The opinion of the court was delivered by: MIRIAM CEDARBAUM, Senior District Judge
Investors in several mutual funds commenced these consolidated
actions asserting class claims under the Investment Company Act
of 1940, 15 U.S.C. § 80a-1 et seq. ("ICA"), common law claims
for breach of fiduciary duty, aiding and abetting breach of
fiduciary duty, and unjust enrichment, as well as a derivative
claim under the Investment Advisers Act of 1940,
15 U.S.C. § 80b-1 et seq. ("IAA"). Plaintiffs sue Davis Selected Advisers,
L.P., the investment adviser to the funds, Davis Selected
Advisers-NY, Inc., the sub-adviser to the funds, Davis
Investments, LLC, the general partner of the investment adviser,
Davis Distributors, LLC, the funds' distributor and principal
underwriter, and fifteen directors of the funds. Plaintiffs also
name the mutual funds as nominal defendants.*fn1 With the exception of the claim brought under the IAA, plaintiffs seek to
bring this action as a class action pursuant to Fed.R.Civ.P.
23(a) and (b) (3) on behalf of "all persons or entities who held
shares, units, or like interests in any of the Davis/Selected
Funds between June 3, 1999 and November 17, 2003, inclusive (the
"Class Period"), and who were damaged thereby (the "Class")."
Defendants move to dismiss the complaint pursuant to
Fed.R.Civ.P. 8(a), 9(b), 12(b) (6), and 23.1. For the reasons that
follow, defendants' motion is granted.
The following allegations are taken as true for the purpose of
this motion. The complaint alleges that during the class period
defendants improperly caused the Davis and Selected mutual funds
to be charged excessive fees in order to pay brokerage firms to
aggressively market the funds to new investors. The arrangements
between defendants and the brokerages were known as "shelf space"
arrangements, and took the form of direct cash payments, improper
"soft dollar" commissions,*fn2 payments for luxury meals and
travel, and the award of trading business on behalf of the funds. According to the
complaint, the "shelf space" arrangements were not disclosed to
investors in the public filings or prospectuses of the mutual
funds. Although the funds had written plans for marketing and
distribution expenses in accordance with Section 12(b) of the ICA
and Securities and Exchange Commission Rule 12b-1,*fn3 these
plans also did not disclose the "shelf space" arrangements. The
complaint alleges that, while the assets of the funds increased
during the class period as a result of defendants' conduct,
investors in the funds were injured because the net asset value
of the funds, which is the price at which investors can redeem
their shares on any given day, decreased by 23.1 percent. Also
during the class period, the expenses charged to the funds by
defendants increased from 1.29 to 1.39 percent of average net
assets. The complaint further alleges that the "shelf space"
arrangements gave rise to conflicts of interest which were not
disclosed to investors. Specifically, defendants did not disclose
that they may select brokers based not solely on the best
interest of the funds' investors but also on the brokers'
willingness to aggressively market the funds to new investors. In
addition, the investment advisers to the funds, whose fees were
calculated as a percentage of overall assets under management,
had an incentive to seek to increase the size of the funds
irrespective of the benefit to investors. The "shelf space"
arrangements also created conflicts of interest for the brokerage
firms that had pushed the funds on unwitting clients. According
to the complaint, the SEC and the National Association of
Securities Dealers have condemned "shelf-space" arrangements and
have brought enforcement proceedings against brokerage firms for
their role in accepting inducements from mutual funds to market
The complaint also alleges that the director defendants failed
to take reasonable steps to prevent the investment advisers from
skimming the funds' assets. The directors allegedly failed to
review the funds' Rule 12b-1 plans on a quarterly basis as
required, and failed to terminate those plans when they were not
reasonably likely to benefit investors. It is also alleged that the directors failed to regularly review the
investment advisory agreements and allocation of brokerage
business and commissions, contrary to representations made in the
funds' public filings.
The complaint asserts nine claims. Count One asserts a class
claim against the investment advisers and the director defendants
for violation of Section 34(b) of the ICA, 15 U.S.C. § 80a-33(b).
