Post Image
Stalled SLUSA Stab Is Stifled: Northstar Financial Advisors, Inc. vs. Schwab Investments
Posted on Categories Class Actions, Court DecisionsTags , ,

Under FRCP 12(g)(2), a SLUSA preclusion defense may be deemed waived or abandoned, for purposes of pre-answer proceedings, if it is first omitted in a motion to dismiss and, in a later motion, resurrected.

Northstar Financial Advisors, Inc. vs. Schwab Investments, No. 08-CV-04119 (N.D. Cal., 10/5/15).

Up and Down

Investors in Schwab Total Bond Market Fund charge, in this putative class action, that the Fund’s fundamental investment objectives were violated by Defendants (the Fund or Trust, the Trustees and the Advisor). This case, in progress since 2008, has been up and down the appellate ladder. In 2010, the Ninth Circuit foreclosed a private right of action under Section 13 of the Investment Company Act (SLA 2010-39), but in a more recent trip to the Circuit Court, Plaintiffs-Appellants won the right to proceed on contractual and fiduciary grounds (SLA 2015-11).


Plaintiffs have now submitted a Fourth Amended Complaint (FAC) and Defendants have moved to dismiss the case in its entirety. The Court grants the motion to dismiss in part. First, it denies the motion to dismiss the breach of fiduciary duty claims on SLUSA grounds, due to a procedural defect. FRCP 12(g)(2) generally precludes the assertion of a defense in a 12(b)(6) or “pre-answer” motion that was available, but omitted, from an earlier motion to dismiss. The Court applies that waiver ruling broadly, denying SLUSA preclusion at this stage, not only as to the fiduciary claims against all Defendants, but the aiding and abetting of fiduciary breaches as well.

The Trustees

At the same time, the Court agrees with Defendants that no fiduciary duty exists between the shareholders and the Trust. The Ninth Circuit only declared the existence of a duty as to the Trustees, as managers of the Trust (the Trust is an amalgam of some 94 mutual funds, including the Fund). Plaintiffs’ claims against the Trustees are not time-barred, either, as the three-year statute accrues not at the time of the alleged breach, but at the time Plaintiffs had knowledge of the breach. Defendants have not convinced the Court that actual knowledge occurred outside the three-year limitations period.

The Adviser

The Court also finds the existence of a fiduciary duty between the shareholders and the Advisor. That the Advisor’s duties are contractual in nature does not preclude a fiduciary breach, in addition to a contractual breach. “[P]arties may ‘proceed with a claim for breach of fiduciary duty in situations where a contract did not entirely govern the parties’ rights and duties or where the contract was breached.’” The shareholders are third-party beneficiaries of the Trustees’ agreement with the Advisor (“the IAA”) and the IAA makes clear that the shareholders are the “ultimate” beneficiaries on whose behalf the Advisor serves. The FAC also supplies sufficient detail for the claims that allege aiding and abetting of a fiduciary breach by the Advisor and the Trustees to stand.

Contract Claims

Finally, there are the third-party beneficiary claims regarding contractual breaches. Defendants did assert a SLUSA preclusion defense in the earlier proceedings, so waiver does not apply, as it did to the direct fiduciary claims. While Northstar claims to have removed any allegation concerning misrepresentations, the Court finds some. It summarizes: “the material misrepresentation and material omission requirements form two sides of the same coin in this case. The Advisor stated that the Advisor would do one thing, but ended up doing another.” It either misrepresented or failed to disclose. “SLUSA preclusion applies to both scenarios,” the Court affirms, and dismisses those counts against the Advisor and the Trust.

(ed: *One of the more interesting facets of this litigation is that the lead plaintiff, an RIA and financial planner representing both institutional and individual clients, traded through Schwab’s Institutional Adviser Platform and purchased the Fund shares for its client through that Platform. Apparently, NFAI did not own Fund shares itself and the First Complaint was dismissed on that basis. NFAI gained standing to represent its clients in this action through an assignment of rights and that approach passed muster with the Ninth Circuit on appeal. **Query whether NFAI would have been able to enforce such an assignment, had it been subject to a pre-dispute arbitration agreement with Schwab. ***The Ninth Circuit’s end-run around the traditional derivative vehicle by recognizing as actionable state law claims against a mutual fund and its adviser moves to the forefront the issue of whether mutual funds and their investment advisers can utilize class action waivers to frustrate representative shareholder actions. So far, we have not seen a registered entity try that maneuver. ****The Court indicates that Schwab has filed a petition for a writ of certiorari seeking review of the Ninth Circuit’s latest decision. SCOTUS denied that petition immediately after this decision issued. *****While some claims have survived, the FAC is in tatters. The Court’s SLUSA ruling as to the third-party beneficiary claims presages the ultimate SLUSA preclusion of all claims. If that happens, the “end-run” by the Ninth Circuit may not have altered the playing field much after all.)

(SLC Ref. No. 2016-02-05)

NOTICE: The court decision synopsis published above represents an abbreviated description of the actual decision and is re-printed here for its educational value. The author's effort is to report concisely the substance of the decision or a selected portion of the decision; commentary or analysis is generally reserved for the italicized section at the bottom of the summary. Subscribers to SAC's Online Litigation Alert (SOLA)from which this synopsis is excerpted, have immediate access to the full decision, in addition to the synopsis.

Like what you see here?

Twice a week we present blog posts consisting of one write-up from each of our two flagship weekly online Alert services. Consider a subscription to these publications to receive the full array of coverage right on your desktop every week. Give it a try and sign up for a free trial to the Securities Arbitration Alert and the Securities Litigation Alert.