United States District Court, W.D. Pennsylvania
September 28, 2005.
In re DREYFUS MUTUAL FUNDS FEE LITIGATION.
The opinion of the court was delivered by: GARY LANCASTER, District Judge
This is a putative class action in securities fraud.
Plaintiffs, Vera A. Hays and Noah Wortman, allege that
defendants, investment advisors, distributors, and directors of
Dreyfus brand mutual funds, engaged in fraudulent fee arrangement
schemes in violation of the Investment Company Act, the
Investment Advisors Act, and Pennsylvania statutory and common
law. Plaintiff seeks to recover the wrongfully charged fees and
rescind the fee agreements under which these payments were made.
Defendants have filed various motions to dismiss in which they
argue that plaintiffs' complaint is legally and factually
For the reasons set forth below, the motions will be disposed
of as follows:
Premier's Motion to Dismiss [doc. no. 22] is granted;
Director Defendants' Motion to Dismiss [doc. no. 25]
is granted; Parent Companies', Dreyfus Service Corporation's, and
Investment Advisor Defendants' Motion to Dismiss [doc. no. 29] is
granted, in part, and denied, in part;*fn1
Nominal Defendant's Motion to Dismiss [doc. no. 33] is granted.
A. The Parties
Two named plaintiffs bring this putative class action suit:
plaintiff Hays, an investor in the Dreyfus Disciplined Stock
Fund, and plaintiff Wortman, an investor in the Dreyfus (Basic)
S&P 500 Stock Index Fund. Plaintiffs allege that they hold their
shares currently, and that they also held them at some point
between January 30, 1999 and November 17, 2003, the proposed
Plaintiffs have named five groups of defendants in their
complaint: The Parent Companies, The Investment Advisors, The
Distributors, The Directors, and The Dreyfus Funds. The Parent
Companies are Mellon Financial and its wholly-owned subsidiary
Mellon Bank, which acts as custodian of the Dreyfus Funds. The
Investment Advisor Defendants are Dreyfus, a wholly-owned
subsidiary of Mellon Bank, and Founders Asset Management LLC. Both are mutual fund management companies and have responsibility
for overseeing the day-to-day management of the Dreyfus Funds.
The Distributor Defendants are Dreyfus Service Corporation, a
wholly-owned subsidiary of Dreyfus, and Premier Mutual Fund
Services.*fn2 The Director Defendants are nine individuals
who acted as directors of some of the Dreyfus Funds, and in some
instances of related entities, such as Mellon Bank. The Dreyfus
Funds, named as nominal defendants, are approximately 155 mutual
funds that are managed by Dreyfus or Founders.
B. The Factual Allegations
Plaintiffs allege the following facts. In the most general
terms, plaintiffs allege that defendants participated in an
undisclosed mutual fund kick-back scheme through which they
obtained substantial payments as a result of pushing Dreyfus
Funds on unwitting investors. According to plaintiffs, the
alleged scheme took the form of Shelf-Space agreements with major
brokerage houses, financed with wrongful Directed Brokerage and
Revenue Sharing arrangements, and improper use of 12b-1 Marketing
Fees and Soft Dollars. Plaintiffs allege that substantial improper payments were made from mutual fund assets to ensure
that major brokerage houses, such as Paine Webber and Merrill
Lynch, would encourage their investors to buy Dreyfus brand
mutual funds, rather than some other brand of mutual
Plaintiffs complain that these arrangements were not disclosed
to investors, created conflicts of interest between investors and
defendants, and resulted in excessive fees being charged to
investors' accounts. According to plaintiffs, because the
Distributor and Investment Advisor Defendants' fees were
calculated based on the aggregate amount of money invested in
Dreyfus products, they participated in these kick-back schemes in
order to increase their own fees, without regard to the best
interest of the investors, whom they were charged with
protecting. In turn, plaintiffs allege that the Investment
Advisor Defendants paid the Director Defendants excessive
salaries in exchange for their approval of these wrongful
schemes, making the Directors beholden to the Investment Advisors
and their schemes, rather than to the best interest of the
investors. C. The Complaint
The consolidated amended complaint [doc. no. 17] asserts causes
of action under the Investment Company Act of 1940,
15 U.S.C. § 80a-1, the Investment Advisers Act of 1940, 15 U.S.C. § 80b-1,
and Pennsylvania statutory and common law. With the exception of
the IAA claim, which is asserted derivatively, all causes of
action are brought on behalf of the proposed Class.
