Plaintiffs appeal from a February 2, 2009 order of the United States District Court for the Southern District of New York (Jones, J.), which dismissed their claims relating to two Morgan Stanley mutual funds brought pursuant to sections 11, 12(a)(2), and 15 of the Securities Act of 1933, 15 U.S.C. §§ 77k, 77l(a)(2), 77o. The district court held that plaintiffs had not identified any legal basis that required defendants to disclose in the funds' offering documents information that related primarily to an affiliated Morgan Stanley broker-dealer.
The opinion of the court was delivered by: Wesley, Circuit Judge
Argued: November 13, 2009
Before: McLAUGHLIN and WESLEY, Circuit Judges, and KAHN,*fn2 District Judge.
These cases concern the boundaries of disclosure obligations in registration statements and prospectuses filed on Form N-1A pursuant to the Securities Act of 1933 ("Securities Act"), 15 U.S.C. § 77a et seq. In separate but substantially similar putative class actions, two groups of plaintiffs brought claims under sections 11, 12(a)(2), and 15 of the Securities Act. In re Morgan Stanley Info. Fund Sec. Litig., No. 02 Civ. 8579 (S.D.N.Y.) ("Info. Fund Action"); In re Morgan Stanley Tech. Fund Sec. Litig., No. 02 Civ. 6153 (S.D.N.Y.) ("Tech. Fund Action"). With the exception of the Morgan Stanley mutual fund specified in the caption of each case, the defendants are identical in both actions. Both groups of plaintiffs allege that defendants failed to make certain disclosures relating to the mutual funds that are required by the federal securities laws.
In a consolidated decision, the United States District Court for the Southern District of New York (Jones, J.) granted defendants' motions to dismiss plaintiffs' Second Amended Consolidated Complaints. In re Morgan Stanley Tech. Fund Sec. Litig., 643 F. Supp. 2d 366, 369 (S.D.N.Y. 2009). The district court held that plaintiffs' failure to identify unlawful omissions in the mutual funds' registration statements or prospectuses doomed their claims. Id. at 381-82.
In this appeal, plaintiffs argue that the district court erred by rejecting their omissions-based legal theory. However, the Securities and Exchange Commission ("SEC" or "Commission") has appeared before us as an amicus curiae and opined that neither the Securities Act nor Form N-1A required defendants to disclose the information that plaintiffs allege was omitted. The Commission's position is consistent with both its prior interpretations of Form N-1A and the decision below, it is entitled to judicial deference, and we find it persuasive. Moreover, a careful review of plaintiffs' allegations reveals that the true object of their claims is the alleged malfeasance of the mutual funds' affiliated broker-dealer entities and not the public offerings conducted by the funds themselves. We decline to expand liability under sections 11, 12(a)(2), and 15 to require issuers and offering participants to make disclosures regarding affiliates that are not otherwise called for by the securities laws. Therefore, we affirm.
The focus of these class actions is, at least nominally, two open-ended Morgan Stanley mutual funds: defendant Morgan Stanley Information Fund ("Info. Fund") and defendant Morgan Stanley Technology Fund ("Tech. Fund," collectively with the Info. Fund, the "Funds"). Plaintiffs have not disputed the district court's finding that the operative pleadings in these two cases are "virtually identical." In re Morgan Stanley Tech. Fund Sec. Litig., 643 F. Supp. 2d at 369 n.2. We agree with that characterization. The gravamen of both actions is that defendants failed to disclose that the Morgan Stanley broker-dealers affiliated with the Funds suffered from internal conflicts of interest, and, because the Funds' managers relied on these broker-dealers' stock research, the broker-dealers' conflicts increased the risk to investors associated with purchasing shares of the Funds.
The lead plaintiffs in both actions purchased the Funds' shares during the class periods set forth in their pleadings.*fn3 Each defendant is a commercial entity that played a role in the Morgan Stanley enterprise, and each action bears the title of the mutual fund to which it relates.
Shares of the Info. Fund were publicly traded starting in 1995, and shares of the Tech. Fund were available to investors beginning in September 2000. In order to sell their shares to the public, both Funds registered their securities with the SEC by utilizing Form N-1A to file a series of registration statements and prospectuses (collectively, the "Offering Documents").*fn4 The Info. Fund made four sets of filings between July 1999 and October 2002; the Tech. Fund made two sets of filings between August 2000 and July 2002.*fn5
The Offering Documents indicate that the "Investment Objective" of each Fund was to "seek long-term capital appreciation," which both Funds defined as "selecting securities with the potential to rise in price rather than pay out income." Each Fund disclosed a slightly different strategy for pursuing this objective. The Info. Fund indicated that it would "normally invest at least 65% of its total assets in common stocks and investment grade convertible securities of companies engaged in the communications and information industry located throughout the world." The Tech. Fund stated that it would "normally invest at least 80% of its assets in common stock of companies of any asset size engaged in technology and technology-related industries." The Funds also disclosed, using nearly identical language, that their managers had been granted "considerable leeway" to select both general trading strategies and specific investments for the Funds' portfolios.
The non-Fund defendants are the same in both actions. Defendant Morgan Stanley is a Delaware corporation that functions as a holding company and parent entity for each of the non-Fund defendants. Defendant Morgan Stanley Distributors Inc. ("MS Distributors") served as the principal underwriter for each Fund. Defendant Morgan Stanley Investment Advisors Inc. ("MS Advisors") was the Funds' principal investment manager. MS Advisors subcontracted with defendant Morgan Stanley Investment Management Inc. ("MS Investment") to perform certain asset-management functions for the Funds, such as the purchase and sale of securities for their portfolios.
