Appeal from a judgment of the United States District Court for the Southern District of New York (Naomi Reice Buchwald, Judge) dismissing a three-count complaint arising from the renegotiation of certain investment advisory agreements. We reserve decision while certifying to the Supreme Judicial Court of Massachusetts a question as to the circumstances under which the business judgment rule may be asserted in response to a shareholder derivative suit under the Massachusetts Business Corporation Act.
Question certified; decision reserved.
The opinion of the court was delivered by: Sack, Circuit Judge
Before: SACK and PARKER, Circuit Judges, and STANCEU, Judge.*fn2
John Halebian, a shareholder of an investment fund within CitiFunds Trust III ("CitiTrust" or the "Trust"), appeals from a judgment of the United States District Court for the Southern District of New York (Naomi Reice Buchwald, Judge). The court dismissed his three-count complaint against members of the Trust's board of trustees, the defendants here, in connection with the sale of an adviser of the Trust and the approval of new investment advisory contracts following that sale. Claim One, styled as a derivative claim on behalf of the Trust, alleges that the defendants breached their fiduciary duties to the Trust "in considering the . . . transaction and in recommending the new advisory agreements." Complaint ¶ 54, Halebian v. Berv, No. 06 Civ. 4099 (S.D.N.Y. filed May 30, 2006) (Doc. No. 1) ("Compl."). Claims Two and Three, styled as direct claims, allege that the defendants violated federal and state law by issuing materially false and misleading statements encouraging their shareholders to approve the new investment advisory contracts.
We conclude that we cannot decide the propriety of the district court's dismissal of Count One without resolving a question of Massachusetts law which appears to us to be one of first impression. We think that issue would best be decided by the Massachusetts Supreme Judicial Court in the first instance. Accordingly, we certify that question to the Supreme Judicial Court. Although we are of the view that dismissal of Counts Two and Three was proper, in light of our decision to certify a question to the Supreme Judicial Court in connection with Count One and because our resolution of the propriety of the district court's dismissal of Counts Two and Three also involves the application of Massachusetts law, we think it the more prudent course to reserve judgment in this respect, too, pending the Supreme Judicial Court's response to the question certified.
The following recitation is based on Halebian's complaint and other documents "integral" to that complaint, see Chambers v. Time Warner, Inc., 282 F.3d 147, 153 (2d Cir. 2002), the factual assertions of which, for purposes of this discussion, we assume to be true, see Ashcroft v. Iqbal, 129 S.Ct. 1937, 1949 (2009). Halebian is a citizen of New York State. At all relevant times, he owned shares in the Citi New York Tax Free Reserves Fund (the "New York Fund"), one of six "series portfolios," or mutual funds (the "Funds"), contained in the Trust. See Compl. ¶ 7. CitiTrust is a Massachusetts business trust with its principal place of business in Maryland. Id. ¶ 8. CitiTrust is "named as a nominal defendant . . . solely in a derivative capacity." Id. ¶ 9. The actual defendants, none of whom is a New York citizen, are members of CitiTrust's Board of Trustees (the "Board"). Id. ¶¶ 10-19.
On June 23, 2005, Citigroup sold substantially all of its asset management business, including a subsidiary that served as an adviser to CitiTrust, to Legg Mason, Inc. Id. ¶ 32. In connection with this transaction (the "Transaction"), the Funds' existing advisory contracts were terminated and new contracts were executed with the Funds' new advisers, id. ¶ 33, for which the Funds' shareholders' approval was required, id. ¶ 34. In August 2005, the Board approved the Funds' new investment advisory agreements with Legg Mason. Id. ¶ 39. Thereafter, the Board issued a proxy statement to its shareholders describing the advisory agreements and recommending that they vote to approve the new agreements, id. ¶¶ 34-35, which they did, id. ¶ 61.
Two aspects of the Transaction are relevant to this appeal. First, the new advisory agreements authorize the payment of "soft dollars." Id. ¶ 43. As described by the district*fn3 court, soft-dollar payments "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." Halebian v. Berv, 631 F. Supp. 2d 284, 289 (S.D.N.Y. 2007).
Second, the voting procedures employ "echo voting," in which Citigroup-affiliated service agents who were record holders of shares for which instructions had not been received would vote those shares "in the same proportion as the votes received from its customers for which instructions have been received." Compl. ¶ 45 (internal quotation marks omitted).*fn4
The Demand Letter and the Board's Response On February 8, 2006, Halebian, through counsel, expressed his dissatisfaction with the Transaction by letter to the Board. Compl. ¶ 48. He asserted that in connection with the Transaction and contrary to its fiduciary duty, the Board "placed the interests of Citigroup before those of the Fund and . . . [its] shareholders" and "failed to avail itself of the opportunity presented to seek to negotiate lower fees" on behalf of the Trust "or to seek competing bids from other qualified investment advisers." Letter from Joel C. Feffer to the Bd. of Trs. of the Citi N.Y. Tax Free Reserves Series of Citi Funds Trust III 1-2 (Feb. 8, 2006). The letter demanded "that the board take action which would include, among other things, the institution of an action for breach of fiduciary duty against any and all persons who are responsible for the board's dereliction of its duties in connection with the . . . transaction" and that "appropriate remedial measures . . . be undertaken, including seeking bids for the advisory contract from other qualified investment advisers, negotiating new terms more favorable to the [New York] Fund with Legg Mason, or both." Id. at 2.