Count I. Asserted against the Investment Advisor Defendants
and the Director Defendants for violations of § 34(b) of the
Investment Company Act. Plaintiffs allege that these defendants
made materially false and misleading statements in prospectuses
by failing to disclose the payment schemes detailed above.
Count II. Asserted against the Distributor Defendants, the
Investment Advisor Defendants, and the Director Defendants for
violations of § 36(a) of the Investment Company Act. Plaintiffs
allege that these defendants breached their fiduciary duties to
investors by taking part in the payment schemes detailed above.
Count III. Asserted against the Distributor Defendants, the
Investment Advisor Defendants, and the Director Defendants for
violations of § 36(b) of the Investment Company Act. Plaintiffs
allege that these defendants breached their fiduciary duties with
respect to the receipt of compensation for services by taking
part in the payment schemes detailed above. Count IV. Asserted against Dreyfus and the Parent Companies
for violations of § 48(a) of the Investment Company Act.
Plaintiffs allege that these defendants, as "control persons",
are secondarily liable for the misconduct of the Investment
Advisor Defendants and Distributor Defendants alleged in Counts
I, II, and III.
Count V. Asserted against the Investment Advisor Defendants
for violations of §§ 206 and 215 of the Investment Advisor Act.
Plaintiffs' allege that these defendants breached their fiduciary
duties by entering into investment advisor contracts which
permitted improper payments under the above schemes.
Count VI. Asserted against all defendants for violations of
the Pennsylvania Unfair Trade Practices and Consumer Protection
Law, 73 Pa. Cons. Stat. § 201-9.2(a). Plaintiffs have
affirmatively abandoned this claim.
Count VII. Asserted against the Investment Advisor Defendants
for breach of fiduciary duty under Pennsylvania common law.
Count VIII. Asserted against the Director Defendants for
breach of fiduciary duty under Pennsylvania common law.
Count IX. Asserted against all defendants for aiding and
abetting breach of fiduciary duty under Pennsylvania common law. Count X. Asserted against all defendants for unjust
enrichment under Pennsylvania common law. Plaintiffs assert that
defendants received wrongful sums as a result of their
participation in the payment schemes.
II. STANDARD OF REVIEW
When the court considers a Rule 12(b)(6) motion to
dismiss,*fn4 the issue is not whether plaintiff will prevail
in the end or whether recovery appears to be unlikely or even
remote. The issue is limited to whether, when viewed in the light
most favorable to plaintiff, and with all well-pleaded factual
allegations taken as true, the complaint states any valid claim
for relief. See ALA, Inc. v. CCAIR, Inc., 29 F.3d 855, 859
(3d Cir. 1994). In this regard, the court will not dismiss a
claim merely because plaintiff's factual allegations do not
support the particular legal theory he advances. Rather, the
court is under a duty to examine the complaint independently to
determine if the factual allegations set forth could provide
relief under any viable legal theory. 5A Charles Alan Wright &
Arthur R. Miller, Federal Practice & Procedure § 1357 n. 40 (2d ed. 1990); see
also Conley v. Gibson, 355 U.S. 41, 45-46 (1957).
Plaintiffs need not prove or establish all of the facts
necessary to ultimately prevail on their claims in order to
survive a motion to dismiss. Nor can defendants prevail on a
motion to dismiss by arguing that plaintiffs' legal theories are
unreasonable or unprovable. Instead, in ruling on a motion to
dismiss, we seek only to determine whether, taking all
well-pleaded factual allegations taken as true, the complaint
states any valid claim for relief.
A. Counts I and II No Private Right of Action
The Dreyfus Defendants, Director Defendants, and Premier have
moved to dismiss Counts I and II of the Complaint on the ground
that there is no implied private right of action under sections
34(b) and 36(a) of the Investment Company Act.
