ORDERED that the defendants' motion to dismiss the complaint is
granted; and it is further
ORDERED that the Report and Recommendation of the United States
Magistrate Judge is adopted and incorporated as the Opinion of this
REPORT AND RECOMMENDATION
HEDGES, United States Magistrate Judge.
This matter comes before me on defendants' motion to dismiss the
Amended Complaint pursuant to Rule 12(b)(6) for failure to state a claim
upon which relief may be granted. The motion was referred to me by Judge
Hayden. I have considered the papers submitted in support of and in
opposition to the motion. There was no oral argument. Rule 78.
STATEMENT OF FACTS
Plaintiff, a shareholder of the Prudential Jennison Growth Fund (the
"Fund"), brought this action pursuant to Section 36(b) of the Investment
Company Act of 1940, as amended (the "ICA"), 15 U.S.C. § 80a-35(b).
The Fund is a registered "investment company" within the meaning of the
ICA. The defendants are Prudential Investments Fund Management LLC, the
investment adviser to the Fund (the "Adviser"), and Prudential Investment
Management Services LLC, the Fund's principal underwriter (the
"Distributor"). The Distributor is a Delaware limited liability company
and an affiliate of the Adviser. The Adviser's principal offices are
located in Newark, New Jersey.
The original Complaint was filed on August 7, 1998. Defendants moved to
dismiss on October 23, 1998. In response, plaintiff filed an Amended
Complaint on December 10, 1998. The Amended Complaint contains a single
claim for relief under Section 36(b) of the ICA, 15 U.S.C. § 80a-35(b).
ICA Section 36(b) provides that an investment adviser has "a fiduciary
duty with respect of the receipt of compensation. . . ."
15 U.S.C. § 80a-35(b). Section 36(b) also provides for a private
cause of action by a shareholder against the investment adviser and
principal underwriter "for breach of fiduciary duty in respect of . . .
compensation" paid by a fund. 15 U.S.C. § 80a-35(b). The Amended
Complaint seeks to recover all of the fees paid by the Fund to its
investment Adviser and Distributor pursuant to management and
distribution agreements (the "Agreements"), which were allegedly entered
into in violation of Section 15(c), of the ICA, 15 U.S.C. § 80a-15(c).
Section 10(a) of the ICA, 15 U.S.C. § 80a-10(a), mandates that at
least 40% of the members of the governing board of every registered
investment company not be "interested persons," i.e., they must be
independent to the investment adviser. Such directors are generally
referred to as independent directors. Section 15(c),
15 U.S.C. § 80a-15(c), further mandates that every agreement with an
investment adviser or distributor be approved by a majority of the
The Amended Complaint alleges that none of the members of the Fund
board are independent, as required by ICA Section 10(a),
15 U.S.C. § 80a-10(a). As a result, plaintiff contends, the
Agreements could not be properly approved as required by ICA Section
15(c), 15 U.S.C. § 80a-15(c). Consequently, by reason of their
receipt of funds from invalid Agreements, defendants have breached their
fiduciary duty to negotiate at arm's-length. 15 U.S.C. § 80a-35(b).
Accordingly, plaintiff seeks judgement: (1) declaring that defendant
violated Sections 10(a), 15(c), and 36(b) of the ICA and that the
Agreements are void; (2) awarding damages against defendants, including
return of all fees paid to it by each of the Funds as well as related
relief; and (3) providing any other relief deemed just and proper.
Specifically, the Complaint alleges that the Fund's board of directors
consists of 11 members, three of whom are admittedly interested by reason
of their employment.
The remaining eight directors are not employed by the Adviser, but serve
on multiple boards of the funds managed by the Adviser or its affiliates
(the "Fund Complex") and receive substantial compensation therefrom (as
high as $135,000). Some also accrued substantial deferred compensation
(as high as $143,909). As a result, 40% of the Fund's board is not
disinterested, as required by ICA Section 10(a), 15 U.S.C. § 80a-10(a),
and approval of the Fund's agreements with defendants violated Section
15(c), 15 U.S.C. § 80a-15(c). Such failure to negotiate at arm's
length violates Section 36(b), 15 U.S.C. § 80a-35(b).
Plaintiff also alleges that in addition to violating Section 36(b) by
virtue of subverting the independence requirement, the defendants
violated Section 36(b) because their adviser-manager's fee were so
disproportionately large that it amounted to a breach of fiduciary duty
in violation of § 36(b). Gartenberg v. Merrill Lynch Asset
Management, Inc., 694 F.2d 923, 930 (2d Cir. 1982), cert. denied,
461 U.S. 906, 103 S.Ct. 1877, 76 L.Ed.2d 808(1983). In this respect, the
Amended Complaint describes the widespread criticism of fees paid by
mutual funds to their advisers and the advisers' affiliates. These
criticisms have been leveled by the Chairman of the SEC, industry
analysts, and industry insiders.
