIN, Circuit Judge:

             Defendant‐appellee Sequoia Fund, Inc. (the ʺFundʺ), a mutual fund,

adopted an investment policy that it may not concentrate its assets, as

concentration is defined in the Investment Company Act of 1940 (the ʺ1940 Actʺ),

15 U.S.C. §§ 80a‐1 et seq., and attendant regulations and guidance. In 1998, the

Securities and Exchange Commission (the ʺSECʺ) adopted guidance defining

ʺconcentrationʺ as having ʺmore than 25 percent of the value of [the fundʹs] assets

in any one industry.ʺ See Registration Form Used by Open‐End Management

Investment Companies, 48 Fed. Reg. 37,928, 37,962 (Aug. 22, 1983) (ʺ1983

Guidanceʺ). The Fund disseminated the investment policy annually in its

prospectus and registration statement filed with the SEC.

             Plaintiffs‐appellants Thomas Edwards and Michael Fortune

(ʺPlaintiffsʺ), shareholders of the Fund, brought this putative class action alleging

that the Fund entered into a contract with its shareholders to observe that policy,

and that the Fund breached this contract when, due to an increase in the value of

its healthcare assets, the value of those assets came to exceed 25% of its overall

assets. The district court granted the Fundʹs motion to dismiss pursuant to

Federal Rule of Civil Procedure 12(b)(6), holding that there was no enforceable

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contract and, even assuming there was an enforceable contract, there was no

breach.

            On appeal, Plaintiffs allege that the district court erred in both

respects. For the reasons set forth below, we agree with the district courtʹs

second reason and therefore AFFIRM the judgment of the district court.

                           STATEMENT OF THE CASE

A.    Background

            The Fund is an open‐ended investment company, i.e., a mutual fund,

organized under Maryland law and registered under the 1940 Act, 15 U.S.C. §§

80a‐1 et seq. As a mutual fund, the Fund sells shares of the Fund to investors and

pools this money to invest in, among other things, equity securities of different

companies. The Fundʹs shares are ʺoffered only to persons in the United States

by way of a prospectus.ʺ Appʹx at 11.

            Under the 1940 Act, the Fund must file an annual registration

statement with the SEC, comprised of a statement of additional information

(ʺSAIʺ) and a prospectus. See 1983 Guidance, 48 Fed. Reg. at 37,929. As required

by the 1940 Act, the Fundʹs SAI, which was incorporated by reference into its

prospectus, includes fourteen ʺinvestment restrictionsʺ it adopted ʺas a matter of

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fundamental investment policy, which may not be changed without a

stockholder vote of a majority of the outstanding securities as defined in Section

2(a)(42) of the 1940 Act.ʺ Appʹx at 35; see 15 U.S.C. § 80a‐8(b)(1)‐(2).1

              One such restriction (the ʺConcentration Policyʺ) included in the

Fundʹs May 2015 SAI, and incorporated by reference into its May 2015

prospectus, states that ʺ[t]he Fund may not . . . [c]oncentrate investments in an

industry, as concentration may be defined under the 1940 Act or the rules and

regulations thereunder . . . or by guidance regarding, interpretations of, or

exemptive orders under, the 1940 Act or the rules or regulations thereunder

published by appropriate regulatory authorities.ʺ Appʹx at 35‐36.

              While neither the 1940 Act nor any rule or regulation promulgated

pursuant to the 1940 Act defines ʺconcentration,ʺ the SEC has twice provided

guidance on concentration policies. See Appʹx at 36 (adopting definition of

ʺconcentrationʺ as ʺmay be defined . . . by guidance . . . published by appropriate

regulatory authoritiesʺ). In 1983, the SEC adopted Form N‐1A, the registration

1       In relevant part, the 1940 Act requires that a registration statement include ʺa
recital of the policy of the registrant [with] respect [to] . . . concentrating investments in
a particular industry or group of industries.ʺ 15 U.S.C. § 80a‐8(b)(1). In addition, the
1940 Act requires that a registration statement include ʺa recital of all investment
policies of the registrant . . . , which are changeable only if authorized by shareholder
vote.ʺ Id. § 80a‐8(b)(2).
                                               5
form for open‐ended investment companies, and provided guidelines (the

ʺGuidesʺ) for preparing and filing Form N‐1A. See 1983 Guidance, 48 Fed. Reg.

at 37,958. Guide 19 states the SECʹs position that ʺinvestment . . . of more than 25

percent of the value of the registrantʹs assets in any one industry represents

concentration.ʺ Id. at 37,962. A fund that intends to concentrate ʺshould . . .

