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Northstar Financial Advisors, Inc. v. Schwab Investments

August 12, 2010


Appeal from the United States District Court for the Northern District of California Susan Illston, District Judge, Presiding. D.C. No. 3:08-cv-04119-SI.

The opinion of the court was delivered by: Schroeder, Circuit Judge


Argued and Submitted April 12, 2010 -- San Francisco, California.

Before: Mary M. Schroeder and N. Randy Smith, Circuit Judges, and James Maxwell Moody, District Judge.*fn1


The issue we must decide in this appeal is whether there is a private cause of action to enforce the provisions of § 13(a) of the Investment Company Act of 1940 ("ICA" or "1940 Act"), 15 U.S.C. § 80a-13(a). That section generally requires an investment company to obtain shareholder approval before deviating from the investment policies contained in the company's registration statement filed with the Securities and Exchange Commission ("SEC").

Our circuit has not decided the issue, but the Second Circuit has held that there is no private right to enforce five other sections of the ICA, reasoning in relevant part that the purpose and structure of the entire Act is grounded upon enforcement by the SEC, not on private enforcement. See Bellikoff v. Eaton Vance Corp., 481 F.3d 110, 116 (2d Cir. 2007) (per curiam); Olmsted v. Pruco Life Ins. Co. of New Jersey, 283 F.3d 429, 433 (2d Cir. 2002). The district court, however, held in a published opinion that Congress did intend private enforcement of § 13(a), citing language in the Sudan Accountability and Divestment Act of 2007 ("SADA"), Pub. L. No. 110-174, 121 Stat. 2516 (2007), that bars suits against investment companies and their advisors for divesting from companies that do business in Sudan. Northstar Fin. Advisors, Inc. v. Schwab Inv., 609 F. Supp. 2d 938, 944-45 (N.D. Cal. 2009). The district court then certified its decision for inter-locutory appeal.

We now reverse and hold that nothing in § 13(a) as originally enacted or as subsequently amended either creates a private cause of action or recognizes one exists with the clarity and specificity required under Supreme Court precedent. We are unable to agree with the district court that the SADA's bar to particular litigation on account of the Sudanese emergency is sufficient to constitute recognition of a pre-existing private right of enforcement that is not otherwise evident in the language or structure of the ICA.

We explain our conclusion by first tracing the statutory background of the ICA, then discussing the impetus for the legislation, and finally analyzing the issues as required under Supreme Court law. We conclude that the Court has come to require increasingly specific congressional direction for the allowance of private suits to enforce public laws, and no such direction is present in this statute.


I. The Original Act

Congress enacted the ICA in 1940 to provide comprehensive regulation of investment companies and the mutual fund industry. See H.R. Rep. No. 76-2639, at 5 (1940); S. Rep. No. 76-1775, at 1 (1940). The ICA was the outgrowth of an extensive study and investigation of investment trusts and investment companies conducted by the SEC in the late 1930s. See S. Rep. No. 76-1775, at 1. Widespread fraud and mismanagement in the mutual fund industry had caused shareholder losses of more than $1 billion that decade. See H. Norman Knickle, The Investment Company Act of 1940: SEC Enforcement and Private Actions, 23 Ann. Rev. Banking & Fin. L. 777, 780-81 (2004). Accordingly, Congress sought to "ad-dress problems including self-dealing and breaches of fiduciary duties by fund managers, directors, and affiliates, misappropriation of fund assets, and misrepresentations to investors" that had plagued the mutual fund industry. Id. at 781 (footnotes omitted); see also 15 U.S.C. § 80a-1(b).

The ICA was the counterpart in the area of mutual fund regulation to the Securities Act of 1933 and the Securities Exchange Act of 1934 (collectively, "the 1933 and 1934 Acts"), which were designed to regulate corporate securities. Like the 1933 and 1934 Acts, the ICA requires registration with the SEC and imposes specific reporting requirements. See 15 U.S.C. §§ 80a-8, 80a-29. Section 8 of the ICA states that once an investment company registers with the SEC, it must file a registration statement that contains a recital of certain types of investment policies adopted by the company, including the company's policy with respect to concentration of investments in a particular industry or group of industries; any policy that is only changeable through a shareholder vote; and any policy the company deems "fundamental." 15 U.S.C. § 80a-8(b). Section 30 of the ICA states that investment companies must file annual reports with the SEC, and that they must transmit financial reports to shareholders on at least a semi-annual basis. 15 U.S.C. § 80a-29(a), (e).

The ICA, however, created a broader regulatory framework for investment companies than the 1933 and 1934 Acts created for corporate securities. See 6 Thomas Lee Hazen, Trea- tise on the Law of Securities Regulation § 20.6 (6th ed. 2009). As one commentator has observed, "a significant focus of the [ICA] is corporate governance and other substantive requirements for investment companies and affiliated entities," which "is in stark comparison to Congress's focus on registration and disclosure" in the 1933 and 1934 Acts. Knickle, supra, 23 Ann. Rev. Banking & Fin. L. at 781. This is reflected in the legislative history, where the Senate Report stated that the 1933 and 1934 Acts "ha[d] been ineffective to correct abuses and deficiencies in investment companies." S. Rep. No. 76-1775, at 11. As one means of correcting these abuses and deficiencies, § 13 of the ICA prohibits investment companies from changing certain investment policies included in their registration statements without first obtaining shareholder approval. Subsection (a) states:

(a) No registered investment company shall, unless authorized by the vote of a majority of its outstanding voting securities-

(1) change its subclassification as defined in section 80a-5(a)(1) and (2) of this title or its subclassification from a diversified to a non-diversified company;

(2) borrow money, issue senior securities, underwrite securities issued by other persons, purchase or sell real estate or commodities or make loans to other persons, except in each case in accordance with the recitals of policy contained in its registration statement in respect thereto;

(3) deviate from its policy in respect of concentration of investments in any particular industry or group of industries as recited in its registration statement, deviate from any investment policy which is changeable only if authorized by shareholder vote, or deviate from any policy recited in its registration statement pursuant to section 80a-8(b)(3) of this title; or

(4) change the nature of its business so as to cease to be an investment company.