Defendants contend that: (1) plaintiff lacks standing since he has
failed to allege damages in accordance with Article III of the
Constitution, (2) Section 36(b) is limited to actions alleging excessive
compensation and the pleadings as now written are insufficiently
particular with respect those allegations, and (3) the Fund's directors
are disinterested as a matter of law.
Plaintiff argues that: (1) plaintiff has standing since he is a
stockholder of the Fund and nothing else is required, (2) Section 36(b)
is not limited to actions alleging excessive fees and even if Section
36(b) can be deemed so limited, the Amended Complaint adequately alleges
excessive fees; and (3) they so dominated the Fund's board of directors
that less than 40% of the board could be deemed "disinterested."
Plaintiff also argues that there are additional "facts" that he can add
to the Amended Complaint as now written.
When reviewing a motion to dismiss under Rule 12(b)(6), all material
allegations of the complaint are accepted as true the complaint must be
construed in favor of the plaintiff. Warth v. Seldin, 422 U.S. 490, 501,
95 S.Ct. 2197, 45 L.Ed.2d 343(1975). A complaint should be dismissed only
if, after accepting as true all of the facts alleged in the complaint,
and drawing all reasonable inferences in the plaintiffs favor, no relief
could be granted under any set of facts consistent with the allegations
of the complaint. ALA, Inc. v. CCAIR, Inc., 29 F.3d 855, 859 (3d Cir.
1994). A court should allow a plaintiff to amend a complaint instead of
dismissing it where "a more carefully drafted complaint might state a
claim upon which relief could be granted." Green v. Fund Asset
Management, L.P., 19 F. Supp.2d 227, 230 (D.N.J. 1998) (quoting
Friedlander v. Nims, 755 F.2d 810, 813 (11th Cir. 1985)).
The Amended Complaint fails to allege that the independent directors are
"interested persons" under the ICA.
Claims brought under the ICA are particularly appropriate for dismissal
for failure to state a claim under Rule 12(b)(6). As one court recently
observed: "[T]he law in this area imposes a large number of threshold
determinations before litigation on the merits of a case may commence.
The common law and the ICA explicitly and implicitly regulate who may
bring a claim and upon what grounds." Olesh v. Dreyfus Corp., 1995 WL
500491, at *11 (E.D.N.Y. Aug. 8, 1995). The Amended Complaint fails to
meet the required "threshold" determinations.
Under the ICA, at least 40% of a mutual fund's board of directors must
i.e., not "interested" in the fund's investment adviser.
15 U.S.C. § 80a-10(a). The ICA defines an "interested person" to mean
one of six enumerated categories, 15 U.S.C. § 80a-2(a)(19), including
any "affiliated person" of the investment adviser.
15 U.S.C. § 80a-2(a)(19)(b)(I). An "affiliated person", in turn, is
defined to include a person or entity "controlled by" another person.
15 U.S.C. § 80a-2(a)(3). The ICA defines "control" as "the power to
exercise a controlling influence over the management or policies of a
company." 15 U.S.C. § 80a-2(a)(9).
Plaintiff's burden to plead facts that state a claim, rather than mere
legal conclusions, is heightened here by the statutory presumption
against his claim. As set forth in defendants' moving brief, the ICA
expressly provides that "[a] natural person shall be presumed not to be a
controlled person within the meaning of [the Act]."
15 U.S.C. § 80a-2(a)(9) (emphasis added). "The burden of overturning
the presumption against control of a natural person is not one that will
be lightly assumed or easily carried to success." Acampora v. Birkland,
220 F. Supp. 527, 543 (D.Colo. 1963) (quoting In the Matter of
Fundamental Investors, Inc., Investment Co.Act. Rel. # 3596).
Rule 8 of the Federal Rules of Civil Procedure further requires that in
a pleading, "facts must be stated, rather than legal conclusions
unsupported by facts,. . . ." Charles A. Wright & Arthur R. Miller,
Federal Practice and Procedure; § 1216 at 152 (2d ed 1990). A
complaint's "bald assertions" or "legal conclusions" do not need to be
credited when deciding a motion to dismiss. Morse v. Lower Merion School
District, 132 F.3d 902, 906 (3d Cir. 1997).
