Alert April 24, 2012

Third Circuit Affirms Dismissal of Excessive Fee Claims Under the Investment Company Act Because Plaintiffs Lacked Continuous Ownership in the Funds and No Private Right of Action Exists Under Section 47(b)

The Third Circuit affirmed a decision by the United States District Court for the District of New Jersey that dismissed claims by participants in retirement plans, alleging that an insurance company and its affiliates charged the retirement plans excessive fees on annuity insurance contracts offered to plan participants in violation of Sections 36(b) and 47(b) of the Investment Company Act of 1940 ("ICA").

Section 36(b). The District Court dismissed the Section 36(b) claim because plaintiffs no longer owned any interest in the funds at issue. The Third Circuit agreed that continuous ownership of securities in the funds in question during the pendency of the litigation is required for a Section 36(b) action. It noted that Section 36(b) actions are similar to derivative actions in that they are brought on behalf of the fund, and any recovery obtained goes to the fund. The statute also plainly requires a plaintiff to be a security holder in the fund at the time the action is initiated.  The Third Circuit thus held that “[i]mposing a continuous ownership requirement throughout the pendency of the litigation assures that the plaintiff will adequately represent the interests of the security holders in obtaining a recovery for the benefit” of the fund.  Since plaintiffs no longer owned the funds, “they lack any real interest in securing a recovery.”

Section 47(b). The District Court also had dismissed plaintiffs’ claim under ICA Section 47(b), which states that a contract made or whose performance involves a violation of the ICA is unenforceable.  Plaintiffs argued that their claim was not based on a violation of Section 36(b), but instead on ICA Section 26(f), which required the fees at issue to be reasonable in relation to the services rendered, the expenses expected to be incurred, and the risks assumed by the insurance company.  While plaintiffs acknowledged that Section 26(f) does not establish a private right of action, they asserted that Section 47(b) creates such a right because the United States Supreme Court in Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11 (1979), found a private right under a similar provision in the Investment Advisers Act (“IAA”), Section 215.  The Third Circuit disagreed, noting that while the IAA does not expressly provide for any private cause of action, Congress intended for Section 36(b) to be the “exclusive” private right of action in the ICA.  The Third Circuit further pointed out differences in the language of IAA Section 215, which renders contracts void if they violate the IAA, and ICA Section 47(b) which merely makes the contract “unenforceable” and carries no such legal implications, thus creating a remedy rather than a distinct cause of action.

ERISA.  The District Court also had dismissed plaintiffs’ claims under Sections 502(a)(2) and 502(a)(3) of ERISA, finding that plaintiffs’ theories of liability were derivative and that plaintiffs did not make the required pre-lawsuit demand on the plan’s trustees or join them in the lawsuit.  The Third Circuit disagreed and vacated dismissal of the ERISA claims, finding that ERISA’s language, legislative history and structure did not require pre-suit demand or mandatory joinder of trustees for ERISA Section 502(a)(2) and 502(a)(3) claims.

Santomenno v. John Hancock Life Insurance Company (U.S.A.), et al., No. 11-2520 (3rd Cir. Apr. 16, 2012).

Goodwin Procter LLP represented the defendants in Santomenno.