15 U.S.C. §§ 80a-33(b) and 80a-35(a). According to these defendants, there is
no contemporaneous Congressional intent to imply private
enforcement of sections 34(b) and 36(a). Defendants assert that
those cases finding implied private rights of action under other
sections of the ICA belong to an ancien regime, and should no
longer be followed. Finally, defendants argue that the existence of an express private right of action in section 36(b) of the Act
negates an intention to imply one under section 36(a).
Plaintiffs contend that implied private rights of action under
sections 34(b) and 36(a) of the ICA have a long and established
history and fulfill Congress's clear intent to protect mutual
fund investors. Plaintiffs argue that the text and structure of
these statutes, as well as the legislative history, support their
position. The court finds that there is no implied private right
of action under either section 34(b) or 36(a) of the ICA.
Therefore, we dismiss Counts I and II of the complaint.
2. Legal Authority
Sections 34(b) and 36(a) of the ICA do not contain an express
private right of action. Therefore, this court must determine
whether an implied private right of action exists under either
section. There is no decision from either the Supreme Court or
the Court of Appeals for the Third Circuit considering whether to
imply a private right of action under these two sections of the
ICA.*fn5 While we acknowledge that both district courts and courts of appeal in other jurisdictions have, in
recent years, moved away from finding implied private rights of
action under the ICA, these cases are not controlling. As such,
we find it advisable to decide this issue by applying the tests
developed by the Supreme Court for evaluating whether to imply a
private right of action under a federal statute.
In Cort v. Ash, 422 U.S. 66 (1975), the Supreme Court set
forth a four part test to determine whether an implied private
right of action exists: (1) whether plaintiff is a member of the
class "for whose especial benefit the statute was enacted"; (2)
whether there is evidence of legislative intent to create or
preclude the relief sought; (3) whether the relief sought is
consistent with the legislative scheme; and (4) whether the
relief sought is the type that is "traditionally relegated" to
the states, such that federal relief would interfere with the
state scheme. Cort, 422 U.S. at 78.
Although the Cort test is still good law, subsequent Supreme
Court decisions have stressed the paramount importance of making
a threshold inquiry into the intent of Congress by looking, first and foremost, to the text of the statute.
Alexander v. Sandoval, 532 U.S. 275, 286-92 (2001); Univ.
Research Ass'n, Inc. v. Coutu, 450 U.S. 754, 771-72 (1981);
Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11,
15-16 (1979); Touche Ross & Co. v. Redington, 442 U.S. 560, 568
(1979). Where this threshold inquiry is answered in the negative,
the analysis ends there. Alexander, 532 U.S. at 288. According
to the Supreme Court, we are no longer to imply private rights of
action simply because such remedies are necessary to effectuate
the Congressional purpose behind a statute. Alexander,
532 U.S. at 287-88; compare Whitman v. Fuqua, 549 F.Supp. 315, 321
(W.D. Pa. 1982) (citing pre-Alexander cases in which courts
implied private rights of action under the ICA because the clear
Congressional purpose of the ICA was to protect investors). Nor
are we to consider the legal context in which a statute was
enacted, other than to the extent that the context clarifies
ambiguities in the text of a statute. Alexander,
532 U.S. at 288. We are to consult the legislative history only in order to
shed light on ambiguous statutory text. Exxon Mobil Corp. v.
Allapattah Services, Inc., ___ U.S. ___, 125 S.Ct. 2611, 2626
We are, where possible, to begin and end our search for
Congress's intent with the text and structure of the federal
statute. Alexander, 532 U.S. at 288. For a statute to create an implied private right of action, its text must be phrased in
terms of the persons benefitted and must manifest an intent to
create a private remedy, in addition to a private cause of
action. Gonzaga Univ. v. Doe, 536 U.S. 273, 284 (2002) (citing
Alexander, 532 U.S. at 286). Statutes that focus on the person
regulated, rather than the individuals protected, do not evidence
an intent to create an implied private right of action.
