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Halebian v. Berv

July 31, 2007


The opinion of the court was delivered by: Naomi Reice Buchwald United States District Judge


Plaintiff John Halebian ("plaintiff") brings this action individually and on behalf of all other similarly situated beneficiaries of the Citifunds Trust III ("CitiTrust" or the "Trust") against its trustees ("defendants" or "trustees"). Plaintiff's claims arise out of the trustees' decision to approve new advisory agreements. Plaintiff asserts that the trustees ignored the best interests of the Trust and its beneficiaries and issued a false and misleading description of voting procedures in their proxy statement (the "Proxy Statement") in order to facilitate the approval of the new agreements. Defendants now move to dismiss pursuant to Federal Rules of Civil Procedure 12(b)(6) and 23.1, and under Massachusetts law governing derivative suits. For the reasons set forth below, we dismiss the complaint in its entirety.


CitiFunds Trust III is an open-ended investment company registered with the Securities and Exchange Commission ("SEC"), under the Investment Company Act of 1940 ("the ICA"), as amended, 15 U.S.C. § 80a-1 et seq. The Trust is organized as a business trust under Massachusetts law, and is comprised of six series portfolios (the "Funds"), each of which is a separate mutual fund with a separate investment portfolio and separate shareholders. Plaintiff states that he is a shareholder in one of the Funds, the Citi New York Tax Free Reserves Fund (the "NY Tax Free Fund"). See Complaint ("Compl.") ¶ 7. The named defendants are members of the Trust's Board of Trustees (the "Board"). CitiTrust is named as a nominal defendant in a derivative capacity; plaintiff's claims are brought on CitiTrust's behalf. See id. ¶ 9.

I. The Citigroup-Legg Mason Agreement and New Investment Advisory Contracts

Prior to December 2005, an affiliate of Citigroup, Inc. served as an investment adviser to each of the Funds. On June 23, 2005, Citigroup entered into an agreement with Legg Mason pursuant to which Citigroup agreed to sell substantially all of its asset management business, including CitiTrust's investment adviser subsidiaries, to Legg Mason. Id. ¶ 32. Consummation of this transaction is considered an "assignment" under the ICA, resulting in the automatic termination of the Funds' existing investment advisory contracts, and requiring the Funds to enter into new contracts. See id. ¶ 33. Section 15 of the ICA requires that each Fund's new contract must be approved by a majority of the trustees who are not "interested persons" under the ICA and by a vote of a majority of outstanding shares of that Fund. See 15 U.S.C. § 80a-15(a), (c).

In August of 2005, the Board approved new investment advisory agreements with Legg Mason. Compl. ¶ 39. In September of 2005, shareholders of the Funds were sent a proxy statement recommending, on behalf of the Board, that the shareholders vote to approve of these new agreements. See Compl. ¶ 2; Declaration of Mark T. Finn ("Finn Decl.") Ex. D ("Proxy Statement"). Shareholders were given the option of voting for or against the new agreements, or voting to abstain. See Proxy Statement ("Form of Proxy Card" attached to end of Proxy Statement). The Proxy Statement explained that a bank or other financial institution or intermediary --- known as a "service agent" --- might be the record holder of the shares owned by many shareholders. See id. at 8. In addition, pursuant to the voting procedures as set forth in the Trust's charter and the Funds' prospectus in effect at the time,*fn2 the Proxy Statement specified that the service agent would vote according to a procedure known as "echo voting" or "proportional voting." Specifically, the Proxy Statement said:

With respect to any shares for which a Citigroup-affiliated service agent (other than a broker-dealer) is the holder of record and for which it does not receive voting instructions from its customers, such service agent intends to vote those shares in the same proportion as the votes received from its customers for which instructions have been received.

Id. The Proxy Statement also informed shareholders of the details surrounding the new advisory agreements, and compared the provisions of the new agreements with those of the existing advisory agreements.*fn3 In particular, the Proxy Statement noted the new advisory agreements in question, like the existing advisory agreements, would permit the advisor to select brokers or dealers who provide both brokerage and research services to the Funds, even though the commissions charged by such brokers or dealers might be higher than those charged by other brokers or dealers who provide execution only or execution and research services --- a practice known as the payment of "soft dollars." See Proxy Statement at 11-12, 21. In Appendix D to the Proxy Statement, which compared in detail the existing "Current Management Agreement" to the "New Management Agreement" to govern the NY Tax Free Fund, the section relating to Brokerage Transactions showed that both the existing and the new agreements allowed for the payment of "soft dollars" in excess of the actual execution price of the trades, as described above, but that the proposed agreement, unlike the existing agreement, specifically allowed the Board to adopt policy and procedures to modify and restrict the adviser's use of such payments. See Id. App. D ("Comparison of Terms of Management Agreement") at D-3.

