In re Mutual Funds Inv. Litigation, No. MDL-1586.

384 F.Supp.2d 873

In re MUTUAL FUNDS INVESTMENT LITIGATION (In re Janus SUBTRACK).

No. MDL-1586.

No. Civ. 04-MD-15863.

United States District Court, D. Maryland.

August 25, 2005.

Matthew L. Mustokoff, Jonathan D. Polkes, Weil, Gotshal and Manges, LLP, for Canadian Imperial Bank of Commerce.

FUND DERIVATIVE OPINION

MOTZ, District Judge.

This opinion addresses the motions to dismiss filed in a derivative action instituted on behalf of Janus Investment Fund ("JIF"), Janus Aspen Series ("JAS"), and Janus Advisor Series ("JAD")¹ against various Janus entities, officers, and fund trustees and numerous third-party broker/dealers and traders. The nature and structure of these MDL proceedings are described in the companion opinion I am issuing today on motions to dismiss filed in the investor class action in the "Janus subtrack."

The derivative plaintiffs have asserted various state law claims and federal claims under the Investment Company Act ("ICA"), 15 U.S.C. §§ 80a-1 et seq., and the Investment Advisers Act ("IAA"), 15 U.S.C. §§ 80b-1 et seq.² By agreement of the parties, briefing was deferred on all issues relating to the cognizability of the state law claims pending my ruling on the demand futility issue. Because none of plaintiffs' state law claims can be pursued unless demand is excused, and because I find that plaintiffs have not alleged sufficient facts to excuse demand, the state law claims will be dismissed without consideration of their underlying merit. My ruling on the demand futility issue is also dispositive of all the federal claims asserted by plaintiffs, other than the claim under Section 36(b) of the ICA, 15 U.S.C. § 80a-35(b), as to which the statute expressly excuses demand.³ However, the parties have briefed other issues concerning the viability of those claims, and in order to prevent the possibility of unnecessary delay in these proceedings, I will consider them now.

This opinion addresses five questions:⁴

(1) Have plaintiffs, as required by Fed.R.Civ.P. 23.1, alleged facts showing that the funds have "failed to enforce a right which may be properly asserted by ... [them]"?

(2) Have plaintiffs alleged sufficient facts excusing their failure to make demand upon the fund trustees before instituting this action?

(3) Have plaintiffs stated a viable claim under Section 47(b) of the ICA, 15 U.S.C. § 80a-46(b)?

(4) Is there a private right of action for damages under the IAA?

(5) Have plaintiffs stated a viable claim for a rescission under Section 215 of the IAA, 15 U.S.C. § 80b-15(b)?

I.

Fed.R.Civ.P. 23.1 permits a shareholder to bring a derivative action to enforce a right belonging to a corporation or unincorporated association when the corporation or association has "failed to enforce a right which may properly be asserted by it." Defendants contend this provision bars plaintiffs' suit because the fund trustees have been actively cooperating with the SEC and state authorities in achieving regulatory settlements that will compensate the fund shareholders harmed by late trading and market timing activities. Plaintiffs counter by pointing out that "a regulatory proceeding does not constitute an action by an investment company" and that "[t]he Trustees did not initiate the regulatory proceedings and they are not in control of them." Derivative Pls.' Omnibus Opp'n Mem. at 36. Therefore, according to plaintiffs, "the failure of the companies themselves to bring these causes of actions is ... sufficient, by itself, to satisfy the threshold requirement of Rule 23.1."⁵ Id.

Plaintiffs are obviously correct that proceedings instituted by regulatory authorities are not the same as suits instituted by the funds. However, plaintiffs' argument ignores the more fundamental question: What is the right that is to be enforced? It is not simply the right to sue. Cf. In re Delta & Pine Land Co. S'holders Litig., No. Civ. A. 17707, 2000 WL 875421, at *7 n. 21 (Del.Ch. June 21, 2000). Rather, it is the right to obtain full compensation for losses caused by late trading and market timing activities. The fund trustees will have enforced this right if, at the end of the day, it is determined that the regulatory settlements resulted in the payment of full compensation. Because the adequacy of the regulatory settlements thus bears directly upon the Rule 23.1 question, I would immediately accelerate resolution of it were I not dismissing plaintiffs' claims (other than their claim under Section 36(b) of the ICA) on other grounds.

II.

Plaintiffs did not make demand upon the fund trustees before instituting this action. The issue of whether demand should be excused on the ground of futility is, of course, determined by state law as to the state law claims plaintiffs are asserting. State law is also applicable to the demand futility issue in connection with claims asserted under the ICA and IAA. See Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 108-09, 111 S.Ct. 1711, 114 L.Ed.2d 152 (1991).

