Green v. Fund Asset Management, L.P. , 245 F.3d 214 ( 2001 )

Opinions of the United
2001 Decisions States Court of Appeals
for the Third Circuit
3-16-2001
Green v. Fund Asset Mgt
Precedential or Non-Precedential:
Docket 99-5734
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Filed March 16, 2001
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
No. 99-5734
JACK GREEN, individually and as Trustee;
LAWRENCE P. BELDEN, Trustee;
STANLEY SIMON, Trustee
v.
FUND ASSET MANAGEMENT, L.P.;
MERRILL LYNCH ASSET MANAGEMENT, L.P .;
MERRILL LYNCH & CO., INC.;
MERRILL LYNCH, PIERCE, FENNER &
SMITH INCORPORATED;
PRINCETON SERVICES, INC.; ARTHUR ZEIKEL;
TERRY K. GLENN; MUNIENHANCED FUND, INC.;
MUNIVEST FUND II INC.; MUNIYIELD FUND, INC.;
MUNIYIELD INSURED FUND, INC.;
MUNIYIELD INSURED FUND II, INC.;
MUNIYIELD QUALITY FUND, INC.;
MUNIYIELD QUALITY FUND II, INC.
Jack Green,
Lawrence P. Belden,
Stanley Simon,
Appellants
Appeal from the United States District Court
for the District of New Jersey
(D.C. Civil Action No. 97-cv-03502)
District Judge: Honorable Dickinson R. Debevoise
Argued on June 27, 2000
Before: ROTH and GARTH, Circuit Judges,
and STANTON,* District Judge
(Opinion filed: March 16, 2001)
Bruce I. Goldstein, Esquire
Alberto G. Santos, Esquire
Saiber, Schlesinger, Satz & Goldstein
One Gateway Center
Suite 1300
Newark, NJ 07102-5311
Lawrence M. Johnson, Esquire
(Argued)
Mahoney, Hawkes & Goldings
75 Park Plaza
The Heritage on the Garden
Boston, MA 02116
Attorneys for Appellants
Alan S. Naar, Esquire
Paul A. Rowe, Esquire
Greenbaum, Rowe, Smith, Ravin,
Davis & Himmel LLP
P.O. Box 5600
Woodbridge, NJ 07095
Attorneys for Appellees-Defendants
Fund Asset Management, L.P.,
Merrill Lynch Asset Management,
L.P., Merrill Lynch & Co., Inc.,
Merrill Lynch, Pierce, Fenner &
Smith Incorporated, Princeton
Services, Inc., Arthur Zeikel and
Terry K. Glenn
_________________________________________________________________
* Honorable Louis L. Stanton, District Court Judge for the Southern
District of New York, sitting by designation.
2
James N. Benedict, Esquire (Argued)
Mark Holland, Esquire
James F. Moyle, Esquire
Sean M. Murphy, Esquire
Danielle A. Prill, Esquire
Clifford Chance Rogers & Wells LLP
200 Park Avenue
New York, NY 10166
Attorneys for Appellees
Fund Asset Management, L.P.,
Merrill Lynch Asset Management,
L.P., Merrill Lynch & Co., Inc.,
Merrill Lynch, Pierce, Fenner &
Smith Incorporated, Princeton
Services, Inc., Arthur Zeikel and
Terry K. Glenn
Robert J. Del Tufo, Esquire
Frank E. Derby, Esquire
Skadden, Arps, Slate, Meagher &
Flom LLP
One Newark Center, 18th Floor
Newark, NJ 07102
Attorneys for Appellees
MuniEnhanced Fund, Inc.,
MuniVest Fund II, Inc., MuniYield
Fund, Inc., MuniYield Insured
Fund, Inc., MuniYield Insured
Fund II, Inc., MuniYield Quality
Fund, Inc., and MuniYield Quality
Fund II, Inc.
OPINION OF THE COURT
ROTH, Circuit Judge:
The plaintiffs, shareholders in several investment
companies, filed an interlocutory appeal of the District
Court's dismissal of their state law claims for br each of
fiduciary duty and deceit. They claim that the District
Court erred in concluding that these claims ar e preempted
3
by S 36(b) of the Investment Company Act of 1940, as
amended (ICA). Because we conclude that the claims are
not preempted, we will reverse their dismissal and remand
this case to the District Court.
I. FACTS1
The plaintiffs are shareholders in seven investment
companies, the named defendants in this action:
MuniEnhanced Fund, Inc., MuniVest Fund II, Inc.,
MuniYield Fund, Inc., MuniYield Insur ed Fund, Inc.,
MuniYield Insured Fund II, Inc., MuniY ield Quality Fund,
Inc., and MuniYield Quality Fund II, Inc. (the Funds). The
plaintiffs invested more than $44,000 in the Funds between
May 22 and October 18, 1995. The named plaintif f, Jack
Green, has brought suit individually and in his capacity as
a trustee of seven trusts that invested in the Funds. The
other plaintiffs, Lawrence P. Belden and Stanley Simon, sue
solely as trustees of trusts that invested in the Funds.
Although not named in the caption, the complaint also
identifies as plaintiffs seven trusts that allegedly purchased
shares of the Funds. The plaintiffs have brought the case
as a putative class action, seeking to repr esent more than
100,000 investors in the Funds.
The Funds are closed-end investment companies, which
are registered with the Securities and Exchange
Commission (SEC) and publicly traded on the New Y ork
Stock Exchange. All of the Funds are incorporated under
the laws of Maryland and have their principal places of
business in Plainsboro, New Jersey. By investing in long-
term tax-exempt municipal bonds, the Funds' aim is to
provide shareholders with income that is exempt from
federal income taxes and to increase retur n to shareholders
through the use of leverage. The Funds gain leverage by
issuing shares of preferred stock that pay dividends based
upon prevailing short-term interest rates and investing the
proceeds from the sale of this preferred stock in longer-
_________________________________________________________________
1. Because the facts of this case are not in dispute, the factual
background that follows is taken largely from an earlier District Court
opinion in this case. See Green v. Fund Asset Management, 19 F. Supp.