The demand letter noted that "shareholder approval does not appear to have been obtained properly," presumably a reference to the echo voting practices described in the proxy statement. The letter did not, however, make a demand with respect to this purported impropriety because, the letter said, the impropriety "gives rise to direct, rather than derivative, claims." Id. at 1 n.1.
The Board acknowledged receipt of the demand letter. Compl. ¶ 49. It later advised Halebian that it had created a "Demand Review Committee" to review his complaint, and that the committee had retained counsel. Id. ¶ 50. Throughout this period of time, counsel for both Halebian and the Demand Review Committee remained in communication with one another.
On May 30, 2006, more than ninety days after the date of Halebian's original demand letter, not having received a definitive response from the Demand Review Committee, Halebian filed a three-count complaint in the United States District Court for the Southern District of New York. In it, he alleges that following his demand letter, Halebian waited "the statutory time required" -- ninety days -- before filing his derivative claim;*fn5 that such a period "provide[d] more than adequate time" for the Board to have reviewed Halebian's demand and have taken action; and that "[n]ot surprisingly, defendants have failed to take action against themselves." Compl. ¶ 51.
Claim One, styled as a derivative claim for breach of fiduciary duty, alleges that members of the Board breached their fiduciary duties of good faith and loyalty under Massachusetts law in their "consider[ation of] the Citigroup/Legg Mason transaction and in recommending the new advisory agreements." Id. ¶ 54. The complaint alleges that the "[d]efendants limited their consideration to whether the . . . transaction would be worse for CitiTrust's beneficiaries than their current situation" and "made no effort to investigate whether a transaction could be fashioned which would benefit CitiTrust's beneficiaries, either with Legg Mason or another asset manager." Id. ¶ 36. Halebian contends that the soft-dollar arrangements allow for the payment of "higher than necessary brokerage commissions," id. ¶ 43, referring to those payments as "kickback[s]," id. ¶ 44.*fn6
Claim Two, styled as a direct claim on behalf of Halebian and members of a class of "all persons and entities who held shares of beneficial interest in CitiTrust on August 22, 2005 (the 'Class')," id. ¶ 26, alleges that the proxy statement at issue violated section 20(a) of the Investment Company Act of 1940 (the "ICA"), 15 U.S.C. § 80a-20(a), because it contained material misstatements and omissions. First, the echo voting procedures described in the proxy statement violated federal law -- section 15(a) of the ICA, 15 U.S.C. § 80a-15(a) -- and unspecified provisions of Massachusetts law, and that the proxy statement was misleading because it did not so state. Compl. ¶¶ 47, 60. Second, the proxy statement failed to disclose that by virtue of the Transaction, assets of CitiTrust were "diver[ted] . . . for the benefit of others," id. ¶ 60, presumably via soft dollar payments. Based on this "material false and misleading information," Halebian alleges, the "[d]efendants secured approval of the new advisory agreements." Id. ¶ 61.
Claim Three, also styled as a direct claim on behalf of Halebian and members of the Class, id. ¶ 26, asserts that the trustees violated Massachusetts law, id. ¶ 64, by failing fully and fairly to disclose in the proxy statement all material information within their control, namely, the "[im]propriety of the voting procedures" and "the diversion of CitiTrust assets for the benefit of others," id. ¶ 65.
The complaint seeks declaratory and injunctive relief and compensatory damages. See Compl. at 20-21, "Prayer for Relief."
Board's Post-Complaint Conduct
By resolution dated July 12, 2006, some six weeks after the timely filing of Halebian's complaint, the Board expressly declined to accede to Halebian's demand, effectively rejecting it. See Res. of the Bd. of Trs. of CitiFunds Trust III 27 (July 12, 2006). The Board stated that it had "studied a large volume of information on the quality and costs of the adviser's services, including a study that indicated the Fund's management fee was in the lowest quintile measured against fees for similar funds, and concluded that the fees were reasonable." Id. at 22. The Board further "found no authority for the proposition that the 1940 Act or Massachusetts law forbids the use of echo voting by a record holder of shares in a vote to approve an advisory contract with a registered mutual fund" and noted that "[e]cho voting is a common practice in the financial industry [the] utility [of which practice] has been recognized both by the Securities and Exchange Commission and the New York Stock Exchange." Id. at 25. According to the Board, "the balance of the Trust's interests weighs against taking the action requested in the Demand Letter." Id. at 26. On that basis, the Board declined to institute any action against its members. It directed its counsel to move to dismiss Halebian's derivative claim instead. Id. at 27-28.
On October 24, 2006, defendants' counsel moved pursuant to, inter alia, Federal Rule of Civil Procedure 12(b)(6) to dismiss the complaint.
The District Court Opinion By Memorandum and Order dated July 31, 2007, the district court granted the defendants' motion to dismiss. See Halebian, 631 F. Supp. 2d at 303.
In addressing Count One, the court acknowledged that Halebian had satisfied Massachusetts's statutory universal demand requirement for derivative actions by demanding that the Trust rectify the alleged improprieties in the Legg-Mason transaction and then waiting the requisite 90 days before filing his suit.
See Mass. Gen. Laws ch. 156D, § 7.42. The district court nonetheless dismissed Count One on two other bases.
First, the court concluded that the complaint failed to comply with Rule 23.1 of the Federal Rules of Civil Procedure because it "asserts no basis for 'plaintiff's failure to obtain the action' from the board as required by Rule 23.1." Halebian, ...