In re Salomon Smith Barney Mut. Fund Fees Lit.

441 F.Supp.2d 579

In re SALOMON SMITH BARNEY MUTUAL FUND FEES LITIGATION

No. 04 CIV. 4055(PAC).

United States District Court, S.D. New York.

July 26, 2006.

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James Joseph Sabella, Grant & Eisenhofer P.A., Sidney Stephen Liebesman, Graham, Miller, Neandross, Mullin & Roonan, LLC, Kim Elaine Levy, Michael Robert Reese, Peter Edward Seidman, Steven G. Schulman, Milberg Weiss Bershad & Schulman LLP, Christopher J. Keller, Labaton Rudoff & Sucharow LLP, New York City, Charles J. Piven, Baltimore, MD, Sidney Stephen Liebesman, Grant & Eisenhofer, PA, Wilmington, DE, for Plaintiffs.

Jeanne Marie Luboja, Willkie Farr & Gallagher LLP, David Robert Gelfand, Milbank, Tweed, Hadley & McCloy LLP, Franklin B. Velie, Sullivan & Worcester LLP, Theodore R. Snyder, Krebsbach & Snyder, P.C., New York City, Joshua L. Solomon, Laura Steinberg, Sullivan & Worcester LLP, Boston, MA, for Defendants.

DECISION AND ORDER

CROTTY, District Judge.

Inspired by the Securities and Exchange Commission ("SEC"), the National Association of Securities Dealers ("NASD") and various state attorneys general investigations into the fee- and revenue-sharing in the mutual fund industry and subsequent settlement of these investigations,¹ Plaintiffs filed a 148-page Consolidated Amended Class Action Complaint (the "Complaint"), together with another 37 pages of exhibits, against Salomon Smith Barney ("SSB"). Plaintiffs, who are owners of some, but not all, of the mutual funds organized and offered by SSB, assert thirteen claims for relief: (1) under the Securities Act of 1933 ("SA" or "the 1933 Act"), 15 U.S.C. §§ 77-k, 77l(a)(2), and 77o; (ii) under the Securities and Exchange Act of 1934 ("SEA" or "the Exchange Act"), 15 U.S.C. §§ 78j(b) and 78t(a), and Rules 10b-5, 17 C.F.R. § 240.10b-5, and 10b-10, 17 C.F.R. § 204.10b-10; (iii) under Investment Company Act of 1940 ("ICA"), 15 U.S.C. §§ 80a-33(b), 80a-35(a), and (b), and 80a-47(a); and (iv) state common law claims for breach of fiduciary duty.

Defendants move to dismiss the complaint pursuant to Federal Rules of Civil Procedure 8(a), 9(b), 12(b)(6), and 23.1. For the reasons that follow, Defendants' motion is granted, with a limited leave to replead on one claim. Further, Plaintiffs have no standing as to funds which they do not own, but Plaintiffs may replead, if they find additional owners of the funds which are not represented by the current claims.

I. STANDARD OF REVIEW

"[A] complaint should not be dismissed for failure to state a claim unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957). On a motion to dismiss based on Rule 12(b)(6), "all factual allegations in the complaint must be taken as true and construed favorably to the plaintiff." LaBounty v. Adler, 933 F.2d 121, 123 (2d Cir.1991) (citations omitted). "The issue is not whether a plaintiff is likely to prevail ultimately, `but whether the claimant is entitled to offer evidence to support the claims.'" Gant v. Wallingford Bd. of Educ., 69 F.3d 669, 673 (2d Cir.1995) (citations omitted).

When deciding a motion to dismiss pursuant to Rule 12(b)(6), the Court may consider documents attached to the Complaint as exhibits or incorporated in it by reference. Chambers v. Time Warner, Inc., 282 F.3d 147, 153 (2d Cir.2002); Brass v. American Film Techs., Inc., 987 F.2d 142, 150 (2d Cir.1993).

II. FACTS ALLEGED IN THE COMPLAINT²

A. The Parties

Plaintiffs include one institutional investor, the Masons (Compl.¶ 18), and twenty-two individual investors (id. ¶¶ 19-40), who own shares in twenty of the eighty-eight mutual funds offered by SSB. Plaintiffs seek class certification "on behalf of a class of all persons or entities that purchased or held one or more shares ... of proprietary mutual funds organized and offered by SSB and its affiliates between March 22, 1999 and March 22, 2004,"—i.e., the "Class Period" (id. ¶ 304).