2d 227 (D.N.J. 1998).
4
term obligations that, under normal market conditions, pay
higher rates. As long as there is a spr ead between the
short-term rates paid by the Funds to holders of the
preferred stock and the longer-ter m rates received by the
Funds from investments, the fund managers ar e able to
provide the shareholders with higher yields.
Defendant Fund Asset Management, L.P., (F AM) serves as
the Funds' investment adviser and is responsible for
managing the Funds' investment portfolios and pr oviding
administrative services to the Funds. Pursuant to written
investment advisory agreements, the Funds pay F AM a fee
for its services based upon a percentage of the Funds'
weekly net assets. The MuniEnhanced Fund, Inc.,
prospectus describes its advisory fee as follows:
For the services provided by the Investment Adviser
[FAM] under the Investment Advisory Agr eement, the
Fund will pay a monthly fee at an annual rate of .50 of
1% of the Fund's average weekly net assets (i.e. , the
average weekly value of the total assets of the Fund,
minus the sum of accrued liabilities of the Fund and
accumulated dividends on the shares of pr eferred
stock). For purposes of this calculation, average weekly
net assets is determined at the end of each month on
the basis of the average net assets of the Fund for each
week during the month.
Green v. Fund Asset Management, 19 F . Supp. 2d 227, 229
(D.N.J. 1998) (Green I).2
Defendant Merrill Lynch Asset Management, L.P ., (MLAM)
is an affiliate of FAM. MLAM and FAM are organized under
the laws of Delaware and have their principal places of
business in Plainsboro, New Jersey. Defendant Princeton
Services, Inc., (PSI), a Delaware corporation with its
principal place of business in Plainsboro, New Jersey, is the
general partner of FAM and MLAM. PSI has a 1% interest
in FAM and MLAM. Defendant Merrill Lynch and Co., Inc.,
is FAM's and MLAM's sole limited partner and has a 99%
interest in FAM and MLAM. Merrill L ynch is a publicly
_________________________________________________________________
2. The prospectuses for the other Funds contain virtually identical
disclosures.
5
traded holding company that provides global investment,
financing, insurance, and related services through its
subsidiaries and affiliates. Merrill Lynch is a Delaware
corporation with corporate headquarters in New Y ork City.
Defendant Arthur Zeikel is the President and a director of
each of the Funds, President and Chief Investment Officer
of MLAM and FAM, President and a dir ector of PSI, and an
Executive Vice President of Merrill L ynch. Defendant Terry
Glenn is the Executive Vice President of each of the Funds
and Executive Vice President of F AM and MLAM.
Defendant Merrill Lynch, Pierce, Fenner & Smith
Incorporated (MLPFS), a securities broker -dealer and
investment bank, is a wholly owned subsidiary of Merrill
Lynch. MLPFS served as the principal underwriter for the
offerings of the Funds' common stock. MLPFS has also
entered into auction agent agreements with the Funds to
sell the Funds' preferred stock. The 1994 MuniYield
Insured Fund, Inc., annual statement describes the fees
generated by the preferred stock auctions as follows:
The Fund pays commissions to certain broker -dealers
at the end of each auction at an annual rate ranging
from 0.25% to 0.375%, calculated on the pr oceeds of
each auction. For the year ended October 31, 1994,
MLPFS, an affiliate of FAMI [FAM's predecessor],
received $591,736 as commissions.
Id.3 MLPFS is a Delawar e corporation and maintains its
corporate headquarters in New York City.
The plaintiffs brought this action seeking to remedy
alleged violations of state law and of S 36(b) of the
Investment Company Act of 1940 (the ICA), codified at 15
U.S.C. S 80a-35(b).4 In their complaint, plaintiffs allege that
defendants breached their disclosure obligations and
fiduciary duties under the ICA and under state law. The
_________________________________________________________________
3. Each of the Funds' annual statements contains virtually identical
disclosures.
4. Plaintiffs originally filed their complaint in the United States
District
Court for the District of Massachusetts on June 21, 1996. Defendants
filed a motion to transfer the case to the District of New Jersey pursuant
to 28 U.S.C. S 1404 and the motion for transfer was granted.
6
plaintiffs contend that the defendants "failed to explicitly or
sufficiently disclose" that the calculation of FAM's
management fee would include assets purchased with the
proceeds from the sale of preferr ed stock. They claim that
because the advisory fee is measured as a per centage of the
Funds' capitalization, including leverage, ther e is a strong
financial incentive for FAM to keep the Funds fully
leveraged at all times, even when it would be in the best
interest of shareholders to reduce or eliminate leverage. The
plaintiffs contend that FAM would lose approximately one-
third of its advisory compensation if it eliminated leverage.
They argue that the fee arrangement cr eates an inherent
conflict of interest, which was not disclosed in the Funds'
prospectuses, the Funds' filings with the SEC, or the
Funds' periodic reports to the shareholders. The plaintiffs
also allege that the defendants failed to disclose that the
issuing of the preferred stock was subject to a conflict of
interest; they find this conflict in the fact that FAM's
affiliate, MLPFS, received fees from the sale of the preferred
stock. In addition, plaintiffs claim that the defendants have
continually misled investors with respect to the advisory
fees, which are ultimately paid by the Funds' shareholders.
The plaintiffs seek both compensatory damages and
injunctive relief. They ask for an order permanently
enjoining the defendants from entering into any
compensation arrangement between the Funds and any
investment adviser under which "the compensation payable
to such investment advisor is determined by, dependent
upon, or measured or influenced by, the amount of
financial leverage of its common equity investment
maintained by such fund." Green I, 19 F. Supp. 2d at 230
(internal quotation marks omitted).