Alexander, 532 U.S. at 289 (citing California v. Sierra Club,
451 U.S. 287, 294 (1981)); Cannon v. Univ. of Chicago,
441 U.S. 677, 692 n. 13 (1979).
In this case, we need not look beyond the text of the statutory
sections asserted by plaintiffs to dispense with their section
34(b) and 36(a) claims. Section 34(b) of the ICA focuses
exclusively on the person regulated, and not the persons
benefitted. That section lists two things that those filing
reports with the SEC are prohibited from doing. Each prohibition
begins with the introduction that "[i]t shall be unlawful for any
person . . ." 15 U.S.C. § 80a-33(b). There is no language in this
section about persons benefitted by this section.
Plaintiffs' attempts to transform section 34(b) into a "persons
benefitted" statute based on its cross reference to section 31(a)
of the ICA is unavailing. Section 31(a) addresses the maintenance of records, more specifically retention policies
and compliance burdens. 15 U.S.C. § 80a-30(a). The phrase "for
the protection of investors" specifically modifies the SEC's duty
to establish appropriate holding periods for records and to
reduce the compliance burden on filers. Therefore, as a factual
matter, section 31(a) itself is not a broad "persons benefitted"
section, as plaintiffs contend. We find in this case that a
cross-reference to another statute that happens to mention the
phrase "for the protection of investors" is not enough to
transform an unambiguous "person regulated" section into a
"person benefit" section.
Therefore, we find no Congressional intent evidenced in the
text or structure of section 34(b) to imply a private right of
action. Under Alexander, our analysis ends there. We are no
longer to consider the Congressional purpose behind the statute,
the legal context in which it was enacted, or the legislative
history. Accordingly, we find that there is no implied private
right of action under section 34(b) of the ICA.
Our conclusion regarding section 36(a) is the same. That
section explicitly states that "the Commission is authorized to
bring an action . . ." alleging a breach of fiduciary duty.
15 U.S.C. § 80a-35(a). This statutory text actually evidences a
legislative intent to preclude the relief sought by its clear
indication of one, and only one, entity that has the power to enforce its provisions. Cort, 422 U.S. at 78. Based on this
unambiguous statutory text, there is no basis on which to find a
Congressional intent to imply a private right of action. Such an
action would, in fact, directly contradict the language of the
statute. Again, where the language of the statute is unambiguous,
we need look no further to answer the dispositive question of
Congressional intent. Therefore, we find that there is no implied
private right of action under section 36(a) of the ICA.
Because we find that there is no implied private right of
action under either section 34(b) or section 36(a) of the
Investment Company Act, we dismiss Counts I and II of the
B. Count III Sufficiency of Factual Allegations
These defendants have also moved to dismiss plaintiffs' 36(b)
claim on the ground that plaintiffs have failed to adequately
plead their cause of action. According to defendants, in order to
successfully plead a cause of action under that statute,
plaintiff must allege sufficient facts to show that the
challenged fees were so disproportionately large that they bear
no reasonable relationship to the services rendered. Plaintiffs contend that they can survive a motion to dismiss this count
because they have satisfied the liberal pleading requirements of
the Federal Rules of Civil Procedure. The court finds that
plaintiffs' 36(b) claim is adequately pled.
Section 36(b) of the ICA provides that an investment advisor
has a "fiduciary duty with respect to the receipt of
compensation." 15 U.S.C. § 80a-35(b). To violate section 36(b),
the advisor must charge a fee that is so disproportionately large
that it bears no reasonable relationship to the services rendered
and could not have been the product of arms'-length bargaining.
Krantz v. Prudential Inv. Fund Mgmtt LLC, 305 F.3d 140, 143 (3d
Cir. 2002); see also Gartenberg v. Merrill Lynch Asset
Mgmt., Inc., 694 F.2d 923, 928 (2d Cir. 1982). Plaintiffs have
alleged that defendants breached this duty by collecting fees
under their wrongful schemes. Specifically, plaintiffs contend
that defendants breached their duties by collecting fees in
excess of standard charges, and in violation of SEC rules, and by
failing to pass savings realized by economies of scale on to the
There is no question that in order to determine whether a fee
is excessive for purposes of section 36(b), a court must examine
the relationship between the fees charged and the services
rendered by the investment advisor. Krantz, 305 F.3d at 143
(citing Migdal v. Rowe Price-Fleming Int'l, Inc., 248 F.3d 321, 330 (4th Cir. 2001)). Merely alleging that fees or costs
were high or wrongful is not enough to satisfy the pleading
requirements for a section 36(b) claim. Id. In layman's terms,
the definitive question is whether the investors got their
money's worth out of their investment managers, not whether the
fee structures were right or wrong, fair or unfair, or high or
The bulk of plaintiffs' section 36(b) allegations center on the
"wrongfulness" of the compensation paid to these defendants,
without regard to the services rendered. As such, they do not
support a section 36(b) claim under the applicable standards.