specify in the prospectus the industry or group of industries in which it will

concentrate.ʺ Id. If the fund does not intend to concentrate, ʺno further

investment may be made in any given industry if, upon making the proposed

investment, 25 percent or more of the value of the registrantʹs assets would be

invested in such industry.ʺ Id. While Guide 19 therefore prohibits a non‐

concentrating fund from making asset purchases that would cause it to exceed

the 25 percent threshold, it also allows for concentration by so‐called ʺpassive

increaseʺ ‐‐ ʺwhen securities of a given industry come to constitute more than 25

percent of the value of the registrantʹs assets by reason of changes in value of either

the concentrated securities or the other securities.ʺ Id. (emphasis added). In that

circumstance, although the fund would otherwise be ʺconcentrat[ing]ʺ as defined

under Guide 19, ʺthe excess need not be sold.ʺ Id.

                                            6
            In 1998, the SEC adopted amendments to Form N‐1A. See

Registration Form Used by Open‐End Management Investment Companies, 63

Fed. Reg. 13,916 (Mar. 23, 1998) (ʺ1998 Guidanceʺ). The 1998 Guidance

recognized the SECʹs position that ʺa fund investing more than 25% of its assets

in an industry is concentrating in that industryʺ and ʺincorporated this

percentage test into [amended] Form N‐1A.ʺ Id. at 13,927.

B.    Procedural History

            Plaintiffs filed this complaint on May 21, 2018, alleging that the

Fund breached a contract with its shareholders based on its Concentration

Policy. Plaintiffs allege that the Fundʹs prospectus and SAI constituted an offer

by the Fund to manage its investments according to the policies set forth therein,

including the Concentration Policy. Plaintiffs further allege that class members

ʺaccepted that offer when they purchased and continued to hold their sharesʺ in

the Fund, thereby creating an enforceable contract. Appʹx at 17.

            According to Plaintiffs, the Fundʹs Concentration Policy ʺprohibits

investment of more than 25% of the value of total assets of the Fund in any single

industry at any given time.ʺ Appʹx at 12. Plaintiffs allege that the Fund violated

the Concentration Policy at least three times in 2015: (1) on March 31, 2015, when

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27.3% of the Fundʹs net assets became concentrated in the healthcare industry,

with the Fund holding 26% of its net assets in Valeant Pharmaceuticals

International, Inc., a healthcare company; (2) on June 30, 2015, when 30% of the

Fundʹs net assets were concentrated in the healthcare industry, with the Fund

holding 28.7% of its net assets in Valeant; and (3) on September 30, 2015, when

26% of the Fundʹs net assets became invested in the healthcare industry. The

complaint alleges that this concentration caused Plaintiffs and putative class

members to suffer losses in the value of their shares when there was a sharp

decline in the value of the Fundʹs healthcare industry investments and the Fund

failed to take corrective action. The Fund moved to dismiss for failure to state a

claim, arguing that its adoption and publication of the Concentration Policy did

not form a contract with Plaintiffs. The Fund also argued that, assuming a

contract was formed, the Complaint failed to allege a breach because SEC

guidance to the 1940 Act, which is incorporated in the policyʹs definition of

concentration, allows for concentration that results from passive changes in

value.

             The district court granted the Fundʹs motion to dismiss. The district

court concluded that Plaintiffs failed to allege a contract based on the

                                         8
Concentration Policy because it found there was no offer, intent to be bound, or

meeting of the minds. In the alternative, the district court held that, even

assuming the existence of an enforceable contract, Plaintiffs failed to sufficiently

allege a breach. The district court held that the 1998 Guidance continues to allow

for concentration by passive increase, and therefore concluded that the complaint

failed to allege a breach of the Fundʹs Concentration Policy. Judgment was

entered accordingly on October 18, 2018. This appeal followed.

                              STANDARD OF REVIEW

             We review a district courtʹs grant of a motion to dismiss under

Rule 12(b)(6) de novo. Bldg. Indus. Elec. Contractors Assʹn v. City of New York, 678
F.3d 184, 187 (2d Cir. 2012). ʺTo survive a motion to dismiss, a complaint must

contain sufficient factual matter, accepted as true, to state a claim to relief that is

plausible on its face.ʺ Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (internal quotation

marks omitted). ʺ[W]e accept as true all factual allegations and draw from them

all reasonable inferences; but we are not required to credit conclusory allegations

or legal conclusions couched as factual . . . allegations.ʺ Nielsen v. Rabin, 746 F.3d
58, 62 (2d Cir. 2014) (internal quotation marks omitted). ʺAccordingly,

ʹthreadbare recitals of the elements of a cause of action, supported by mere

                                           9
conclusory statements, do not suffice.ʹʺ Id. (quoting Iqbal, 556 U.S. at 678)

(brackets omitted).