The defendants filed a motion, pursuant to Federal Rule
of Civil Procedure 12(c), to dismiss the plaintiffs' state law
claims for breach of fiduciary duty and deceit. The
defendants contend that the plaintiffs' state law claims are
preempted by S 36(b) of the ICA, which cr eates a federal,
private right of action for breach of fiduciary duty by an
investment adviser or mutual fund management company
with respect to payment and compensation for services. The
District Court granted the defendants' motion and
7
dismissed the plaintiffs' state law claims. The District Court
did acknowledge, however, that the question presented, i.e.,
whether S 36(b) of the ICA preempts the plaintiffs' state law
claims for breach of fiduciary duty and deceit, was a close
one and a question of first impression in the courts of
appeals. For that reason, the District Court permitted the
plaintiffs to file an interlocutory appeal pursuant to 28
U.S.C. S 1292(b). Green v. Fund Asset Management, 53 F.
Supp. 2d 723, 731-32 (D.N.J. 1999) (Green II).
II. JURISDICTION & STANDARD OF REVIEW
The District Court had jurisdiction over the plaintiffs'
federal claim under 28 U.S.C. S 1331. The District Court
had jurisdiction over the plaintiffs' state law claims under
28 U.S.C. S 1367. We have jurisdiction over the plaintiffs'
appeal under 28 U.S.C. S 1292(b).
We have plenary review of the District Court's order
dismissing the plaintiffs' claims pursuant to Federal Rule of
Civil Procedure 12(c). See, e.g., Consolidated Rail Corp. v.
Portlight, Inc., 188 F.3d 93, 95-96 (3d Cir. 1999). We must
"view the facts presented in the pleadings and the
inferences to be drawn therefrom in the light most favorable
to the . . . non-moving party." Institute for Scientific Info.,
Inc. v. Gordon & Breach, Science Publishers, Inc., 931 F.2d
1002, 1004 (3d Cir. 1991). We will affirm the District
Court's judgment only if the plaintiffs would not be entitled
to relief under any set of facts that could be proved. See
Consolidated Rail Corp., 188 F.3d at 95-96.
III. DISCUSSION
The question we must answer on this appeal is as
follows: Does state law (in this case, common law
establishing liability for breach of fiduciary duty and deceit)
stand as an obstacle to the accomplishment and execution
of the full purposes and objectives which Congr ess had in
mind in enacting S 36(b) of the ICA?
Defendants argue that S 36(b) of the ICA, codified at 15
U.S.C. S 80a-35(b), preempts the plaintif fs' state law claims
for breach of fiduciary duty and deceit. Section 36(b) is a
8
lengthy and detailed statutory provision. It pr ovides that an
investment adviser of a registered investment company has
a fiduciary duty with respect to compensation for services.
An action may be brought in district court by a security
holder of the registered investment company against the
investment adviser for breach of that fiduciary duty
regarding compensation. In such an action, it is not
necessary to allege or prove personal misconduct on the
part of any defendant.5
_________________________________________________________________
5. The full text of 15 U.S.C. S 80a-35(b) provides:
For the purposes of this subsection, the investment adviser of a
registered investment company shall be deemed to have a fiduciary duty
with respect to the receipt of compensation for services, or of payments
of a material nature, paid by such registered investment company, or by
the security holders thereof, to such investment adviser or any affiliated
person of such investment adviser. An action may be brought under this
subsection by the Commission, or by a security holder of such registered
investment company on behalf of such company, against such
investment adviser, or any affiliated person of such investment adviser,
or any other person enumerated in subsection (a) of this section who has
a fiduciary duty concerning such compensation or payments, for 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. With r espect to any such action the
following provisions shall apply:
(1) It shall not be necessary to allege or pr ove that any
defendant
engaged in personal misconduct, and the plaintif f shall have the
burden of proving a breach of fiduciary duty.
(2) In any such action approval by the boar d of directors of such
investment company of such compensation or payments, or of
contracts or other arrangements providing for such
compensation or payments, and ratification or appr oval of such
compensation or payments, or of contracts or other
arrangements providing for such compensation or payments, by
the shareholders of such investment company, shall be given
such consideration by the court as is deemed appr opriate under
all the circumstances.
(3) No such action shall be brought or maintained against any
person other than the recipient of such compensation or
payments, and no damages or other relief shall be granted
against any person other than the recipient of such
9
In order to determine whether S 36(b) preempts the
plaintiffs' state law claims for breach of fiduciary duty and
deceit, we must first determine what pr eemption theory is
applicable. Federal law preempts, and ther eby displaces,
state law in three different situations: (1) "express
preemption," (2) "field preemption" (which is also sometimes
referred to as "implied preemption"), or (3) "conflict
preemption." See, e.g., Orson, Inc. v. Miramax Film Corp.,
189 F.3d 377, 381-82 (3d Cir. 1999) (en banc).
Preemption is "express" when ther e is an explicit
statutory command that state law be displaced. See
Morales v. Trans World Airlines, Inc. , 504 U.S. 374, 382
(1992). An example of express preemption can be found in
the Employee Retirement Income Security Act of 1974
(ERISA) which states that the provisions of that Act "shall
supersede any and all State laws insofar as they may now
or hereafter relate to any employee benefit plan." 29 U.S.C.
S 1144(a). See Orson, 189 F.3d at 381. Preemption is
"implied," and state law may be displaced,"if federal law so
_________________________________________________________________
compensation or payments. No award of damages shall be
recoverable for any period prior to one year before the action
was instituted. Any award of damages against such recipient
shall be limited to the actual damages resulting from the breach
of fiduciary duty and shall in no event exceed the amount of
compensation or payments received from such investment
company, or the security holders thereof, by such recipient.
(4) This subsection shall not apply to compensation or payments
made in connection with transactions subject to section 80a-17
of this title, or rules, regulations, or or ders thereunder, or to
sales loads for the acquisition of any security issued by a
registered investment company.
(5) Any action pursuant to this subsection may be brought only in
an appropriate district court of the United States.