However, plaintiffs have also included key allegations that save
their complaint from dismissal. They allege that the fees were
excessive because savings realized from economies of scale were
not passed on to the investors. Section 36(b) was enacted in
large part because Congress recognized that as mutual funds grew
larger, it became less expensive for investment advisors to
provide additional services. See Migdal, 248 F.3d at 326-27.
Congress wanted to ensure that investment advisors passed on to
fund investors the savings that they realized from these
economies of scale. Id. (citing Fogel v. Chestnutt,
668 F.2d 100, 111 (2d Cir. 1981)). In addition, plaintiffs have alleged
that the board of directors were neither independent or
conscientious. See Krinsk v. Fund Asset Mgmt., Inc., 875 F.2d 404, 409 (2d Cir. 1989) (noting that a court must examine, among
other factors, the independence and conscientiousness of the
trustees, in determining whether a fee is excessive under section
36(b)). Taking all of these allegations as true, and applying the
deferential motion to dismiss standard, we find that plaintiffs
have adequately pled a cause of action under section 36(b).
We recognize that this is a close case, but in ruling on a
motion to dismiss, we will give plaintiffs every possible benefit
of the doubt and reasonable inference. We emphasize that we do
not determine at this stage in the case whether plaintiffs can
prove their allegations, or, if proven, whether those facts alone
will legally support a claim under section 36(b).*fn7 We
find only that plaintiffs have satisfied the threshold
requirements of Rule 12(b)(6). We will not dismiss Count III on
the ground that it is insufficiently pled. C. Count III No Liability Against Director Defendants
The Director Defendants have moved to dismiss the section 36(b)
claim against them because they are not the recipients of any
advisory compensation. The Director Defendants argue that because
the only monies that they received were their salaries, they
cannot be held liable under section 36(b). Plaintiffs contend
that the Director Defendants could be held liable under section
36(b) as indirect recipients of the advisory compensation.
Plaintiffs argue that a final determination on this issue should
be addressed at the summary judgment, and not the motion to
dismiss, stage. The court finds that plaintiffs' 36(b) claim
against the Director Defendants is not legally cognizable.
Therefore, Count III will be dismissed as to the Director
Under section 36(b), investment advisors, and their affiliates,
have a fiduciary duty with respect to the receipt of compensation
or payments for their services. 15 U.S.C. § 80a-35(b). There is
no dispute that a security holder may bring a cause of action
under this section. However, the statute limits, but its terms,
who such an action may be brought against. Section 36(b)(3)
No such action shall be brought or maintained against
any person other than the recipient of such
compensation or payments, and no damages or other
relief shall be granted against any person other than the recipient of such compensation or
15 U.S.C. § 80a-35(b)(3) (emphasis added).
Plaintiffs acknowledge that the Director Defendants did not
actually receive compensation for investment advisor services,
but instead contend that the Director Defendants were indirect
recipients of such compensation. Plaintiffs provide the court
with no legal support for the concept that section 36(b),
contrary to its express language, applies to indirect recipients
of advisory compensation. Plaintiffs instead simply argue that
the Director Defendants should be, or could possibly be, liable
under section 36(b) because they were paid high salaries in order
to induce them to breach their fiduciary duties to investors.
However, this argument ignores the plain text of the statute. The
statute does not provide for the recovery of any and all monies
from anyone who may have been involved in a breach of fiduciary
duty owed to mutual fund investors. Instead, the statute allows
for recovery of advisory compensation from the person or entity
who received it. Where Congress has provided so carefully for one
method of enforcement, courts are not lightly to impute another
method. Transamerica Mortgage, 444 U.S. at 19.