The Complaint names numerous defendants, including corporate parents, investment advisers, proprietary funds, registrants, and the directors and trustees of the proprietary funds. Defendant Citigroup, Inc. ("Citigroup") is the corporate parent of all of the corporate defendants named in the Complaint (id. ¶ 41). Defendant Citigroup Global Markets Holding, Inc. ("CGMHI"), f/k/a Salomon Smith Barney Holdings Inc., is an investment banking and securities brokerage business, a subsidiary of Citigroup, and the sole parent of SSB (id. ¶ 42). SSB is a diversified financial services firm that offers investment banking, investment analysis, and brokerage services, and also operates a family of mutual funds (i.e., the Proprietary Funds) for which it solicits business through affiliate brokers and provides advisory services through advisory subsidiaries (id. ¶ 126). Defendant investment advisers include SSB, Citigroup Asset Management ("CAM"),³ Salomon Brothers Asset Management, Smith Barney Fund Management (collectively the "Investment Adviser Defendants") (id. ¶¶ 43-47). Plaintiffs also name as defendants eighty-eight proprietary funds (collectively referred to as "Defendant Proprietary Funds") (see id. ¶ 48 & Ex. A). Defendant Proprietary Fund Registrants, of which there are thirty-six, served as the registrant and issuer, or a successor in interest to a registrant and issuer, of the Proprietary Funds sold to Plaintiffs (id. ¶ 49). Finally, the Complaint also asserts claims against seventy-three individuals in their capacity as directors and trustees of the Proprietary Funds (collectively referred to as the "Director Defendants") (id. ¶¶ 50-125).⁴

B. The Claimed Wrongdoing

In main part, the Complaint alleges a scheme, with three primary components. First, SSB uses a nationwide network of broker-dealers to steer Plaintiffs to invest in Proprietary Funds that SSB employers and officers managed and administered (Compl.¶¶ 2, 133-145). This practice involved (among other allegations) undisclosed cash and non-cash incentives (id. ¶¶ 3, 134-36), road shows (id. ¶¶3, 137), skewed financial publications and data (id. ¶¶¶ 3, 141), and penalties for non-compliant brokers (id. ¶¶ 142-45). Plaintiffs also assert that SSB broker-dealers also improperly steered them to other mutual funds with which SSB had undisclosed kickback arrangements (id. ¶¶ 5, 146-72). This program was called the "Strategic Partners Program" (id. ¶¶ 5, 146) whereby participating companies paid for "shelf space" in SSB's mutual funds operation (id. ¶¶ 5, 147). Both methods of steering occurred because SSB offered undisclosed incentives to brokers and financial advisers to sell SSB Proprietary Funds, instead of better performing mutual funds (id. ¶¶ 3-7, 151 (describing disparate commission rates paid to brokers based on whether sales occurred with Proprietary Funds or non-Proprietary Funds)). Plaintiffs contend that SSB and its affiliates engaged in these practices because they reaped lucrative fees for managing and advising the Proprietary Funds, which were calculated as a percentage of assets under management by the funds. Plaintiffs allege that Defendants, thus, had an incentive to increase collective investments in the Proprietary Funds as much as possible (id. ¶ 4).

Second, once the mutual funds were sold, SSB then extracted improper fees from Plaintiff-customers of the Proprietary Funds (id. ¶¶ 8, 173-74). Plaintiffs allege that defendants charged excessive fees in several ways (id. ¶¶ 9, 174). Defendants failed to inform Plaintiffs of "breakpoints" (i.e., levels of investment at which the fees being charged declines in percentage terms), by dividing investments into multiple purchases to fall just below "breakpoints," and by steering Plaintiffs to purchase less economically advantageous Class "B" shares as opposed to Class "A" shares (id. ¶¶ 9 n. 2, 175-80, 183-87). (Class "A" shares have an up-front fee but lower continuing fees, while Class "B" shares have no up-front fee, but higher continuing payments (id. ¶ 9).) Defendants also imposed annual payments, called "12b-1 trails," to pay for distribution costs, including payments to broker-dealers that were set at "abnormally high levels" to pay for the unjustified and undisclosed payments to SSB brokers (id. ¶¶ 9, 188-96). Since these fees were set as a percentage of the total assets of the Proprietary Funds, which were growing, investors' expenses continued to grow, thereby depriving them of economies of scale associated with increased investments (id. ¶¶ 189-90). Defendants also paid commissions called "soft dollars," which did not benefit Plaintiffs and were excessive (id. ¶¶ 9, 197-200). Plaintiffs charge that Defendants used soft dollars to pay for improper expenses such as overhead costs (id. ¶ 198); and that SSB did not allow customers to rollover funds transferred from other mutual funds into Proprietary Funds, forcing Plaintiffs to incur unnecessary, customary fees for first liquidating and then purchasing shares (id. ¶¶ 81-82).

Third, the fraudulent scheme involved SSB's use of Proprietary Funds to support its investment banking clients (id. ¶¶ 10, 201-11). According to Plaintiffs, SSB and other Defendants caused the Funds to purchase shares in under-performing and non-performing companies to the detriment of Plaintiffs and the benefit of SSB (id.).

None of the materials SSB provided to clients—including prospectuses, Statements of Additional Information ("SAIs"), and semi-annual and annual reports for the Proprietary Funds—disclosed these practices (id. ¶¶ 11, 212-69).

The Complaint alleges that Plaintiffs suffered three types of damages. First, Defendants improperly steered Plaintiffs into poorly-performing Funds such that Plaintiffs received lower returns for their investments (id. ¶ 271). Second, Plaintiffs paid excessive fees in connection with their purchases and ownership of shares...