With the presumption that the non-employee directors are not
"controlled" and Rule 8's prohibition against pleading legal
conclusions, in mind, does the Amended Complaint allege adequate facts? A
careful review reveals that it is almost completely devoid of
allegations, conclusory or otherwise, that the directors are in fact
controlled by any defendant. Plaintiff charges that the independent
directors of the Fund are controlled by Prudential — and therefore
"interested" — solely because they serve on multiple funds managed
by Prudential, for which they receive between $1,000 and $7,500 per
fund, for aggregate compensation ranging between $45,000 and $135,000 per
year. Paragraph 28 sets forth a table of the compensation received by
each of the non-employee directors. The table is supplemented by
The excessive number of boards upon which the Fund's
directors serve and concomitant assembly-line,
truncated board meetings, effectively prevents them
from being able to fulfill their statutory role as
watchdogs for the public investors. Rather, the Fund's
board is effectively controlled by the Adviser and its
affiliates and merely rubber-stamps proposals of
defendants. As a result, each of the directors is an
`interested person' within the meaning of ICA Sections
2(a)(3), 2(a)(19)(A)(I), and 2(a)(19)(B)(I).
These conclusory assertions are not supported by any other allegation.
The Amended Complaint does not allege a single instance where defendants'
alleged "truncated board meeting" invoked a course of action which
prejudiced the shareholders of the funds and should have been resisted by
the independent directors. Nor is a single instance alleged in which a
proposal was "rubber-stamped" without an informed decision.
The only factual allegation plaintiff does include in the Amended
Complaint — that the Fund's directors serve on boards of multiple
funds for which they receive significant compensation — fails to
state a claim for relief. Courts have unanimously held so. In Verkouteren
v. Blackrock Fin. Management, Inc., 37 F. Supp.2d 256 (S.D.N.Y. 1999),
the court dismissed a complaint filed by the same firm that represents
plaintiff here and which was virtually identical to the complaint filed in
action. In Verkouteren, the plaintiff alleged that the defendants
violated Section 36(b) because the investment advisory contracts were
approved by directors who sat on over twenty fund boards for which they
received between $140,000 and $160,000 in aggregate compensation. The
court concluded that plaintiffs bare allegation that the directors served
on multiple boards for substantial compensation was insufficient to plead
domination. Verkouteren, at 260-61.
In Migdal v. Rowe Price-Fleming, No. AMD-98-2162, 1999 WL 104795,
slip. op. (D.Md. Jan. 20, 1999), the court held that plaintiffs complaint
— again, drafted by plaintiffs counsel here and nearly identical to
the complaint here — failed to state a claim under Section 36(b).
Similarly, in Strougo v. BEA Associates, No. 98 Civ. 3725, 1999 WL 147737
(S.D.N.Y. March 18, 1999), Judge Sweet dismissed another complaint filed
by plaintiff's counsel here for failure to state a claim pursuant to Rule
Yet another opinion, in Olesh v. Dreyfus Corp., 1995 WL 500491
(E.D.N.Y. Aug. 8, 1995), dismissed a complaint at the pleading stage
which alleged that service on multiple boards for substantial
compensation rendered directors "controlled" under Section 2(a)(9) of the
ICA. The plaintiffs alleged that the directors of the Dreyfus funds were
"interested" under the ICA solely because (I) they sat on boards of over
fifteen Dreyfus funds and (ii) received over $50,000 annually in
compensation for their services. Id. at *11. The court held that these
allegations failed to plead facts sufficient to demonstrate that
directors were "controlled" under § 2(a)(19) and § 2(a)(9)*fn1.
Id. at *16. The court ruled that the plaintiffs were required to present
evidence establishing "actual domination and operation." Id. Mere
influence would fall short of this level of proof.
The ICA's legislative history confirms that Congress did not intend for
multiple board membership, standing alone, to compromise a director's
independence. H.R.Rep. No. 91-1382 (Aug. 7, 1970) at 15; S.Rep. No.
910184 (May 21, 1969) reprinted in 1970 U.S.C.C.A.N. 4897, 4929. In view
of the legislative history, the statutory presumption and the prohibition
against pleading legal conclusions, plaintiff's general allegations that
the Fund's outside directors are "controlled" by Prudential are
inadequate. See Olesh, 1995 WL 500491, at *16.*fn2
Plaintiff fails to plead facts demonstrating that the fund paid excessive
fees in violation of Section 36(b).
Plaintiff contends that he need not allege that the Fund paid
Prudential "excessive" fees to state a claim under 36(b),
15 U.S.C. § 80a-35(b), citing Green, et al. v. Fund Asset
Management, L.P., at al., 19 F. Supp.2d 227, 234-35 (D.N.J. 1998).