The only allegation regarding monies paid to the Director
Defendants is a listing of each Director's "excessively high"
salary. Plaintiffs' complaint contains no allegations that the
Directors' salaries were used as a way to divert, disguise, or launder advisory compensation. See Green v. Fund Asset Mgmt.,
L.P., 147 F.Supp.2d 318, 329-30 (D.N.J. 2001) (holding that
officers could not be held liable where only allegations were
that officers received salaries, and no allegations were made
regarding attempts to evade liability by disguising advisory fees
as officers' salaries). There are no allegations that the
Director Defendants were affiliated persons of the advisors under
the statute. 15 U.S.C. § 80a-35(b). There is not even the
fundamental allegation that the Director Defendants received
compensation for advisory services, putting them within the reach
of section 36(b). See In re TCW/DW N. Am. Gov't Income Trust
Security Litig., 941 F.Supp. 326, 343 (S.D.N.Y. 1996) (holding
that underwriters could not be held liable where the complaint
did not allege that they received compensation for advisory
services, even though they received other fees); see also
Halligan v. Standard & Poor's/Intercapital, Inc.,
434 F.Supp. 1082, 1085 (E.D.N.Y. 1977) (noting that section 36(b) must be
narrowly read to mean that only those who receive money paid by
the investment company for investment advisory services may be
held liable for breach of their fiduciary duty with respect to
such payments); In re Eaton Vance Mut. Funds Fee Litig., 2005
WL 1813001, *13 (S.D.N.Y. Aug. 1, 2005) (rejecting argument that
a section 36(b) claim could be sustained based on allegations of
indirect receipt of advisory compensation). Although we are mindful of the deferential standard governing a
motion to dismiss, we find that, under the facts alleged in this
case, the Director Defendants' receipt of a salary cannot fall
within section 36(b)'s cause of action for recovery of investment
advisor fees from the advisor or his affiliates. Drawing a
purportedly high director's salary, without more, is simply not
enough to sustain liability under section 36(b). We will dismiss
Count III to the extent it is asserted against the Director
D. Count III No Liability Against Premier
Premier, one of the Distributor Defendants, has moved to
dismiss the section 36(b) claim against it on statute of
limitations grounds. Premier argues that because this action was
instituted nearly four years after it stopped distributing
Dreyfus Funds, there is no possibility of a section 36(b)
recovery against it. Plaintiffs argue that because they have
adequately alleged that Premier participated in wrongdoing during
the proposed Class Period (January 30, 1999 to November 17,
2003), the potential liability of Premier is a question of fact
to be decided at a later time. The court finds that the 36(b)
claim against Premier is time barred and will dismiss Count III
as to Premier.
Technically, the Federal Rules of Civil Procedure require that
the affirmative defense of the statute of limitations be pleaded in the answer. Fed.R.Civ.P. 12(b). However, under the
so-called "Third Circuit Rule" a limitations defense can be
raised by a motion under Rule 12(b)(6), but only if "the time
alleged in the statement of a claim shows that the cause of
action has not been brought within the statute of limitations."
Robinson v. Johnson, 313 F.3d 128, 135 (3d Cir. 2002) (citing
Hanna v. U.S. Veterans' Admin. Hosp., 514 F.2d 1092, 1094 (3d
Cir. 1975)). "If the bar is not apparent on the face of the
complaint, then it may not afford the basis for a dismissal of
the complaint under Rule 12(b) (6)." Id. (citing Bethel v.
Jendoco Constr. Corp., 570 F.2d 1168, 1174 (3d Cir. 1978)).
In this case, the statute of limitations bar is apparent on the
face of the complaint. Section 36(b) contains a one year statute
of limitations. 15 U.S.C. § 80a-35(b)(3) ("No award of damages
shall be recoverable for any period prior to one year before the
action was instituted.") This case was instituted on January 30,
2004. Therefore, plaintiffs cannot recover any damages sustained
prior to January 30, 2003. Premier ceased distributing Dreyfus
funds in March of 2000. It is clear on the face of the complaint,
and undisputed, that Premier's involvement with the Dreyfus Funds
ended nearly three years prior to the expiration of the one year
statute of limitations.