                                    DISCUSSION

             We assume, without deciding, that Plaintiffs plausibly alleged the

existence of a contract that included the Concentration Policy as an enforceable

term that could not be changed without a shareholder vote. We reach only the

district courtʹs alternative holding and conclude that, even assuming the

existence of a binding contract, Plaintiffs failed to plausibly allege a breach.

I.    Applicable Law

             ʺTo state a claim for breach of contract under New York law, the

complaint must allege: (i) the formation of a contract between the parties; (ii)

performance by the plaintiff; (iii) failure of defendant to perform; and (iv)

damages.ʺ Orlander v. Staples, Inc., 802 F.3d 289, 294 (2d Cir. 2015) (internal

quotation marks omitted).2 At issue here is only whether the Fund failed to

perform under the contract ‐‐ i.e., whether the Fund breached the Concentration

Policy.

2      Both parties agree that either New York or Maryland law applies and there is no
conflict between the two. We therefore apply New York law. See Fin. One Pub. Co. v.
Lehman Bros. Special Fin., 414 F.3d 325, 331 (2d Cir. 2005) (holding that choice‐of‐law
analysis is not required where there is no actual conflict).
                                          10
             Because we must determine the meaning of the Concentration

Policy, including the SEC guidance incorporated therein, the threshold question

is whether the terms of the Concentration Policy are ambiguous. See Krumme v.

WestPoint Stevens Inc., 238 F.3d 133, 138 (2d Cir. 2000). A contract is

unambiguous ʺwhere the contract language has a definite and precise meaning,

unattended by danger of misconception in the purport of the contract itself, and

concerning which there is no reasonable basis for a difference of opinion.ʺ Law

Debenture Tr. Co. of N.Y. v. Maverick Tube Corp., 595 F.3d 458, 467 (2d Cir. 2010)

(internal quotation marks and brackets omitted). Conversely, a contract is

ambiguous if the language ʺis capable of more than one meaning when viewed

objectively by a reasonably intelligent person who has examined the context of

the entire integrated agreement.ʺ Krumme, 238 F.3d at 139 (internal quotation

marks omitted).

             Under New York law, ʺwhen the terms of a written contract are clear

and unambiguous, the intent of the parties must be found therein,ʺ and ʺ[t]he

words and phrases used in an agreement must be given their plain meaning so

as to define the rights of the parties.ʺ Mazzola v. Cty. of Suffolk, 533 N.Y.S.2d 297,

297 (2d Depʹt 1988) (internal quotation marks omitted). Where ʺthe partiesʹ

                                          11
intent is unambiguously conveyed by the plain meaning of the agreements, . . .

interpretation is a matter of law.ʺ Crane Co. v. Coltec Indus., Inc., 171 F.3d 733, 737

(2d. Cir. 1999) (internal quotation marks omitted). ʺAt the motion to dismiss

stage, a district court may dismiss a breach of contract claim only if the terms of

the contract are unambiguous.ʺ Orchard Hill Master Fund Ltd. v. SBA Commcʹns

Corp., 830 F.3d 152, 156 (2d Cir. 2016).

II.   Application

             We turn to the question of whether Plaintiffs have plausibly alleged

that the Fund concentrated its investments in the healthcare industry in violation

of the Concentration Policy. Plaintiffs concede that under the 1983 Guidance a

requirement not to concentrate would not give rise to an obligation to divest if

the concentration (exceeding 25%) resulted from changes in market values rather

than from transactions by the Fund. They argue, however, that the 1998

Guidance rescinded the 1983 Guidance and that the 1998 Guidance does not

permit concentration by passive increase. We disagree.

             Plaintiffs contend that because the 1998 Guidance rescinded the 1983

Guidance, the Concentration Policy did not incorporate by reference the 1983

                                           12
Guidanceʹs definition of concentration.3 Relying on a footnote from the 1998

Guidance, Plaintiffs argue that ʺthe SEC unambiguously states that all prior

Guides, [Generic Comment Letters] and Guide Releases were not being

republished, were rescinded, and should not be applied henceforth.ʺ Appellantsʹ

Br. at 35‐36 (citing 1998 Guidance, 63 Fed. Reg. at 13,940 n.214).4 At the very

least, Plaintiffs argue that the Concentration Policy is ambiguous and its meaning

should not be resolved at the motion to dismiss stage.