Defendants maintain that plaintiff must allege that the compensation
which has actually been paid to them was excessive or disproportionate.
They note that the Second Circuit Court of Appeals has held that a
plaintiff must establish that an advisory fee is "so disproportionately
large that it bears no reasonable relationship to the services rendered
and could not have been the product of arm's length bargaining" in order
to prevail under Section 36(b). Gartenberg, supra, 694 F.2d at 928; see
Krinsk v. Fund Asset Management, Inc., 875 F.2d 404 (2d Cir. 1989).
Plaintiff argues that Section 36(h) has not been "amended" by the
Second Circuit in Gartenberg by limiting it to actions alleging excessive
fees and that, even if Section 36(b) can be deemed so limited, the
Amended Complaint adequately alleges
excessive fees. Plaintiff cites Green, in which Judge Debevoise stated:
Section 36(b) of the ICA is not expressly limited to
situations in which the advisory fees received by an
investment adviser were excessive disproportionate or
otherwise unreasonable. The statute encompasses the
receipt of fees by an investment adviser in violation
of the adviser's fiduciary duty, as it provides that
`[n]o action shall be brought or maintained against
any person other than the recipient of such
compensation or payments.' 15 U.S.C.A. §
80a-35(3). [19 F. Supp.2d at 234-35].
Judge Debevoise explained that when fees are collected in breach of
fiduciary duty in violation of Section 36(b), "[i]t would flow that such
fees were excessive and recoverable to the extent permitted under that
Section." Id. at 235*fn3. See also Green v. Nuveen Advisory Corp., 186
F.R.D. 486, 490 (N.D.Ill. 1999) ("holding that compensation received
while acting in breach of fiduciary duty violates" Section 36(b)).
I agree that receipt of compensation while breaching a fiduciary duty
violates Section 36(b), 15 U.S.C. § 80a-35(b). Plaintiff argues that
since none of the members of the Fund board are independent, their
Agreements could not be properly approved as required by ICA Section
15(c), 15 U.S.C. § 80a-15(c). Hence, receipt of funds from invalid
Agreements breaches their fiduciary duty of ICA Section 36(b),
15 U.S.C. § 80a-35(b). However, the Amended Complaint does not
sufficiently allege that the non-employee directors were "interested."
Plaintiff's conclusion that a fiduciary breach necessarily flows from the
invalid Agreements must therefore fail.
Plaintiff's second argument, that the Amended Complaint adequately
alleges excessive fees, is also without merit. In Krinsk, the court noted
six factors to be considered when determining whether fees are
"excessively" large. Krinsk, supra, 875 F.2d at 409. Those are the nature
and quality of the service, the extent to which economies of scale are
realized, the performance of the fund, the fees charged by other
advisers, and the independence and conscientiousness of the trustees.
Id. (citing Gartenberg, supra, 694 F.2d at 929-30). The Amended Complaint
only addresses the last factor (the mooted "independence" factor).
As pleaded, the Amended Complaint fails to allege how the fees were
excessive in light of the factors articulated in Krinsk. Krinsk, 875 F.2d
at 409. It simply characterizes all the fees as "excessive, " without
pleading any facts that, if true, would demonstrate that the fee is "so
disproportionately large that it bears no reasonable relationship to the
services rendered." Id.
Defendant also alleges that plaintiff lacks standing since he has
failed to allege damages in accordance with Article III. Plaintiff argues
that he meets the standing requirements of Section 36(b) because he is a
stockholder of the Fund and nothing else is required. However, in the
context of the ICA, plaintiff must allege enough facts to show that the
violations caused some sort of damages. Seidel v. Lee, 954 F. Supp. 810,
818 (D.Del. 1996). Plaintiff's argument that simply owning shares of the
Fund confers standing upon himself, fails to grasp the distinction
between statutory standing and constitutional standing. Satisfying the
Article III "case or controversy" requirement is the irreducible
constitutional minimum of standing. Lujan v. Defenders of Wildlife,
504 U.S. 555, 560, 112 S.Ct. 2130, 119 L.Ed.2d 351(1992).
In the context of this case, a properly pleaded Amended Complaint would
allege facts sufficient to establish injury. By
definition, a violation of Section 36(b) encompasses excessive payments
to the fund's advisers. These payments belong to the plaintiff via the
Fund. As such, damages would be implicit in a properly pleaded Amended
Complaint. However, plaintiff here has failed to properly plead his
Amended Complaint, and, as such, the complaint should be dismissed.
For the reasons set forth above, I recommend that plaintiff's Amended
Complaint be dismissed. June 10, 1999.