The final two defendants were Morgan Stanley's primary broker-dealer subsidiaries during the Class Period: Morgan Stanley & Co., Inc. and Morgan Stanley DW Inc. (collectively, "MS&Co."). Each is a registered broker-dealer. Both entities offered a variety of financial services relating to research, institutional and retail brokerage, corporate finance, and investment banking. Plaintiffs allege that, during the Class Period, both entities sold shares of the Funds to the public pursuant to a contract with MS Distributors.
B. Plaintiffs' Allegations
The thrust of plaintiffs' cases is that the Funds' Offering Documents unlawfully omitted certain information relating to the manner in which MS&Co. conducted its operations, and that MS&Co.'s undisclosed conduct increased the risks associated with purchasing shares of the Funds. The central allegations are that defendants failed to disclose: (1) that there were conflicts of interest at MS&Co. that could potentially taint the objectivity of its stock research, and (2) that the Funds nevertheless relied on MS&Co.'s research, as evidenced by the proportion of securities in the Funds' portfolios from companies that were either covered by MS&Co.'s research analysts or being pursued by MS&Co. as potential investment banking clients.
With respect to the conflicts of interest at the Funds' affiliated broker-dealer, plaintiffs assert that MS&Co. intentionally dismantled the "Information Barrier" between its investment banking and research functions during the Class Period, and that defendants unlawfully failed to disclose that fact in the Offering Documents.*fn6 Following this change, MS&Co.'s research analysts received compensation based partially on MS&Co.'s generation of investment banking revenue. The resulting conflicts of interest allegedly led these analysts to disseminate biased research reports that exaggerated the merits of investing in some of the securities issued by MS&Co.'s potential investment banking clients. Such reports, plaintiffs contend, artificially inflated the price of those securities to the detriment of the Funds (and, presumably, all investors using MS&Co.'s research).
In addition to the conflicts of interest arising out of MS&Co.'s compensation system, plaintiffs also allege that "[d]efendants" (without further specification) participated in "schemes" to "have research analysts issue false reports in order to obtain investment banking business" and to "manipulate the price of initial public offerings." With respect to their allegations of IPO manipulation, plaintiffs incorporated into their pleadings the "specific facts" from "the approximately 303 complaints" filed as part of the consolidated Multi-District Litigation Panel action captioned as In re IPO Securities Litigation, No. 21 M.C. 92.
Plaintiffs also incorporated by reference the SEC's allegations in an enforcement action against MS&Co. relating to its lack of an Information Barrier during the Class Period. In 2002, following the close of the Class Period, nine brokerage firms agreed to a $1.4 billion global settlement with the SEC and other regulators relating to improper conflicts of interest that arose from the commingling of research and investment banking functions. See Press Release, Sec. & Exch. Comm'n, SEC, NY Attorney General, NASD, NASAA, NYSE and State Regulators Announce Historic Agreement to Reform Investment Practices; $1.4 Billion Global Settlement Includes Penalties and Funds for Investors, Release No. 2002-179 (Dec. 20, 2002), available http://www.sec.gov/news/press/2002-179.htm.*fn7 As part of the global settlement agreement, the implicated firms were required to "sever the links between research and investment banking" in order to "ensure that stock recommendations are not tainted by efforts to obtain investment banking fees." Id.
As part of the global settlement, the SEC commenced a separate enforcement action against MS&Co., which was filed in the Southern District of New York on April 28, 2003. See Press Release, Sec. & Exch. Comm'n, SEC Sues Morgan Stanley for Research Analyst Conflicts of Interest: Firm to Settle with SEC, NASD, NYSE, NY Attorney General, and State Regulators ("MS&Co. Settlement Release"), Release No. 18,117 (Apr. 28, 2003), available at http://www.sec.gov/litigation/ litreleases/lr18117.htm. In that action, the SEC asserted that, between approximately July 1999 and 2001:
Morgan Stanley engaged in acts and practices that created conflicts of interest for its research analysts with respect to investment banking activities and considerations. . . . As a result, Morgan Stanley research analysts were faced with a conflict of interest between helping generate investment banking business for Morgan Stanley and their responsibilities to publish objective research reports that, if unfavorable to actual or potential banking clients, could prevent Morgan Stanley from winning that banking business. (Compl. ¶ 2, SEC v. Morgan Stanley & Co. Inc., No. 03 Civ. 2948 (S.D.N.Y. Apr. 28, 2003).) MS&Co. consented to the entry of a final judgment in that action, which directed it to separate its investment banking and research functions, disgorge $25 million, pay a $25 million civil penalty, and spend $75 million over five years on independent research consultants for use by retail brokerage customers. (Consent of Morgan Stanley & Co., SEC v. Morgan Stanley & Co. Inc., No. 03 Civ. 2948 (S.D.N.Y. Apr. 2003).)
Against this backdrop of allegations relating to MS&Co., plaintiffs assert that the Funds' reliance on MS&Co.'s research introduced additional investment risks associated with the purchase of the Funds' shares. Specifically, plaintiffs contend that the Funds were aware of the conflicts at MS&Co. because of their status as proprietary mutual funds under the Morgan Stanley umbrella, but that the Funds' managers nevertheless utilized MS&Co.'s research when making investment decisions for the Funds' portfolios. Plaintiffs argue that the Funds should have disclosed that these circumstances led to heightened investment risks, and that the Offering Documents contained "numerous" material omissions relating ...