Smith v. Oppenheimer Funds Distrib., Inc.

824 F.Supp.2d 511

Bradley C. SMITH, Plaintiff,

v.OPPENHEIMER FUNDS DISTRIBUTOR, INC., et al., Defendants.

Nos. 10 Civ. 7387(LBS)

10 Civ. 7394(LBS).

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

June 6, 2011.

Andrew Wilson Myers, Jeffrey A. Chase, Jacobs, Chase, Frick, Kleinkopf & Kelley, LLC, Denver, CO, Janine Lee Pollack, Lauren Block, Michael Champlin Spencer, Milberg LLP, New York, NY, Ronald A. Uitz, Uitz & Associates, Washington, DC, for Plaintiff.

David Adam Kotler, Jennie Boehm Krasner, Dechert, LLP, Princeton, NJ, Robert Nolen Miller, Stephanie E. Dunn, Perkins Coie LLP, Edward Thomas Lyons, Jr., Jones & Keller, PC, Denver, CO, William Kennedy Dodds, Dechert, LLP, Arthur Harlod Aufses, III, Yehudis S. Lewis, Kramer, Levin, Naftalis & Frankel, LLP, Nakeeb Mian Siddique, USDC, Southern District of New York, New York, NY, for Defendants.

MEMORANDUM & ORDER

SAND, District Judge.

Plaintiff Bradley C. Smith brings two actions under the Investment Company Act (“ICA”), 15 U.S.C. § 80a–1 et seq. Plaintiff brings two actions: 10 Civ. 7394 derivatively on behalf of Nominal Defendant Oppenheimer Gold & Special Minerals Fund (the “ Gold action”), and 10 Civ. 7387 derivatively on behalf of Nominal Defendant Oppenheimer Quest for Value Funds (the “ Quest action”). In each of these actions, Plaintiff raises four claims: (1) a claim under Section 47(b) of the ICA; (2) a claim under Massachusetts state law of breach of contract; (3) a Massachusetts breach of fiduciary duty claim; and (4) a Massachusetts claim of per se waste of corporate assets. Defendants have moved to dismiss the Complaints in both actions.

For the reasons set forth below, Defendants' motions to dismiss are granted.

I. Background

A. Parties

Plaintiff, a resident of North Carolina, owns Class C shares of Nominal Defendant Oppenheimer Gold & Special Minerals Fund (the Gold action) and Class C shares of the Oppenheimer Small & Mid–Cap Fund, a series of Nominal Defendant Oppenheimer Quest for Value Funds (10 Civ. 7387) (the Quest action). Verified Compl. 10 Civ. 7394 (“Complaint”) ¶ 10; Verified Compl. 10 Civ. 7387 ( “Quest Compl.”) ¶ 10. Plaintiff has held shares in both Funds since June 9, 2006; those shares are held in a brokerage account at broker-dealer Merrill Lynch, Pierce, Fenner & Smith Incorporated. Id.

Nominal Defendants in both cases are business trusts classified under the ICA as open-ended management investment companies—better known as mutual funds. Both are incorporated in Massachusetts and maintain their principal places of business at the same address in Centennial, Colorado. Compl. ¶ 11; Quest Compl. ¶ 11. Both Complaints name individual Defendants Brian F. Wruble, David K. Downes, Matthew P. Fink, Phillip A. Griffiths, Mary F. Miller, Joel W. Motley, Mary Ann Tynan, Joseph M. Wikler, Peter I. Wold, John V. Murphy, and Russell S. Reynolds, Jr., who are current trustees of both Funds. Compl. ¶¶ 12–23; Quest Compl. ¶¶ 12–21, 25. The Quest action also names as Defendants William F. Glavin, Thomas W. Courtney, and Lacy B. Hermann, trustees of Nominal Defendant Oppenheimer Quest for Value Funds. Quest Compl. ¶¶ 22–25. Both cases also name Defendant OppenheimerFunds Distributor, Inc. (“OFDI”), a New York corporation with its principal place of business in New York, New York. Compl. ¶ 23; Quest Compl. ¶ 26. OFDI is a broker-dealer member of the Financial Industry Regulatory Authority (FINRA). Id.¹

B. Factual Background

The Funds finance distribution of their own shares out of Fund assets as permitted by Securities and Exchange Commission (“SEC”) Rule 12b–1, 17 C.F.R. § 270.12b–1. Compl. ¶ 48. The Board of Trustees for each Fund decides how to compensate broker-dealers for selling shares. Here, the Funds pay distribution fees pursuant to Rule 12b–1 to OFDI, the Funds' distributor, which in turn forwards these payments to retail broker-dealers such as Merrill Lynch who actually distribute shares in the Funds. Plaintiff alleges that since October 1, 2007, the Funds and OFDI have made these payments in the form of asset-based compensation, Compl. ¶ 50, and that such compensation violates the Investment Advisers Act of 1940, 15 U.S.C. § 80b–1 et seq. (“IAA”). Plaintiff also alleges that the Defendant Trustees have an affirmative obligation to ensure that the distribution fees are paid in accordance with the IAA and other governing law. Compl. ¶ 54.