Counts Two and Three assert class claims against the funds'
distributor, investment advisers, and directors for violation of
Sections 36(a) and (b) of the ICA, 15 U.S.C. § 80a-35. Count Four
asserts a class claim against the investment advisers, as control
persons of the funds' distributor and directors, for violation of
Section 48(a) of the ICA, 15 U.S.C. § 80a-47(a). Count Five
asserts a derivative claim against the investment advisers under
Section 215 of the IAA, 15 U.S.C. § 80b-15, for a violation of
Section 206 of the IAA, 15 U.S.C. § 80b-6. Count Six asserts a
class claim against the investment advisers for common law breach
of fiduciary duty. Count Seven asserts a class claim against the
director defendants for common law breach of fiduciary duty.
Count Eight asserts a class claim against all defendants for
aiding and abetting breach of fiduciary duty. Count Nine asserts
a class claim against all defendants for unjust enrichment. Defendants move to dismiss the complaint on several grounds.
They argue that Counts One, Two, and Four should be dismissed
because there are no private rights of action under Sections
34(b), 36(a), and 48(a) of the ICA. Defendants argue that Count
Four should be dismissed because the complaint does not
adequately allege that the funds were charged excessive fees by
defendants. Defendants also argue that the derivative claim
asserted in Count Five fails to allege the demand requirements of
Fed.R.Civ.P. 23.1. In addition, defendants contend that Counts
Six to Nine, while asserted as class claims, should have been
brought derivatively, and fail to comply with Fed.R.Civ.P.
In a thoughtful and persuasive opinion, my colleague Judge
Koeltl recently dismissed a complaint filed by investors in the
Eaton Vance mutual funds which contained substantially the same
allegations as those made in this complaint. See In re Eaton
Vance Mutual Funds Fee Litig., 380 F. Supp.2d 222 (S.D.N.Y.
2005). Judge Koeltl held that there are no private rights of
action under Sections 34(b), 36(a), and 48(a) of the ICA and
dismissed the claims asserted under those provisions. I adopt
Judge Koeltl's reasoning and accordingly dismiss Counts One, Two,
I also agree with Judge Koeltl that allegations of "improper
12b-1 fees, soft dollar payments, and commissions to brokers are insufficient to allege a claim under 36(b), which
addresses only the negotiation and enforcement of payment
arrangements between investment advisers and funds, not whether
investment advisers acted improperly in the use of the funds."
Eaton Vance, 380 F. Supp.2d at 237. The complaint contains no
allegations from which it can be inferred that the investment
advisory fees paid to defendants were "so disproportionately
large" that they bore "no reasonable relationship to the services
rendered and could not have been the product of arm's-length
bargaining." Id. at 236 (quoting Gartenberg v. Merrill Lynch
Asset Mgmt., Inc., 694 F.2d 923, 928 (2d Cir. 1982)).
Accordingly, Count Three must be dismissed.
Count Five of the complaint, a derivative claim under the IAA,
seeks rescission of the investment advisory contracts and
recovery of past fees paid. Defendants move to dismiss this claim
for failure to comply with Fed.R.Civ.P. 23.1.
Rule 23.1 requires that the complaint in a derivative action
"allege with particularity the efforts, if any, made by the
plaintiff to obtain the action the plaintiff desires from the
directors or comparable authority and, if necessary, from the
shareholders or members, and the reasons for the plaintiff's
failure to obtain the action or for not making the effort." In
Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 108-109 (1991), the Supreme Court held that the requirements of demand for a
derivative suit are determined by the law of the state of
incorporation, in this case, Maryland law.*fn4
Plaintiffs acknowledge that they never made a demand on the
boards of the funds, but contend that the complaint adequately
pleads the futility of demand by alleging that (1) several of the
directors were appointed by and serve at the pleasure of the
investment adviser, (2) the directors have approved or failed to
cure the wrongdoing, (3) the directors had an interest in the
wrongdoing since it enhanced the size and prospects of the funds
and thus the likelihood that defendants would continue to serve
as directors, (4) the directors received annual compensation
ranging from $62,000 to $99,300 for their services on the board,
and (5) the directors would be required to sue themselves and
their fellow directors. Under Maryland law, these allegations are
insufficient to excuse demand. Maryland's requirements for demand futility are set forth in
Werbowsky v. Collomb, 766 A.2d 123
(2001). In Werbowsky, the
Supreme Court of Maryland Court noted that demand futility is:
a very limited exception, to be applied only when the
allegations or evidence clearly demonstrate, in a
very particular manner, either that (1) a demand, or
a delay in awaiting a response to a demand, would
cause irreparable harm to the corporation, or (2) a
majority of the directors are so personally and
directly conflicted or committed to the decision in
dispute that they cannot reasonably be expected to
respond to a demand in good faith and within the
ambit of the business judgment rule.
