The opinion of the court was delivered by: Whitman Knapp, Senior District Judge.
Defendant Blackrock Financial Management, Inc. has moved, pursuant to
Federal Rule of Civil Procedure 12(b)(6), to dismiss plaintiffs First
Amended Complaint for failure to state a claim upon which relief can be
granted. For reasons which follow, defendant's motion is granted.
The facts are here presented as alleged in the complaint. Plaintiff T.
Robert Verkouteren ("plaintiff") is a shareholder of The Blackrock Target
Term Trust Inc., one of twenty-one funds within a fund complex that is
advised by defendant Blackrock Financial Management ("defendant"). He
brings this action pursuant to the Investment Company Act of 1940 (the as
amended, 15 U.S.C. § 80a-35(b). Defendant is a registered investment
adviser specializing in fixed income securities. Defendant receives an
advisory fee, measured as a fixed percentage of the average weekly net
assets in the fund complex, for its services to the funds. Through this
action, plaintiff seeks to recover the fees received by defendant
pursuant to investment advisory agreements between it and the funds within
The crux of the complaint is as follows. Plaintiff claims that,
contrary to the requirements of Section 10(a) of the ICA,
15 U.S.C. § 80a-10(a),*fn1 more than 60% of the directors who sit on
the boards managing the funds within the complex are "interested" persons
within the meaning of the ICA. As a result, Section 15(c)'s requirement
that every agreement with an investment adviser be approved by a majority
of the independent directors cannot be met due to the fact that all of
the fund managers are "interested" under that term's definition in the
ICA.*fn2 The import of the absence of independent directors serving
within the fund complex is that the share-holders' interests cannot be
adequately safeguarded as contemplated by the ICA.
The complaint further claims that because 40% of the directors of the
funds within the complex are not independent, the advisory agreements
between the funds and the defendant, pursuant to which defendant receives
its advisory fees, are invalid. Plaintiff seeks recovery of those fees
under Section 36(b) of the ICA, 15 U.S.C. § 80a-35(b), on behalf of
all the funds within the complex.
Finally, the complaint alleges that defendant, by reason of its receipt
of funds from invalid advisory agreements, has breached its fiduciary
duty to negotiate at arm's-length with the funds in the complex. See
15 U.S.C. § 80a-35(b). Accordingly, plaintiff seeks judgment: (1)
declaring that defendant violated Sections 10(a), 15(c) and 36(b) of
the ICA, and that the advisory agreements are void; (2) awarding damages
against defendant, including the return of all fees paid to it by each of
the funds as well as related relief; and (3) providing any other relief
deemed just and proper by the Court.
As is apparent, the crux of all charges in the complaint is that the
seven supposedly independent directors are not truly independent, but
actually controlled by defendant.
A. The ICA and the mutual fund industry
The Investment Company Act of 1940 was enacted by Congress to regulate
investment companies that operate mutual funds. Kamen v. Kemper Financial
Services, Inc. (1991) 500 U.S. 90, 93, 111 S.Ct. 1711, 114 L.Ed.2d 152.
Unlike other corporations, investment companies are typically created and
managed by pre-existing entities known as investment advisers. Daily
Income Fund, Inc. v. Fox (1984) 464 U.S. 523, 536, 104 S.Ct. 831, 78
L.Ed.2d 645. "Because the adviser generally supervises the daily
operation of the fund and often selects affiliated persons to serve on the
company's board of directors, the relationship between investment
advisers and mutual funds is fraught with potential conflicts of
interest." Id. (internal quotation omitted).
Mindful of those potential conflicts, Congress crafted a regulatory
scheme in the ICA that placed quantitative and qualitative limits on the
relations between advisers and investment companies. Subsequent to the
Act's passage, investment companies enjoyed enormous growth, prompting
studies on the Act's effectiveness in protecting the interests of
investors. Daily Income, 464 U.S. at 537, 104 S.Ct. 831. The SEC, having
sponsored or authored several such studies, concluded that the Act did not
prevent advisers from receiving extraordinary compensation from mutual
funds relative to moneys received from other clients. Id. The SEC also
concluded that unaffiliated directors were "of restricted value as an
instrument for providing effective representation of mutual fund
shareholders in dealings between the fund and its investment adviser."
Id. (quoting Wharton School Study of Mutual Funds (1962), H.R.Rep. No.
2274, 87th Cong., 2d Sess., at 34).
These realities prompted Congress to take further action. In response
to legislative proposals submitted by the SEC, the ICA was amended in
1970. Among the amendments was 15 U.S.C. § 80a-10(a), which sought to
make the outside directors of investment companies more independent from
advisers. Id. at 538, 104 S.Ct. 831. Congress rejected an SEC proposal
which would have required advisers to accept only "reasonable" fees; it
opted instead to impose a fiduciary duty on advisers. Id. at 538-39, 104
Neither Congress (which amended the ICA in 1970) nor the SEC (which
often asserts its views regarding the susceptibility of outside directors
to the influence of advisers) has taken any action proscribing the use of
interlocking boards within mutual fund complexes. In 1994, the SEC
amended the proxy rules for registered investment companies to require
disclosure of the aggregate compensation received by directors who serve
on multiple fund boards. See Amendments to Proxy Rules for Registered
Investment Companies (1994) SEC Release No. IC-20614, 1994 SEC Levis
3098. There is no other regulation regarding interlocking boards.
Congress and the SEC are both undoubtedly aware that such schemes are
rife in the industry, as they are also aware that the shareholders of
mutual funds have the authority to set levels of director compensation
and to remove directors from office. It is therefore apparent ...