II. Plaintiff's Demand Letter and Appointment of the Demand Review Committee

On February 8, 2006, plaintiff's counsel sent a letter to the Board (the "Demand Letter"). See id. Ex. E. The Demand Letter stated that "[a] review of the lengthy discussion of the

[B]oard's deliberations over the new advisory agreements set forth in the [P]roxy [S]tatement fails to disclose that the

[B]oard ever considered the best interests of the Fund. For example, it appears that the [B]oard failed to avail itself of the opportunity presented to seek to negotiate lower fees or to seek competing bids from other qualified investment advisors." Id. at 1-2. It further alleged that in approving the new advisory contracts and recommending them to shareholders, the Board had "placed the interests of Citigroup before those of the Fund and their shareholders, notwithstanding that it owes fiduciary duties to the latter and not to Citigroup," and that the Board's sole focus appeared to be assisting Citigroup to comply with the requirements of Section 15(f) of the ICA. Id. The letter demanded that the Board institute an action for breach of fiduciary action against "any and all persons who are responsible for the [B]oard's dereliction of its duties in connection with the Citigroup-Legg Mason transaction" and take other appropriate remedial measures, including seeking bids for the advisory contract from other qualified investment advisers, negotiating new terms more favorable to the Fund, or both. Id. at 2. The letter also stated that "shareholder approval [of the new contracts] does not appear to have been obtained properly," but that "as this issue gives rise to direct, rather than derivative, claims it will not be addressed in this letter." Id. at 1 n.1.

On March 24, 2006, the Board voted to appoint independent trustees Mark T. Finn and Stephen R. Gross to serve as a Demand Review Committee ("DRC"). Finn Decl. ¶ 16. Board member R. Jay Gerken, a Citigroup employee, abstained from this vote because he is an "interested person" under the ICA. Id. Thus, the vote was taken by the remaining nine independent trustees --- the defendants in this case --- who are not "interested parties" as defined by the ICA. The Committee retained independent counsel, Leboeuf, Lamb, Greene & MacRae LLP ("LeBoeuf"), led by Ralph C. Ferrara, former General Counsel of the SEC, to assist in the inquiry of the Plaintiff's demand, and counsel undertook a review of the adoption of the new advisory agreements. Id. ¶¶ 17-18. During the investigation, Mr. Ferrara wrote to plaintiff's counsel on April 10, 2006, to inform him of the appointment of the DRC and to invite him to provide any additional information which might support the assertions made in the Demand Letter. Id. Ex. F. Plaintiff's counsel, Joel C. Feffer, sent a response dated April 20, 2006 to Mr. Ferrara, noting that he was "unclear" about the DRC's mandate, members, and powers in light of "the obvious anomaly of appointing people to consider suing themselves or their colleagues." Id. Ex. G. After asking "[w]hat type of 'additional information or support' does the Committee believe could be either relevant or in my possession", Mr. Feffer declined to provide any further information. Id. Accordingly, on April 28, Mr. Ferrara sent a letter enclosing the resolution appointing the DRC which was passed by the Board of Trustees in response to the Demand Letter, and invited plaintiff and his counsel to meet with the DRC towards the end of the review process. Id. Ex. H. Plaintiff's counsel's response, dated May 3, 2006, again asked what "additional information or support" was necessary. Declaration of Daniella Quitt, Ex. B. Mr. Ferrara's letter, dated May 9, 2006, once again invited plaintiff and counsel to meet with the DRC to discuss the demand. Finn Decl. Ex. I.

Plaintiff did not respond to said correspondence, and instead filed his complaint in this lawsuit on May 30, 2006.

III. Plaintiff's Complaint

Plaintiff's complaint alleges that the Board acted improperly in approving and recommending that shareholders approve new advisory agreements with Legg Mason subsequent to the sale of the investment adviser, Citigroup. Specifically, plaintiff argues that the new advisory contracts injure the Funds because defendants failed to avail themselves of the opportunity to negotiate more favorable advisory fees or seek competing bids from other qualified investment advisers.*fn4 See, e.g., Compl. ¶¶ 32, 36. According to plaintiff, shareholder approval of the contracts was obtained through a misleading proxy statement. Id. ¶¶ 37-47. Plaintiff brings three claims as a result of these events. Claim I is a derivative claim on behalf of the Trust, alleging a breach of fiduciary duty by the trustees in considering the Citigroup-Legg Mason transaction and in recommending the new advisory agreements. See Compl. ¶¶ 53-56. Claim II is brought as a direct claim pursuant to ICA Section 20(a), alleging that the Proxy Statement used was materially false and misleading, and failed to disclose material information concerning the voting procedure's compliance with the ICA Section 15(a) and Massachusetts law, "as well as the diversion of CitiTrust assets for the benefit of others." Id. ¶ 60. Claim III, another direct claim, alleges that the Trustees breached their fiduciary duties as trustees of Massachusetts business trusts to CitiTrust's shareholders by failing to fully and fairly disclose all material information within their control. Plaintiff claims that in seeking to have CitiTrust's holders of beneficial interests approve the new advisory agreements, the Trustees "failed to adequately disclose material information concerning the propriety of their voting procedures, as well as the diversion of CitiTrust assets for the benefit of others." Id. ¶¶ 63-65.


I. Standards of Review and ...

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