Class Action Complaint Properly Dismissed Because no Private Rights of Action Exist for Alleged Violations of Sections 34(b), 36(a) and 48(a) of the Federal Investment Company Act of 1940 (ICA), and Section 36(b) Claim Failed as a Matter of Law Second Circuit Court Holds
Plaintiffs filed a putative class action against various Eaton Vance entities under sections 34(b), 36(a) and 48(a) of the federal Investment Company Act of 1940 (ICA) arising out of the marketing, managing, and distributing shares of various Eaton Vance mutual funds. Bellikoff v. Eaton Vance Corp., 481 F.3d 110, 113-14 (2d Cir. 2007). The thrust of the class action complaint was that defendants paid kickbacks to brokers who promoted the sale of Eaton Vance mutual funds, that the increase in fund assets meant higher advisory fees paid to certain defendants “while providing no benefits to the funds or the fund investors,” and that the advisory fees paid were too high. Id., at 114. Defense attorney’s moved to dismiss the class action, arguing that no private rights of action exist under ICA for the claims alleged, id. The district court agreed with the defense and dismissed the class action; the Second Circuit affirmed.
The class action complaint alleged that defendants entered into arrangements with Morgan Stanley, Salomon Smith Barney, Wachovia and others that included “(1) cash payments to brokers in return for the brokers’ agreement to promote sales of fund shares; (2) directing fund portfolio brokerage to brokers in return for agreements by the brokers to promote the funds (a practice known as “directed brokerage”); and (3) excessive commission arrangements with brokers.” Bellikoff, at 114. At bottom, “as more investors were drawn to the funds through these arguably nefarious business practices, the fees paid to various defendants mushroomed,” id. The Second Circuit noted that SEC had investigated and sanctioned Morgan Stanley “for accepting impermissible payments from the defendants here in exchange for aggressively pushing Eaton Vance funds over other comparable investment options” while “fail[ing] to disclose adequately certain material facts to its customers … [namely that] it collected from a select group of mutual fund complexes amounts in excess of standard sales loads and Rule 12b-1 trail payments.” Id., at 114-15. The SEC fine resulted in the predictable Pavlovian response. In the words of the Circuit Court, “Smelling blood in the water, five investors then filed complaints . . . against Eaton Vance and many of its affiliated entities, alleging, inter alia, violations of the ICA, the Investment Advisers Act, and breaches of fiduciary duties.” Id., at 115.
The separate class action complaints were consolidated, and the operative class action complaint contained 10 claims for relief. Bellikoff, at 115. Only 4 of the claims were at issue on appeal: (1) whether defendants violated ICA § 34(b); (2) whether defendants breached fiduciary duties owed under ICA §§ 36(a) and 36(b); and (3) whether certain defendants were subject to “control person liability” under ICA § 48(a), id. The district court granted the defense motion to dismiss the complaint finding that private rights of action did not exist under these sections of the ICA, id.
The Second Circuit began its analysis by holding that because the ICA does not explicitly authorize private actions for violations of §§ 34(b), 36(a) or 48(a), the presumption is that Congress did not intend to authorize private rights of action for such violations. Bellikoff, at 116. This conclusion was supported by the fact that ICA § 42 expressly provides for SEC enforcement “through investigations and civil suits for injunctions and penalties,” and by the fact that Congress specifically provided for a private right of action under ICA § 35(b), but not under §§ 34(b), 36(a) or 48(a). Id. Additionally, the Circuit Court held that Congressional focus “on regulated entities in §§ 34(b), 36(a), and 48(a) preclude finding an implied right of action.” Id. The appellate court rejected plaintiffs’ invitation to give an expansive reading to the ICA, see id., at 116-17, finding that “[s]uch an expansive reading of the statutory text would find implied rights of action in every section of the ICA” which “was clearly not Congress’s intent,” id., at 117. The Second Circuit held, therefore, that “implied private rights of action do not exist under ICA §§ 34(b), 36(a), and 48(a).” Id.
With respect to the claim under ICA § 36(b) regarding excessive fees, the Second Circuit held that the claimed failed as a matter of law because the defendants sued “were not the recipients of the commissions and fees in question” and “it is clear from the language of § 36(b)(3) that no action may be brought under this section ‘against any person other than the recipient of such compensation or payments.’” Bellikoff¸ at 117-18. The Circuit Court held that the claim against certain other defendants failed because the class action complaint failed to “specifically allege that the fees were so disproportionately large that they bore no relationship to the services rendered.” Id., at 118.
NOTE: The Second Circuit also held that the district court did not abuse its discretion in denying plaintiffs leave to file a third amended complaint. See Bellikoff, at 118.