JIF is organized in Massachusetts, and JAS and JAD are organized in Delaware. Therefore, Massachusetts and Delaware law apply to the demand futility issues here presented. Both of these states take a very narrow view of when demand may be excused. See, e.g., Guttman v. Huang, 823 A.2d 492, 500 (Del.Ch.2003); Harhen v. Brown, 431 Mass. 838, 730 N.E.2d 859, 868 (2000). More than a century ago, the Massachusetts Supreme Judicial Court posited: "[i]t would be contrary to the fundamental principles of corporate organizations to hold that a single shareholder can at any time launch the corporation into litigation to obtain from another what he deems to be due it, or to prevent methods of management which he thinks unwise." Dunphy v. Travelers' Newspaper Ass'n, 146 Mass. 495, 16 N.E. 426, 431 (1888). Therefore, under Massachusetts law a derivative plaintiff must plead specific facts demonstrating "the corporation itself had refused to proceed after suitable demand, unless excused by extraordinary conditions." Ross v. Bernhard, 396 U.S. 531, 534, 90 S.Ct. 733, 24 L.Ed.2d 729 (1970). It is presumed that directors are "acting, not fraudulently, but with fair discretion in obedience to the law," Bartlett v. New York, New Haven & Hartford R.R. Co., 221 Mass. 530, 109 N.E. 452, 453 (1915), and demand will be excused only if there is a particularized showing that the majority of directors "have participated in wrongdoing, or are otherwise interested," Harhen, 730 N.E.2d at 865.⁶

Delaware law is to the same effect.⁷ It is "[a] cardinal precept of the General Corporation Law of the State of Delaware ... that directors, rather than shareholders, manage the business and affairs of the corporation." Aronson v. Lewis, 473 A.2d 805, 811 (Del.1984) (citation omitted), overruled on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del.2000). Because "[b]y its very nature the derivative action impinges upon the managerial freedom of directors," strict demand requirements are imposed. Aronson, 473 A.2d at 811. In situations where derivative plaintiffs are attacking an affirmative business decision made by the board, a "Court of Chancery in the proper exercise of its discretion must decide whether, under the particularized facts alleged, a reasonable doubt is created that: (1) the directors are disinterested and independent and (2) the challenged transaction was otherwise the product of a valid exercise of business judgment." Id. at 814.⁸ Further, a derivative plaintiff must establish that a majority of the board is interested or lacks independence in order to excuse demand on that ground. Id. at 815-17; see also Harhen, 730 N.E.2d at 864-65; Beneville v. York, 769 A.2d 80, 82 (Del.Ch.2000).⁹

The Delaware Supreme Court has somewhat modified the second prong of the Aronson test in cases where the derivative plaintiffs are not challenging an affirmative decision made by the present board. This modified test applies in cases, such as this one, in which the board is charged with a failure of oversight.¹⁰ Under the modified test, a court of chancery is to determine (in addition to making an appropriate inquiry under the first prong of the Aronson test), "whether or not the particularized factual allegations of a derivative stockholder complaint create a reasonable doubt that, as of the time the complaint is filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand." Rales v. Blasband, 634 A.2d 927, 934 (Del.1993). Because the same fundamental principles underlie Delaware and Massachusetts demand futility law and because the Aronson/Rales test provides a well considered and useful means for deciding the demand futility issue in a failure of oversight context, I will employ that test in deciding whether demand upon the fund trustees was excused.

Plaintiffs make two arguments in asserting that demand upon the fund trustees is excused. First, they contend that their allegations that the fund trustees sit on the boards of multiple funds and are highly compensated provide sufficient facts to create a reasonable doubt as to whether a majority of the trustees are disinterested and independent. Delaware and Massachusetts have enacted statutes expressly declaring that any investment company trustee who is not to be considered an "interested" trustee under the ICA is deemed "to be independent and disinterested for all purposes." Del.Code Ann. tit. 12, § 3801(h) (1998); Mass. Gen. Laws Ann. ch. 182, § 2B (1998) (same). These statutes are substantively identical to the Maryland statute, Md.Code Ann., Corp. & Ass'ns § 2-405.3(b) (1998), which was enacted in response to the decision in Strougo v. Scudder, Stevens & Clark, Inc., 964 F.Supp. 783, 795 (S.D.N.Y.1997), holding that service on multiple fund boards at a high salary could render a trustee "interested" and undermine his "independence" in considering a demand for suit from a derivative plaintiff. See Burton M. Leibert, Fund...