(6) No finding by a court with respect to a breach of fiduciary
duty
under this subsection shall be made a basis (A) for a finding of
a violation of this subchapter for the purposes of sections 80a-
9 and 80a-48 of this title, section 78o of this title, or section
80b-3 of this title, or (B) for an injunction to pr ohibit any
person from serving in any of the capacities enumerated in
subsection (a) of this section.
10
thoroughly occupies a legislative field as to make
reasonable the inference that Congr ess left no room for the
States to supplement it." Cipollone v. Liggett Group, Inc.,
505 U.S. 504, 516 (1992) (internal quotation marks
omitted). Finally, as we stated in Orson, state law may be
displaced under conflict preemption principles if the state
law in question presents a conflict with federal law in one
of two situations: when it is impossible to comply with both
the state and the federal law, or when the state law"stands
as an obstacle to the accomplishment and execution of the
full purposes and objectives of Congress." Orson, 189 F.3d
at 382 (quoting Jones v. Rath Packing Co., 430 U.S. 519,
525 (1977)).
In this case, the defendants do not contend thatS 36(b)
expressly preempts the plaintiffs' state law claims for
breach of fiduciary duty and deceit,6 nor do they assert that
S 36(b) of the ICA, or even the entire ICA itself, impliedly
preempts these claims.7 The preemption theory that the
_________________________________________________________________
6. The defendants would be precluded fr om making such an argument
because neither S 36(b), nor any other section of the ICA, contains an
"explicit statutory command" indicating that federal law preempts and
thereby displaces state law.
7. The defendants would be precluded fr om making such an argument
since it is well-settled that neither the ICA alone nor all federal
securities
laws taken together occupy the field of corporate law or securities law.
See, e.g., Burks v. Lasker, 441 U.S. 471, 477 (1979) (discussing the ICA
and noting that while "in certain areas[the Supreme Court has] held
that federal statutes authorize the federal courts to fashion a complete
body of federal law, [c]orporation law . . . is not such an area"); Baker,
Watts & Co. v. Miles & Stockbridge, 876 F .2d 1101, 1107 (4th Cir. 1989)
(en banc) ("It is well-settled that federal law does not enjoy complete
preemptive force in the field of securities[; s]tate securities laws exist
in
every state, the District of Columbia, and Puerto Rico, and, ``far from
preempting the field,' Congress has expr essly preserved the role of the
states in securities regulation.") (citations omitted). Such state
securities
laws are commonly referred to in the securities industry as "Blue Skies"
laws. The instant case, moreover, is distinguishable from the recent
decision in Buckman Co. v. Plaintiffs' Legal Committee, No. 98-1768,
2/21/01, ___ U.S. ___ (2001), ___ S.Ct. ___ (2001), in which the Supreme
Court found state common law fraud claims relating to a medical device
impliedly preempted by the Medical Device Amendments to the Food,
Drug and Cosmetic Act. Although the Buckman Court acknowledged that
11
defendants claim is applicable is conflict pr eemption. In
doing so, the defendants do not argue that"it is impossible
to comply with both the state and federal law." 8 Instead,
they assert the other prong of conflict pr eemption: that
state law in this case "stands as an obstacle to the
accomplishment and execution of the full purposes and
objectives of Congress." The District Court was persuaded
by the defendants' arguments and dismissed the claims,
concluding that they were preempted byS 36(b) under the
theory of "conflict preemption." W e conclude, however, that,
when plaintiffs' state law claims are pr operly analyzed
under the Supreme Court's "conflict pr eemption"
jurisprudence, they are not preempted byS 36(b).
In arguing for conflict preemption, the defendants have
attempted to analogize this case to earlier cases. However,
as the District Court recognized, none of the cases they cite
are controlling; the cited cases dealt with the proposition
that, with respect to other sections of the ICA, S 36(b) is the
exclusive remedy for grievances concerning mutual fund
service fees. Green II, 53 F. Supp. 2d at 728-29 (citing
numerous cases). The District Court also corr ectly noted
that, while "defendants cite the unpublished decision in
Batra v. Investors Research Corp., No. 89-0528-CV-W-6,
1990 WL 165242 (W.D. Mo. May 3, 1990), and a
_________________________________________________________________
a presumption against federal preemption of a state law cause of action
exists when a field is traditionally occupied by the states, the fraud
action was not subject to such a presumption because the defendant
manufacturer was accused of making fraudulent r epresentations to the
Food and Drug Administration during the course of the product approval
process. The Court held that the prevention of fraud against federal
agencies cannot be regarded as a field traditionally occupied by the
states. Buckman, ___ U.S. ___ at___. Unlike the plaintiffs in Buckman,
the plaintiffs in the case at bar allege not fraud against a federal
agency,
but rather violations of state and federal securities laws.
8. The defendants would be precluded fr om making such an argument
because no direct conflict exists between state law and federal law in
this case. Cf., e.g., Florida Lime & Avocado Growers, Inc. v. Paul, 373
U.S. 132, 143 (1963) ("That would be the situation here if, for example,
the federal orders forbade the picking and marketing of any avocado
testing more than 7% oil, which the Califor nia test excluded from the
State any avocado measuring less than 8% oil content.").
12
subsequent unpublished decision in a related case, Batra v.
Investors Research Corp., No. 91-0190-CV -W-6, 1992 WL
280790 (W.D. Mo. Apr. 2, 1992) (" Batra II"), as authority for
their preemption argument, . . . these decisions concern the
exercise of pendent jurisdiction[, and n]either decision
expressly holds that Section 36(b) preempts state common
law remedies." Id. at 729 (citing several cases).
The plaintiffs and the defendants have also attempted to
analogize this case to several Supreme Court pr eemption
cases, all of which address the issue of "express
preemption," not "conflict preemption," and thus are
inapposite. See, e.g., Freightliner Corp. v. Myrick, 514 U.S.
280, 284 (1995); Pilot Life Ins. Co. v. Dedeaux , 481 U.S. 41,
45-48 (1987); Jones v. Rath Packing Co., 430 U.S. 519,
531-33 (1977).