15 U.S.C. § 80a-13(a).

To ensure compliance with the requirements of the ICA, Congress gave the SEC broad authority to police violations of the Act. Section 42(a) of the ICA states that the SEC may make such investigations as it deems necessary to determine whether any person has violated or is about to violate any provision of [the ICA] or of any rule, regulation, or order hereunder, or to determine whether any action in any court or any proceeding before the [SEC] shall be instituted under [the ICA] against a particular person or persons, or with respect to a particular transaction or transactions.

15 U.S.C. § 80a-41(a). Section 42(d) and (e) authorize the SEC to initiate actions in federal court for injunctive relief or civil penalties against any person or entity the Commission suspects of violating the ICA. See 15 U.S.C. § 80a-41(d)-(e). Additionally, Congress granted the SEC discretion to make exemptions consistent with public interest and policy. Section 6(c) of the ICA states that the Commission may conditionally or unconditionally exempt any person, security, or transaction, or any class or classes of persons, securities, or transactions, from any provision or provisions of [the ICA] or of any rule or regulation thereunder, if and to the extent that such exemption is necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of [the ICA].

15 U.S.C. § 80a-6(c).

Only one section of the ICA as originally enacted authorized anyone other than the SEC to sue for violations of the Act. Section 30(f) of the 1940 Act incorporated a remedy under the 1934 Act. The section subjected officers, directors, advisory board members, investment advisors, and affiliates of closed-end investment companies, as well as all beneficial owners of ten percent or more of the company's securities, to "the same duties and liabilities as those imposed by section 16 of the Securities Exchange Act of 1934 upon certain beneficial owners, directors, and officers in respect of their transactions in certain equity securities." Pub. L. No. 76-768, § 30(f), 54 Stat. 789, 837 (1940) (now codified at 15 U.S.C. § 80a-29(h)). Section 16(b) of the 1934 Act states that those individuals subject to its requirements may be sued "at law or in equity in any court of competent jurisdiction by the issuer, or by the owner of any security of the issuer in the name and in behalf of the issuer" to recover short-swing profits realized by a regulated individual. 15 U.S.C. § 78 p(b). The Supreme Court has said that by incorporating the provisions of § 16(b) of the 1934 Act into § 30(f) of the ICA, Congress expressly authorized private suits for damages against closed-end investment company insiders who make short-swing profits. Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 20 & n.10 (1979). There was no other authorization for private suits in the original Act of 1940.

II. 1970 Amendments

Congress did not make any major amendments to the ICA until 1970. See Investment Company Amendments Act of 1970, Pub. L. No. 91-547, 84 Stat. 1413 (1970). Those amendments included relatively minor changes to §§ 8 and 13. See id. §§ 2(b), 3(c), & 3(d), 84 Stat. at 1414, 1415. The original § 8(b)(2) of the ICA required an investment company's registration statement to contain a recital of all investment policies "which the registrant deems matters of fundamental policy." Pub. L. No. 76-768, § 8(b)(2), 54 Stat. at 804 (now codified as amended at 15 U.S.C. § 80a-8(b)(3)). The 1970 amendments added the requirement that a company's registration statement also contain a recital of all investment polices "which are changeable only if authorized by shareholder vote." Pub. L. No. 91-547, § 3(c)(1), 84 Stat. at 1415 (codified at 15 U.S.C. § 80a-8(b)(2)). In a corresponding amendment, Congress supplemented the language in § 13(a)(3), which originally said an investment company could not, without shareholder approval, "deviate from its policy in respect of concentration of investments in any particular industry or group of industries as recited in its registration statement, or deviate from any fundamental policy recited in its registration statement." Pub. L. No. 76-768, § 13(a)(3), 54 Stat. at 811. The 1970 amendment added a limitation barring an investment company from deviating, without shareholder approval, "from any investment policy which is changeable only if authorized by shareholder vote." Pub. L. No. 91-547, § 3(d), 84 Stat. at 1415 (codified at 15 U.S.C. § 80a-13(a)(3)).

Congress made these changes to §§ 8 and 13 to clarify that an investment company violates § 13(a) whenever it deviates, without shareholder approval, from an investment policy that its registration statement says is changeable only by shareholder vote, even if the registration statement does not also identify the policy as "fundamental." See H.R. Rep. No. 91-1382, at 19 (1970). Both Congress and the SEC agreed this amendment was necessary in light of a federal district court's ruling that an investment company must label an investment policy as "fundamental" in its registration statement before the company could be held liable under § 13(a) for deviating from the policy, even if the company's registration statement said that the policy could not be changed without shareholder approval. Id. (citing Green v. Brown, 276 F. Supp. 753 (S.D.N.Y. 1967), rev'd, 398 F.2d 1006 (2d Cir. 1968)). Congress wanted to prevent any further confusion. Id.

The 1970 amendments to the ICA also included changes to § 36, which deals with actions for breach of fiduciary duty. Because mutual funds are usually managed by separately owned and operated investment advisors rather than by the investment companies themselves, Congress added § 36(b), which imposed an explicit fiduciary duty on a fund's investment advisor with respect to the management fees it receives. Pub. L. 91-547, § 20, 84 Stat. at 1429 (codified at 15 U.S.C. § 80a-35(b)); H.R. Rep. No. 91-1382, at 7; S. Rep. No. 91-184, at 5-6 (1969). Section 36(b) also authorized the security holders of a ...

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