Tuesday, January 06, 2015

High Court Asked to Find ’40 Act Breach of Duty, Private Right of Action

[This story previously appeared in Securities Regulation Daily.]

By Amy Leisinger, J.D.

Two pension funds have petitioned the Supreme Court to determine whether an investment adviser may avoid liability under Investment Company Act Section 36(b) for overcompensation by conducting securities-lending activities through an affiliate and whether fund investors have a private right of action against the fund’s investment adviser, as well as the fund directors, for violations of Section 36(a). Specifically, the petitioners ask the court resolve the circuit split created by the Sixth Circuit in determining that Section 36(b) will not support an action when an adviser structures transactions through an affiliate and refusing to find an implied private right of action under Section 36(a) (Laborers’ Local 265 Pension Fund v. iShares Trust, December 29, 2014).

Background. Two pension funds were shareholders in exchange-traded funds issued by iShares, Inc. and iShares Trust (iShares), whose revenue came largely from lending its securities holdings to various borrowers. BlackRock Fund Advisors (BFA) managed and advised the iShares funds with respect to their investment activities, and BlackRock Institutional Trust Company, N.A. (BTC), the corporate parent of BFA, provided securities-lending services to the iShares investment companies and other funds. BTC received a 35-percent fee of all securities-lending net revenue, and BFA managed the funds’ portfolio for a separate, additional fee.

The shareholders’ filed a complaint against iShares, BFA, and BTC, contending that BTC and BFA violated Sections 36(a) and (b) by charging an excessive lending fee that bore no relationship to the actual services rendered. The district court dismissed the action (covered in the Securities Regulation Daily Wrap Up for August 29, 2013) based on the defendants’ arguments that the Section 36(b) claim was barred by the language of the section in relation to a previous SEC exemption order and that Section 36(a) does not provide for an implied private right of action.

On appeal to the Sixth Circuit, the shareholders contended that Section 36(b) permitted a lawsuit against BFA for excessive compensation despite the SEC’s approval of the operations and that BTC’s 35-percent fee should be aggregated with BFA’s separate advisory fee to show excessiveness. The appellate court disagreed, finding that the shareholders forfeited their “aggregation argument” because they did not object to the advisory fee and, in any case, the two fees were for entirely different services (see the Securities Regulation Daily Wrap Up for September 30, 2014). If the fees for each service viewed separately were not excessive for the particular service rendered, then the two fees combined were also permissible, the court reasoned. In considering the shareholders’ arguments in support of a private right of action under Section 36(b), the appellate court concluded that the text of Section 36(a) does not contain any “rights-creating language” and, instead, focuses on the “person(s) regulated rather than on the individuals protected.”

Cert petition. By its decision, the petitioners state, the Sixth Circuit has exacerbated an existing circuit split by refusing to recognize an implied private right of action under Section 36(a). Several circuits have found implied rights of action under the Act and reiterated this position in later actions, and the Court should step in to resolve the division, according to the petitioners.

In addition, the petitioners contend that the Sixth Circuit created a circuit split regarding the correct interpretation of Section 36(b). According to the petitioners, the Sixth Circuit’s dismissal based on BlackRock’s use of an affiliated securities-lending agent and Section 36(b)(4)’s notation that the subsection does not apply to payments made in connection with affiliate transactions subject to Section 17 conflicts with the First Circuit’s interpretation of these provisions as mutually exclusive. The First Circuit has held that overcompensation of an adviser’s affiliate is actionable by individual investors unless actionable under Section 17, the petitioners stress, and, in the form of releases, the SEC has provided support for the proposition that overcompensation of an adviser-affiliate remains actionable against an adviser under Section 36(b). By its determination, the petitioners explain, the Sixth Circuit has provided undue protection for overcompensation received by the structuring actions through affiliates.

“The overcompensation of BlackRock’s investment advisers and their affiliates through BlackRock’s short-sale operation is exactly the problem the Congress intended to remedy,” the petitioners emphasize.

The case is No. 14-771.

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