We conclude that prior case law is not on point. We are
left, therefore, to determine, guided by the Supreme Court's
"conflict preemption" jurisprudence, whether state law,
specifically common law establishing liability for breach of
fiduciary duty and deceit, "stands as an obstacle to the
accomplishment and execution of the full purposes and
objectives of Congress" as set forth inS 36(b) of the ICA.
The Supreme Court has held on multiple occasions that,
when analyzing preemption issues, "because the States are
independent Sovereigns in our federal system, we have long
presumed that Congress does not cavalierly pre-empt state-
law causes of action." Medtronic, Inc. v. Lohr, 518 U.S. 470,
485-86 (1996). We start with an assumption that the
historic police powers of the States will not be pr eempted
unless that was the "clear and manifest purpose of
Congress." Id. Moreover , in making our analysis, the
"purpose of Congress is the ultimate touchstone in every
pre-emption case." Id. (inter nal quotation marks omitted).
See, e.g., Chicago & Northwestern T ransp. Co. v. Kalo Brick
& Tile Co., 450 U.S. 311, 317-18 (1981); New York State
Dep't of Soc. Servs. v. Onondaga County Dep't of Soc.
Servs., 413 U.S. 405, 414-15 (1973); Florida Lime &
Avocado Growers, Inc. v. Paul, 373 U.S. 132, 141-43 (1963).
Thus, in deciding whether state law stands as an
obstacle to the accomplishment and execution of the full
13
purposes and objectives of Congress, as set forth in S 36(b),
we must focus on and attempt to discern the intent of
Congress in enacting S 36(b). Further more, because S 36(b)
represents congressional legislation in a field which the
States have traditionally occupied9 -- tort actions for
breach of fiduciary duty and fraud -- we must, as the
Court stated in Medtronic, "start with the assumption that
the historic police powers of the States," in this case the
power of states to hold investment company management
liable for improper compensation arrangements,"were not
to be superseded . . . unless that was the clear and
manifest purpose of Congress." Medtr onic, 518 U.S. at 485.
In arguing that state law "stands as an obstacle to the
accomplishment and execution of the full purpose and
objectives of Congress," and thus that the plaintiffs' state
law claims "conflict" with and are pr eempted by S 36(b), the
defendants rely heavily upon and quote extensively from
the legislative history of S 36(b) of the ICA. Because
congressional intent is "the ultimate touchstone in every
pre-emption case," we will examine that legislative history
to discern the intent of Congress in enacting S 36(b).
In its own review of the legislative history, the District
Court found that "Congress enacted the ICA because it had
concluded that the nationwide activities of investment
companies called for federal regulation and, more relevant
_________________________________________________________________
9. See, e.g., Baggett v. First National Bank, 117 F.3d 1342, 1352 (11th
Cir. 1997) ("[C]auses of action for br eaches of fiduciary duties are
traditionally creatures of state law, and under Cort, it would be
inappropriate to infer a cause of action for such based solely on federal
law."); Gruber v. Price Waterhouse, 911 F.2d 960, 962 (3d Cir. 1990)
("The complaint asserted claims pursuant to section 11 of the Securities
Act of 1933, section 10(b) of the Securities Act of 1934 and rule 10b-5,
and common law fraud and deceit."); Pin v. T exaco, Inc., 793 F.2d 1448,
1452 (5th Cir. 1986) ("As to Texaco, the complaint alleges nothing more
than corporate mismanagement and breaches offiduciary duty that are
traditionally a matter of state regulation."); Data Probe Acquisition
Corp.
v. Datatab, Inc., 722 F.2d 1, 4 (2d Cir . 1983) ("The gravamen of the
claim
advanced here is a breach of management'sfiduciary duty to
shareholders, a matter traditionally committed to state law, which, if
entertained, would unquestionably embark us on a course leading to a
federal common law of fiduciary obligations.").
14
to the issue at hand, enacted Section 36(b) because the
existing remedies for improper compensation arrangements
had been ineffective." Green II , 53 F. Supp. 2d at 730. We
agree with this conclusion. A careful survey of the relevant
legislative history clearly and unequivocally indicates that
Congress enacted S 36(b) because it deter mined that
existing remedies for improper compensation arrangements
were inadequate to protect mutual fund investors.
The District Court quoted the Senate Report,
accompanying the final version of the 1970 Amendments,
which states that "the unique structure of mutual funds
has made it difficult for the courts to apply traditional
fiduciary standards in considering questions concerning
management fees." S. REP. NO. 91-184 (1970), reprinted in
1970 U.S.C.C.A.N. 4897, 4898 (Senate Report). Id. at 727-
28. The court then added that the "Senate Report . . . noted
that the provisions contained in the ICA as originally
passed in 1940 concerning the regulation of management
fees and other charges to the investor ``did not provide any
mechanism by which the fairness of management contracts
could be tested in court'." Id., quoting Senate Report at
4901. The Senate Report went on to conclude that under
general rules of law, advisory contracts that had been
ratified by the shareholders or approved by disinterested
directors could not be upset except upon a showing of
"corporate waste":
As one court put it, the fee must "Shock the conscience
of the court." Such a rule may not be an impr oper one
when the protections of arm's-length bar gaining are
present. But in the mutual fund industry wher e, these
marketplace forces are not likely to operate as
effectively, your committee has decided that the
standard of "corporate waste" is unduly r estrictive and
recommends that it be changed. Id.
The District Court then cited the conclusion in the
Senate Report that the express statutory r equirement of
"reasonableness" be eliminated and a specific "fiduciary
duty" be "imposed on mutual fund investment advisers with
respect to management fee compensation." Green II, 53
F. Supp. 2d at 728 (citing Senate Report at 4902). The
"fiduciary duty" standard would make it easier for a
15
shareholder to prevail in an action against an investment
adviser who had entered into an improper or unfair
compensation arrangement.10
The defendants acknowledge that Congress enacted
S 36(b) and implemented the "breach offiduciary duty"
standard because it concluded that the "corporate waste"
standard previously applied in most states was largely
ineffective in preventing improper compensation
arrangements. However, neither the District Court nor the
defendants point to any language, either in the legislative
history of S 36(b) or in the statute itself, that suggests that
Congress intended to preempt state law claims for breach
of fiduciary duty or deceit when it enacted S 36(b).