Plaintiff originally filed these actions in the District of Colorado on March 19, 2010. Defendants moved to transfer venue to this District pursuant to 28 U.S.C. § 1404(a) on May 19, 2010, and the cases were transferred on September 28, 2010. In each case, Defendants submitted three separate motions to dismiss the Complaint on June 25, 2010: one from Defendant Murphy and OFDI, one from the remaining Trustee Defendants, and one from the Nominal Defendant.

II. Legal Standard

On a motion to dismiss, a court reviewing a complaint will consider all material factual allegations as true and draw all reasonable inferences in favor of the plaintiff. Lee v. Bankers Trust Co., 166 F.3d 540, 543 (2d Cir.1999). “To survive dismissal, the plaintiff must provide the grounds upon which his claim rests through factual allegations sufficient to raise a right to relief above the speculative level.” ATSI Commc'ns Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 93 (2d Cir.2007) (internal quotation marks omitted). Ultimately, the plaintiff must allege “enough facts to state a claim to relief that is plausible on its face.” Bell Atl. Corp. v. Twombly, 550 U.S. 544, 547, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007). “[A] simple declaration that defendant's conduct violated the ultimate legal standard at issue ... does not suffice.” Gregory v. Daly, 243 F.3d 687, 692 (2d Cir.2001). “The tenet that a court must accept as true all of the allegations contained in a complaint is inapplicable to legal conclusions. Threadbare recitals of the elements of a cause of action, supported by mere conclusory statements, do not suffice.” Ashcroft v. Iqbal, 556 U.S. 662, 129 S.Ct. 1937, 1949, 173 L.Ed.2d 868 (2009).

III. Discussion

A. Plaintiff's Theory of Liability

Plaintiff's theory of liability has two separate phases. First is the underlying merits issue of whether the broker-dealers retained by Defendants violated the IAA. Plaintiff does not bring his claims under the IAA because he is suing OFDI and the Funds' trustees, rather than the broker-dealers themselves. Therefore, the second phase of Plaintiff's theory of liability is concerned with the cause of action he claims under the ICA.

i. Broker–Dealers and Special Compensation under the IAA

Broker-dealers are regulated by the Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq., whereas the IAA applies to investment advisers. The IAA also applies to full-service broker-dealer firms who provide investment advice to their customers. A broker-dealer firm providing investment advice must comply with the IAA by registering as an investment adviser, maintaining record-keeping and reporting procedures, adopting policies to prevent violations of the securities laws, and maintaining compensation arrangements in accordance with the IAA. 15 U.S.C. § 80b–1 et seq. Firms registered as both broker-dealers and investment advisers are called “dual registrants.” They often segregate accounts for which they provide investment advice (“advisory accounts”) from accounts for which they only serve as brokers (“brokerage accounts”). Plaintiff alleges that his mutual fund shares are held in a brokerage account at broker-dealer Merrill Lynch. Compl. ¶ 10.

The IAA contains a “Broker–Dealer Exclusion” for a broker-dealer who gives advice that is only “incidental” to his conduct as a broker-dealer “and who receives no special compensation therefor.” 15 U.S.C. § 80b–2(a)(11)(C). Such broker-dealers are exempted from the IAA's registration and reporting requirements. According to Plaintiff, “special compensation” includes anything other than transactional commissions. Therefore, Plaintiff contends that broker-dealer dual registrants who receive any form of compensation other than transactional commissions cannot offer investment advice under the IAA to holders of brokerage accounts.² In 2005, the SEC promulgated a regulation holding that broker-dealers who provide incidental investment advice could receive non-transactional compensation so long as they did not contract to provide that advice or charge a separate fee for it. Certain Broker–Dealers Deemed Not to be Investment Advisers, 70 Fed. Reg. 20,424 (Apr. 19, 2005). The D.C. Circuit invalidated the regulation in Fin. Planning Ass'n v. SEC, 482 F.3d 481 (D.C.Cir.2007). Plaintiff interprets this holding as forbidding broker-dealers providing non-incidental investment advice to customers holding brokerage accounts from receiving any form of compensation other than transactional commissions.

ii. Plaintiff's Cause of Action under the ICA

The relevant substantive provisions of the IAA contain no private right of action against a mutual fund, its trustees, or its distributors. Therefore Plaintiff brings his claim under Section 47(b) of the ICA, which provides that contracts that violate provisions of the ICA and accompanying regulations, or whose performance involves such violation, are unenforceable. 15 U.S.C. § 80a–46(b)(1). To bring a claim under section 47(b), a plaintiff must allege that a contract violated a substantive provision of the ICA or rules promulgated under the statute. Plaintiff alleges two such underlying predicate violations. First, Plaintiff alleges that OFDI and the Defendant trustees have a fiduciary duty of care to the Fund under ICA section 36(a), 15 U.S.C. § 80a–35. Second, Plaintiff claims that SEC Rule 38a–1, 17 C.F.R. § 270.38a–1, promulgated under the ICA, imposes a duty on mutual fund boards to oversee compliance with federal securities laws and ensure that shareholders are not harmed. Both of these provisions, Plaintiff argues,...