             The 1998 Guidance, however, is not ambiguous ‐‐ it did not rescind

Guide 19 of the 1983 Guidance. After explaining that ʺ[t]he Commission

proposed to continue to require a fund to disclose . . . any policy to concentrate,ʺ

the 1998 Guidance cites Guide 19 in noting that the SEC had ʺtaken the position

. . . that a fund investing more than 25% of its assets in an industry is

concentrating in that industry.ʺ 1998 Guidance, 63 Fed. Reg. at 13,927 n.99. The

3       Assuming the Concentration Policy was a contractual obligation, because the
term that the parties unambiguously incorporated into the contract is a provision of a
statute (the term ʺconcentrateʺ as stated in the 1940 Act), the meaning of the Fundʹs
obligation not to ʺconcentrateʺ is not determined in the manner in which courts
ordinarily determine the meaning of an ambiguous contractual provision. The meaning
of term as used in the 1940 Act is its meaning in the contract.
4       The Guide Releases were the guidelines initially adopted by the SEC in 1972 to
assist funds in preparing and filing registration statements. 1998 Guidance, 63 Fed. Reg.
at 13,940 n.209. The Guide Releases are different from the Guides provided by the SEC
in 1983.
                                           13
1998 Guidance then states that the SEC ʺcontinues to believe that 25% is an

appropriate benchmark to gauge the level of investment concentration that could

expose investors to additional riskʺ and that ʺ[t]he Proposed Amendments

incorporated this percentage test into Form N‐1A.ʺ Id. (emphasis added). ʺ[T]his

percentage test,ʺ as Plaintiffs admit in their brief, refers back to the sentence that

cites Guide 19, and Guide 19ʹs percentage test makes clear that, for purposes of

concentration, valuation is at the time of purchase. See 1983 Guidance, 48 Fed.

Reg. at 37,962.

             While not expressly speaking to the issue of passive increases, the

section of the 1998 Guidance addressing concentration cites to and effectively

incorporates Guide 19, which allows for such increases. It repeatedly indicates

continuity with the SECʹs previous policy regarding concentration. See 1998

Guidance, 63 Fed. Reg. at 13,927 (ʺThe Commission proposed to continue to

require a fund to disclose . . . any policy to concentrate . . . .ʺ) (emphasis added);

see also id. (explaining, after noting the previous position taken by the

Commission, that the ʺProposed Amendments incorporated this percentage testʺ)

(emphasis added); see also id. (ʺthe Commission continues to believeʺ) (emphasis

added). Nothing in the 1998 Guidance suggests a change in SEC policy

                                          14
regarding concentration such as rescinding the prior exception for passive

increases.5 We assume that the agency would not adopt such a major change sub

silentio, in a guidance document that cites and repeatedly indicates continuity

with prior guidance on the issue in question. If the SEC had indeed adopted

such a change, non‐concentrating funds would be required to constantly monitor

for sudden increases and decreases in asset values, and adjust their investments

in each industry to avoid exceeding the 25% threshold. 6 It seems doubtful that

the SEC would adopt such a major change without calling attention to it and

without explanation.

              Accordingly, the Concentration Policy defines concentration by

reference to Guide 19 of the 1983 Guidance, and so a fund is concentrating in an

5       Plaintiffs rely in significant part on a footnote in the 1998 Guidance, which states
that the Guides ʺhave not been republishedʺ and ʺwill [not] apply to registration
statements prepared on the amended Form.ʺ See 1998 Guidance, 63 Fed. Reg. at 13,940
n.214. Although the 1998 Guidance may have generally rescinded prior guidance to
write on a clean slate, it incorporated by reference and thus retained Guide 19ʹs
definition of concentration, and nothing in the text of the 1998 Guidance suggests a
change from that definition. Cf. Blackrock Multi‐Sector Income Tr., SEC No‐Action Letter,
2013 WL 3477065, at *4 (July 8, 2013) (ʺAlthough the Guides have since been rescinded,
Guide 19 may be generally instructive with respect to industry concentration.ʺ).
6       Plaintiffs suggest that such monitoring and compliance could be accomplished
by means of sophisticated software rather than labor‐intensive manual monitoring.
Even assuming this were true, the adoption of such software would itself represent a
significant undertaking, and would perhaps also require major changes in investment
practices and strategy.
                                             15
industry when, at the time of purchase, investing in an industry would lead the

fund to have more than 25% of its net assets in that industry. See 1983 Guidance,

48 Fed. Reg. at 37,962.

             Here, Plaintiffs alleged only that the Fund ʺviolated the

Concentration Policy by allowing its investment in healthcare industry stocks . . .

to exceed 25% of the value of its net assets and failing to take any action to bring

the Fund within its policy limitations.ʺ Appʹx at 17‐18. Because the 1998

Guidance ‐‐ and by extension the Concentration Policy ‐‐ allows for such passive

increases, Plaintiffs have failed to allege a violation of the Concentration Policy.

                                  CONCLUSION

             For the reasons set forth above, the judgment of the district court is

AFFIRMED.

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