Plaintiffs argue, in a footnote, that their section 36(b) claim
against Premier survives because they have ". . . adequately allege[d] that Premier participated in the wrongdoing during the
Class Period". See Doc. No. 43, pp. 7-8, n. 8. However,
plaintiffs have provided this court with no legal or factual
support for their contention that they can evade a clear,
statutory limitations period by unilaterally proposing a Class
Period that stretches beyond it. The proposed Class Period does
not change the one year statute of limitations, nor the fact that
Premier stopped distributing Dreyfus Funds almost three years
prior to its expiration. As such, we will dismiss Count III to
the extent that it is asserted against Premier.*fn8
E. Count V Demand Is Not Excused
The Investment Advisor Defendants move to dismiss plaintiffs'
breach of fiduciary duty claim under the Investment Advisors Act
on the ground that plaintiffs failed to make a demand on the
directors to bring the case and that plaintiffs failed to
adequately plead fraud. Plaintiffs respond that demand on the
directors should be excused because it would have been futile and
that they have adequately pled fraud. As an initial matter,
because this claim is brought derivatively, the court finds that
it can only be asserted on behalf of the two funds that
plaintiffs own. Further, the court finds that, based on the
allegations of the complaint, plaintiffs have failed to meet the standards for
allowing demand on those two boards of directors to be excused as
futile. Therefore, Count V is dismissed.
1. Derivative Suit Against Owned Funds Only
Plaintiffs' Investment Advisor Act claim is brought
derivatively. Plaintiffs are investors in only two of the
approximately 155 mutual funds named as nominal defendants. It is
settled law that an investor does not have standing to bring a
derivative action on behalf of mutual funds in which he has not
invested, even if those funds are similarly situated. Kauffman
v. Dreyfus Fund, Inc., 434 F.2d 727, 734 (3d Cir. 1970). As a
result, regardless of our ultimate disposition of Count V,
plaintiffs could only maintain their derivative IAA claim on
behalf of the Disciplined Fund and the S&P Index Fund.
2. Demand on the Board of Directors
Next we turn to defendants' argument that demand on the board
of directors should not be excused as futile. Plaintiffs'
derivative claim must comply with Rule 23.1 of the Federal Rules
of Civil Procedure. That rule imposes a duty on a derivative
action plaintiff to allege the efforts made to obtain the desired
action from the board of directors, or the reasons for
plaintiff's not making the effort. Fed.R.Civ.P. 23.1. Here,
plaintiffs allege that they made no demand on the board of
directors because such demand would have been futile. Under Maryland Law,*fn9
demand on the board of directors is excused as futile when a
majority of the directors are so personally and directly
conflicted or committed to the decision in dispute that they
cannot reasonably be expected to respond to a demand in good
faith. Werbowsky v. Collomb, 766 A.2d 123, 144 (Md. 2001). The
court finds that it is unable to excuse the demand requirement as
futile under the facts as currently pled.
Plaintiffs have named nine individual Director Defendants, and
have made allegations as to their improper conduct, their role in
the alleged schemes, and their service at the pleasure of the
Investment Advisor Defendants. However, we have been unable to
locate any factual allegations indicating whether these nine
Directors served on the boards of the two funds owned by
plaintiffs, or, if they did, whether they comprised a majority on
those boards. Although plaintiffs include a one line allegation
in their complaint that "a majority of the Boards is incapable of
evaluating a demand", that allegation is not supported by any
other facts. In addition, the allegation is now meaningless
considering that plaintiffs were speaking, at the time, to the boards of the approximately 155 mutual funds. In short, based on
plaintiffs' complaint, we have no way of knowing whether these
nine Directors were simply rogue minorities on the boards of the
two relevant funds who convinced well-meaning directors to
approve their scams, or whether, as required by Maryland law,
they comprised a majority of the board and were so personally and
directly conflicted or committed to the decision in dispute that
they could not reasonably be expected to respond to a demand in
Without such key information, we cannot make a finding that
demand should be excused as futile under Maryland law. As such,
we will dismiss Count V, without prejudice. After a re-evaluation
of the facts, plaintiffs may, or may not, wish to seek leave to
amend their complaint in an attempt to meet the requirements of
Maryland law.*fn10 F. Counts VII, VIII, IX, and X Pre-empted by SLUSA
All defendants have moved to dismiss Counts VI,*fn11 VII,
VIII, IX, and X, on the ground that they are preempted by the
Securities Litigation Uniform Standards Act of 1988 ("SLUSA"),
15 U.S.C. § 77p(b), 15 U.S.C. § 78bb(f)(1). According to defendants,
because plaintiffs allege a misrepresentation or omission of a
material fact in connection with the purchase or sale of
securities, plaintiffs' state law claims are preempted by federal
law. Plaintiffs argue that because they have carefully defined
their Proposed Class to include only those people who held
securities, not those that bought or sold them, their claims
survive federal preemption. The court finds that the state law
claims are preempted by SLUSA and dismisses Counts VI, VII, VIII,
IX, and X.
