Addressing an interlocutory appeal of Northstar Financial Advisors v. Schwab Investments, 609 F. Supp. 2d 938 (N.D. Cal. 2009), the U.S. Court of Appeals for the Ninth Circuit (the “Court”) held that the SEC alone may enforce Section 13(a) of the Investment Company Act of 1940 (the “1940 Act”). The Ninth Circuit’s decision reverses a decision by the District Court for the Northern District of California (the “District Court”), which held that, on the basis of changes to Section 13 made by Sudan Accountability and Divestment Act of 2007 (the “SADA”), there is a private right of action to enforce Section 13(a) of the 1940 Act. The suit alleged that a bond index fund had violated Section 13(a) of the 1940 Act by (a) improperly changing its concentration policy of investing no more than 25% in any industry so that the fund could invest more than 25% of its total assets in US agency and non-agency mortgage-backed securities and (b) failing to follow its investment objective of tracking a specified broad bond market index by investing in high-risk, non-US agency collateralized mortgage obligations that were not included in the index. In relevant part, Section 13(a) of the 1940 Act prohibits a registered investment company from deviating from certain investment policies absent shareholder approval. Among the policies subject to this condition, which are generally referred to as fundamental policies, are a registered investment company’s concentration policy and any policy designated in its prospectus as fundamental in its registration statement filed with the SEC, which in the bond index fund’s case included its investment objective. (The District Court decision was discussed in greater detail in the March 10, 2009 Alert.)
The Court reached its decision based on an analysis of the language and structure of the 1940 Act and the 1970 and 2007 amendments to the 1940 Act. In reaching its holding, the Court of Appeals stated that it agrees with the U.S. Court of Appeals for the Second Circuit that the structure of the 1940 Act does not indicate that Congress intended to create an implied private right to enforce the individual provisions of the 1940 Act, citing the Second Circuit’s decisions in Bellikoff v. Eaton Vance Corp., 481 F.3d 110 (2d Cir. 2007) (per curiam) and Olmsted v. Pruco Life Ins. Co. of New Jersey, 283F.3d 429 (2d Cir. 2002). The Court also noted Congress’ enactment of the Comprehensive Iran Sanctions, Accountability and Divestment Act of 2010 (the “Iran Sanctions Act”), which added a rule of construction to Section 13(c) of the 1940 Act clarifying that the text of Section 13(c) (which was added to the 1940 Act by the SADA) does not imply or create a private right of action under Section 13(a) of the Act. (The Iran Sanctions Act was discussed in greater detail in the July 13, 2010 Alert). The District Court’s reasoning in holding that there is an implied private right of action under Section 13(a) relied on the addition of Section 13(c) to the 1940 Act by the SADA.
The Court remanded the case to the District Court with instructions to dismiss the plaintiff’s federal law claims.