Because Congress had found that the "corporate waste"
standard was inadequate to meet the problem, it sought to
provide mutual fund shareholders with additional
protection from improper compensation arrangements.
Nevertheless, the fact that the prior remedy might be less
effective does not mean that it stands as an obstacle to "the
accomplishment and execution of the full purpose and
objective of Congress." Even though the common law is less
effective than S 36(b), it may still be the remedy of choice in
certain situations. The creation of a gr eater protection does
not mean that the lesser protection is an obstacle if a
complainant elects to employ it. Moreover , the "lesser
protection," even if it is more difficult for a complainant to
prove a breach of the standard of car e, may offer a greater
range of targets and of remedies. Defendants have not
demonstrated that Congress intended to eliminate common
law access to these targets or these r emedies.
Our conclusion that S 36(b) does not pr eempt the
_________________________________________________________________
10. Inherent in the discussion of br each of fiduciary duty vs. corporate
waste is the concept that stockholder ratification or disinterested
director approval of an advisory contract eliminated the breach of
fiduciary duty standard in an attack on the terms of the advisory
contract. See, e.g., Saxe v. Brady, 184 A.2d 602 (Del. Ch. 1962) (holding
that where stockholders ratified investment adviser contract, interested
parties were relieved of burden of pr oving fairness of transaction; under
corporate waste standard, plaintiffs had not sustained burden of
establishing that fees were legally excessive.)
16
plaintiffs' state law claims is reinfor ced by cases, involving
other aspects of corporate governance, which hold that the
presence of a federal remedy to relieve a problem does not
preclude the recourse to a common law r emedy which is
directed at the same problem. An example is CTS Corp. v.
Dynamics, Corp., 481 U.S. 69 (1987), a securities
law/corporate law case discussing the potential pr eemptive
effect of the Williams Act. In holding that the Williams Act
did not preempt an Indiana state law r egulating corporate
takeovers, the Court stated:
The Indiana Act operates on the assumption, implicit
in the Williams Act, that independent shar eholders
faced with tender offers often are at a disadvantage. By
allowing such shareholders to vote as a gr oup, the Act
protects them from the coercive aspects of some tender
offers. . . . In such a situation under the Indiana Act,
the shareholders as a group, acting in the corporation's
best interest, could reject the of fer, although individual
shareholders might be inclined to accept it. The desire
of the Indiana Legislature to protect shareholders of
Indiana corporations from this type of coer cive offer
does not conflict with the Williams Act. Rather, it
furthers the federal policy of investor protection.
CTS Corp., 481 U.S. at 82-83 (emphasis added).
This conclusion can be stated in another way: The
creation of a federal remedy, in the field of securities law,
does not necessarily eradicate existing state law r emedies
or require that the federal remedy be exclusive. See, e.g.,
Medtronic, Inc. v. Lohr, 518 U.S. 470, 495-501 (1996)
(holding that S 360(k) of the Medical Device Amendments of
1976 does not preempt overlapping state tort law).
The defendants contend, nevertheless, that the strict
limitations of S 36(b) demonstrate that the plaintiffs' state
law claims should be preempted. The defendants point out
that, unlike the plaintiffs' state law claims:
(1) Section 36(b) expressly limits the parties against
whom relief can be sought, see 15 U.S.C. S 80a-
35(b)(3) (2000);11
_________________________________________________________________
11. While S 36(b) authorizes suit only against the "recipient" of the
alleged excessive compensation and expressly forbids bringing suit
17
(2) Section 36(b) limits the type and amount of r elief
a shareholder may recover, see id.;12
(3) Section 36(b) precludes shareholders from suing
for advisory fees paid more than one year prior to
the filing of the complaint, see id.; 13
(4) Section 36(b) imposes upon the plaintif f the
burden of proving that the investment adviser
breached his or her fiduciary duty, see 15 U.S.C.
S 80a-35(b)(1);14
(5) Section 36(b) requires plaintif fs to bring suit in
federal district court, see 15 U.S.C. S 80a-35(b)(5);15
(6) Section 36(b) creates no cause of action for the
investment fund itself--only the Securities and
Exchange Commission and shareholders of the
investment fund may bring suit against an
investment adviser for breach of fiduciary duty;16
and
_________________________________________________________________
against other parties, the plaintiffs in this case have sued numerous
parties under state law, many of which are not"recipient[s]" (as defined
by S 36(b)) of the alleged excessive compensation.
12. Plaintiffs are seeking compensatory damages with respect to their
state law claims.
13. As the District Court noted, this one-year statute of limitations is
significantly shorter than the corresponding six-year statute of
limitations for common law breach of fiduciary duty claims brought
under New Jersey law. See N.J. STAT. ANN. S 2A:14-1 (West 1999).
14. As the District Court noted, under the common law, a fiduciary who
allegedly breached his or her fiduciary duty must justify his or her
conduct. See, e.g., Gedes v. Anaconda Copper Mining Co., 254 U.S. 590,
599 (1921).
15. A plaintiff seeking to bring a br each of fiduciary duty claim under
state law would not have to bring his claim in federal district court and
indeed would be unable to bring his claim in federal district court unless
jurisdiction was provided for under 28 U.S.C.S 1367 (supplemental
jurisdiction) or 28 U.S.C. S 1332 (diversity jurisdiction).
16. At common law, the shareholder's suit for breach of fiduciary duty is
a derivative suit; the shareholder's right to bring suit is derived from
the
corporation's right to bring suit.
18
(7) At least one Court of Appeals has concluded that
S 36(b) creates an equitable cause of action and
thus plaintiffs suing under S 36(b) ar e not entitled
to a jury trial, see Krinsk v. Fund Asset
Management, Inc., 875 F.2d 404, 414 (2d Cir.