Id. at 144. After acknowledging a widespread trend toward
requiring demand in all cases, the Werbowsky Court chose to
"adhere, for the time being, to the futility exception," but
emphasized that the exception must be narrowly construed because
it "essentially eliminates any chance at meaningful prelitigation
alternative dispute resolution." Id.; see also Scalisi v.
Fund Asset Mgmt., L.P., 380 F.3d 133
, 141 (2d Cir. 2004) (noting
the Werbowsky Court's "insistence that the [demand] requirement
is rarely excused on grounds of futility."). Under Maryland law,
the Court observed, demand is not excused "simply because a
majority of the directors approved or participated in some way in
the challenged transaction or decision, or on the basis of
generalized or speculative allegations that they are conflicted
or are controlled by other conflicted persons, or because they
are paid well for their services as directors, were chosen as directors at the behest of
controlling stockholders, or would be hostile to the action."
Werbowsky, 766 A.2d at 143-144; see also Scalisi,
380 F.3d at 140 (demand not excused under Maryland law where directors of
mutual funds were alleged to have been appointed by the
investment adviser to the funds and to have received compensation
for their service on the board). Thus, plaintiffs' allegations
that the director defendants were appointed by the investment
adviser, had approved the challenged conduct, or had a financial
interest in sitting on the board and in increasing the size of
the funds, are insufficient to excuse demand under Maryland Law.
Count Five is therefore dismissed.
Counts Six to Nine are brought under state law. Defendants
contend that these causes of action should have been brought as
derivative as opposed to direct claims. Both sides agree that a
claim may only be brought directly by a shareholder in
circumstances in which the shareholder's injury is "distinct"
from that suffered by the corporate entity. See Strougo v.
Bassini, 282 F.3d 162, 171 (2d Cir. 2002) ("In deciding whether
a shareholder may bring a direct suit, the question the Maryland
courts ask is not whether the shareholder suffered injury; if a
corporation is injured those who own the corporation are injured too. The inquiry, instead, is whether the shareholders' injury is
`distinct' from that suffered by the corporation.").*fn5
The gravamen of plaintiffs' complaint is that defendants used
fees paid by the funds to compensate brokerage firms for steering
new investors to the funds, and that the investment advisers,
whose fees were calculated as a percentage of overall assets
under management, benefited from the resulting increase in the
funds' assets. As Judge Koeltl observed, "the injury asserted
the misuse of [fund] assets to provide excessive compensation to
brokers, improper 12b-1 plans, and soft dollar compensation to
brokers is an injury to the [funds] that adversely affects the
plaintiffs only indirectly through their status as investors in
the [funds.]" Eaton Vance, 380 F. Supp.2d at 235. Plaintiffs
did not directly pay the fees at issue. They were only injured
by having their shares diluted as the funds' net asset value
decreased because the fees were paid from the assets of the funds. See id.; see also
Strougo, 282 F.3d at 174 ("Underwriter fees, advisory fees, and
other transaction costs incurred by a corporation decrease share
price primarily because they deplete the corporation's assets,
precisely the type of injury to the corporation that can be
redressed under Maryland law only through a suit brought on
behalf of the corporation."); In re Merrill Lynch & Co., Inc.
Research Reports Sec. Litig., 272 F. Supp.2d 243, 260 (S.D.N.Y.
2003) (claim brought by mutual fund investor alleging that funds'
net asset value declined as a result of improper investment and
excessive investment advisory fees was derivative and could not
be maintained directly by investor); Green v. Nuveen,
186 F.R.D. 486, 490 (N.D. Ill. 1999) ("Diminution in the value of the