1989).17
Focusing on these procedural differ ences between a
common law cause of action and one under S 36(b), the
defendants reason that the differ ences reflect Congress's
intent to preempt state law claims and, as a consequence,
demonstrate that state law "stands as an obstacle to the
accomplishment and execution of the full purpose and
objectives of Congress." If, however , procedural differences
were sufficient both to indicate congr essional intent to
preempt overlapping state law and to demonstrate that
state law "stands as an obstacle to the accomplishment and
execution of the full purpose and objectives of Congress,"
federal law would preempt overlapping state law every time
federal law did not exactly mirror all the state law or state
laws in question. This argument finds no support in
relevant federal case law and is actually contrary to the
Supreme Court's preemption jurisprudence. See, e.g.,
Medtronic, Inc. v. Lohr, 518 U.S. 470, 495-96 (1996); Florida
Lime & Avocado Growers, Inc. v. Paul, 373 U.S. 132, 141-43
(1963). In short, establishing that federal law overlaps state
law is, by itself, insufficient to establish that federal law
preempts state law.
Indeed, if we were to accept the defendants' ar gument
that procedural differences both indicate congressional
intent to preempt the plaintiffs' state law claims and
demonstrate that state law "stands as an obstacle to the
accomplishment and execution of the full purpose and
objectives of Congress," then the '33 Act and the '34 Act
would also, by definition, preempt much state law in the
areas of corporate and securities law since many of the
procedural and substantive requirements of the '33 Act and
the '34 act differ markedly from the corr esponding
procedural and substantive requirements of corporate and
_________________________________________________________________
17. Presumably, a plaintiff seeking damages for common law fraud or
deceit is entitled to a jury trial.
19
securities law in most states. However, as noted above, it is
well-settled that the '33 Act and the '34 Act do not preempt
overlapping state law except where the overlapping state
law "stands as an obstacle to the accomplishment and
execution of the full purpose and objectives of Congress" or
where it is impossible to comply with both state and the
federal law. The '33 Act and the '34 Act are just two of
many possible examples of federal laws that do not
generally preempt overlapping state law. As the Supreme
Court noted in Medtronic in r egard to the potential
preemptive effect of S 360(k) of the Medical Device
Amendments of 1976:
Nothing in S 360(k) denies Florida the right to provide
a traditional damages remedy for violations of
common-law duties when those duties parallel federal
requirements. Even if it may be necessary as a matter
of Florida law to prove that those violations were the
result of negligent conduct, or that they cr eated an
unreasonable hazard for users of the pr oduct, such
additional elements of the state-law cause of action
would make the state requirements narr ower, not
broader, than the federal requir ement. While such a
narrower requirement might be"different from" the
federal rules in a literal sense, such a dif ference would
surely provide a strange reason for finding pre-emption
of a state rule insofar as it duplicates the federal rule.
The presence of a damages remedy does not amount to
the additional or different "r equirement" that is
necessary under the statute; rather, it mer ely provides
another reason for manufacturers to comply with
identical existing "requirements" under federal law.
Medtronic, 518 U.S. at 495 (emphasis added).
In this case, as in Medtronic, we ar e presented with
overlapping state and federal laws that impose dif ferent
procedural requirements upon plaintif fs seeking to bring
suit. However, here, as in Medtr onic, state law furthers "the
accomplishment and execution of the full purpose and
objectives of Congress." Neither the language of S 36(b) nor
the accompanying legislative history indicates, or even
suggests, that the plaintiffs' state law claims stand "as an
obstacle to the accomplishment and execution of the full
20
purpose and objectives of Congress."18 This fact is fatal to
the defendants' preemption arguments, especially in light of
the presumption against preemption in situations where
Congress has "legislated . . . in a field which the States
have traditionally occupied." See, e.g., Medtronic, 518 U.S.
at 484-86.
While the defendants argue that the pr ocedural
differences in question both indicate congressional intent to
preempt the plaintiffs' state law claims and demonstrate
that state law in this case "stands as an obstacle to the
accomplishment and execution of the full purpose and
objectives of Congress," we find it mor e likely that these
differences demonstrate a congressional attempt to limit the
relief available to plaintiffs underS 36(b). In enacting S 36(b)
in 1970, Congress not only created a federal, private right
of action previously unavailable under federal law,
Congress also radically altered the legal standard under
which the fairness and corresponding legality of mutual
fund compensation arrangements had been evaluated.
Consistent with Congress's intent in enactingS 36(b), the
legal standard under which mutual fund compensation
arrangements are evaluated under S 36(b) is markedly more
"plaintiff-friendly" than the "corporate waste" standard
applied by most state courts prior to 1970. In or der to
temper the radical change in the legal standar d under
which the fairness and corresponding legality of mutual
fund compensation agreements would be evaluated under
S 36(b), Congress instituted various pr ocedural limitations.
These procedural limitations are the same procedural
differences highlighted by the defendants as evidence that
state law in this case "stands as an obstacle to the
accomplishment and execution of the full purpose and
objectives of Congress."
_________________________________________________________________
18. Defendants argue in their brief that the ICA generally and S 36(b)
specifically demonstrate a "Congressional desire to replace . . .
ineffective
state laws with a ``national' uniform standard." Brief for Appellees at 13
(emphasis added). As a threshold matter , we note that the defendants
have cited no authority that indicates or even suggests that a desire for
uniformity alone gives rise to "conflict preemption" of state law by
federal
law.
21
Although the defendants argue to the contrary, we
conclude that these procedural differ ences and limitations
do not indicate that state law in this case "stands as an
obstacle to the accomplishment and execution of the full
purpose and objectives of Congress," but rather show that
Congress realized that S 36(b)'s sweeping change in the
legal standard, under which the fairness of mutual fund
compensation agreements would be evaluated, necessitated
corresponding limitations in the relief available.
In addition, we note that the defendants' reliance on
recent the Supreme Court preemption decisions in United
States v. Locke, 120 S. Ct. 1135 (2000), Geier v. American
Honda Motor Co., 120 S. Ct. 1913 (2000), Nor folk Southern
Ry. v. Shanklin, 120 S. Ct. 1467, 1477 (2000), and Crosby
v. National Foreign Trade Council, 2000 WL 775550 (June
19, 2000) is misplaced. The Supreme Court's holding in
Locke that Title II of the Ports and W aterways Safety Act
(PWSA) preempts conflicting state law was based primarily
on the doctrine of stare decisis. Many of the issues raised
in Locke were raised, analyzed and addr essed by the
Supreme Court in Ray v. Atlantic Richfield Co., 435 U.S.
151 (1978). To the extent that the subsequent enactment of
the Oil Pollution Act (OPA) modified or amended the Ports
and Waterways Safety Act, the relevant statutory history
explicitly states that the OPA "does not disturb the
Supreme Court's decision in Ray v. Atlantic Richfield Co.,
435 U.S. 151 (1978)." Locke, 120 S. Ct. at 1147 (quoting
H.R. CON. REP. NO. 101-653, at 122 (1990)). More
importantly, Locke is distinguishable fr om the case now
before us because Congress, in enacting the OPA and
PWSA, did not "legislate[ ] . . . in afield which the States
have traditionally occupied." Thus, the pr esumption against
preemption present in this case did not exist in Locke.
Locke, 120 S. Ct. at 1147-48.
In Geier, the Supreme Court held that the petitioners'
state tort claim, based on a lack of an automobile airbag,
conflicted with the objectives of Federal Motor V ehicle
Safety Standard 208 and therefore was preempted by the
National Traffic and Motor Vehicle Safety Act of 1966. See
Geier, 120 S. Ct. at 1922. However, Geier, like Locke, is
distinguishable from the case before us because the Court
22
in Geier relied upon federal statutory language and the
corresponding legislative history, concluding that state law
stood "as an obstacle to the accomplishment and execution
of the full purpose and objectives of Congress."
Similarly, the Supreme Court's recent opinions in Norfolk
Southern Ry. v. Shanklin, 120 S. Ct. 1467, 1477 (2000) and
Crosby v. National Foreign Trade Council, 2000 WL 775550
(June 19, 2000) are distinguishable. The Court in Norfolk
held that the Federal Railroad Safety Act of 1970, in
conjunction with various regulations pr omulgated under
the act, preempted state law tort claims stemming from a
railroad's failure to maintain adequate warning devices at
crossings where federal funds were used to install such
warning devices. See Norfolk, 120 S. Ct. at 1474-77.
However, the Supreme Court's holding in Norfolk, like its
holding in Locke, was based primarily on the doctrine of
stare decisis. See Norfolk, 120 S. Ct. at 1474-77; CSX
Transp., Inc. v. Easterwood, 507 U.S. 658 (1993). Moreover,
Norfolk addressed the issue of "express preemption," not
"conflict preemption" and thus is inapposite to the case
now before us.
The Court in Crosby also held that a Massachusetts law
barring state entities from buying goods and services from
companies doing business in Burma was pr eempted by a
subsequent federal law imposing mandatory and
conditional economic sanctions on Burma. In contrast to
Norfolk, Crosby clearly pr esented a question of "conflict
preemption." However, like Locke and Geier, Crosby is
distinguishable because the Court in Crosby relied upon
the language of three clear and unambiguous federal
statutory provisions in concluding that state law stood "as
an obstacle to the accomplishment and execution of the full
purpose and objectives of Congress." In addition, in
enacting the federal statutory provisions at issue in Crosby,
Congress sought to affect national for eign policy: not "a
field which the States have traditionally occupied." Thus,
the presumption against preemption pr esent in this case
did not exist in Crosby.
Finally, we note that the party claiming preemption bears
the burden of demonstrating that federal law pr eempts
state law. See, e.g., Silkwood v. Kerr-McGee Corp., 464 U.S.
23
238, 255 (1984); Buzzard v. Roadrunner T rucking, Inc., 966
F.2d 777, 780 (3d Cir. 1992). Her e, the defendants bear the
burden of demonstrating that S 36(b) of the ICA preempts
the plaintiffs' state law claims for br each of fiduciary duty
and deceit. In order to prevail under a theory of "conflict
preemption," the defendants must demonstrate that the
state law at issue in this case "stands as an obstacle to the
accomplishment and execution of the full purpose and
objective of Congress" as set forth in S 36(b). Because we
conclude that the defendants have failed to make this
showing, we hold that the plaintiffs' state law claims are
not preempted by S 36(b).
IV. CONCLUSION
In arguing that the plaintiffs' state law claims for breach
of fiduciary duty and deceit are preempted by S 36(b) of the
ICA, the defendants fail to point to any language, either in
S 36(b) itself or in the accompanying legislative history that
demonstrates that Congress intended S 36(b) to preempt,
and thereby displace, the plaintiffs' state law claims. The
defendants also fail to demonstrate how state law in this
case "stands as an obstacle to the accomplishment and
execution of the full purpose and objectives of Congress."
We hold, therefore, that the plaintiffs' state law claims are
not preempted by S 36(b). We will reverse the District
Court's grant of judgment and remand this case to the
District Court for further proceedings.19
_________________________________________________________________
19. In so ruling, we note that the disposition of this appeal does not
hinge on the merits of plaintiffs' state law claims. Rejection of the
defendants' arguments in favor of preemption in no way suggests that
the plaintiffs should ultimately prevail on the merits. We hold only that
S 36(b) of the ICA does not preempt the plaintiffs' state law claims for
breach of fiduciary duty and deceit.
24
STANTON, District Judge, Dissenting:
For the reasons stated in the District Court's opinion,
Green v. Fund Asset Management, L.P. , 53 F. Supp. 2d 723
(D.N.J. 1999) which I would affirm, I r espectfully dissent.
A True Copy:
Teste:
Clerk of the United States Court of Appeals
for the Third Circuit
25