SLUSA preempts covered class actions that allege a
misrepresentation or omission of material fact in connection with
the purchase or sale of a covered security.
15 U.S.C. § 78bb(f)(1)(A). This language mirrors existing federal securities
law under 10(b) and Rule 10b-5 of the Securities Exchange Act of
1934, which has interpreted the phrase broadly. See
15 U.S.C. § 78j(b), 17 C.F.R. § 240.10b-5. The dispositive question in this
case is whether plaintiffs' case alleges misrepresentations or omissions "in connection with the purchase or sale of a covered
The Court of Appeals for the Third Circuit has recently set
forth a number of factors to be considered in distinguishing
between preempted and non-preempted claims under SLUSA: (1)
whether the fraudulent scheme coincides with the purchase of
securities; (2) whether the alleged misrepresentations or
material omissions were disseminated to the public in a medium
upon which a reasonable investor would rely; (3) whether the
nature of the parties' relationship is such that it necessarily
involves the purchase or sale of securities; and (4) whether the
prayer for relief connects the state law claims to the purchase
or sale of securities. Rowinski v. Salomon Smith Barney Inc.,
398 F.3d 294, 302 (3d Cir. 2005) (citing cases). These factors
are not exclusive, but serve as guideposts in a flexible
preemption inquiry. Id. at 302 n. 7.
As an initial matter, we must dispense with plaintiffs'
contention that because they defined their Proposed Class to
include only "holders" of securities, the analysis ends there.
First, our Court of Appeals has not yet issued a ruling on
whether or not class actions asserted by "holders" (i.e.,
non-purchasers and non-sellers), as plaintiffs contend is the
case here, are preempted by SLUSA. Rowinski, 398 F.3d at n. 9.
In Rowinski, the Court of Appeals acknowledged the arguments in support of and opposition to preemption in such circumstances,
and explicitly stated that "[w]e need not explore this frontier
of SLUSA." Id. Therefore, even if we determined that plaintiffs
have asserted a true "holder" case, we would not automatically
conclude that the state law claims were not preempted under
SLUSA. Although we need not, and do not rule on this issue, we
note that SLUSA's preemption language is not limited to cases
involving damages that were suffered as a result of the purchase
or sale of securities. Instead, preemption under SLUSA focuses on
whether untrue statements or omissions of material fact were made
in connection with the sale or purchase of securities.
Second, a preemption determination is not a "name game"; the
fact that a plaintiff calls its case a "holder class action" does
not make it so. This court must make a independent assessment of
all the allegations of the complaint and the relevant legal
factors as set forth by our Court of Appeals to reach a reasoned
decision on the preemption issue. See Prof'l Mgmt. Ass'n, Inc.
Employees' Profit Sharing Plan v. KPMG LLP, 335 F.3d 800, 803
(8th Cir. 2003); Riley v. Merrill Lynch, Peirce, Fenner &
Smith, Inc., 292 F.3d 1334, 1345 (11th Cir. 2002);
Korsinksy v. Salomon Smith Barney, Inc., 2002 WL 27775, at *2
(S.D.N.Y. Jan. 10, 2002).
Upon application of the Rowinski factors to this case, we
find that the state law claims are preempted. First, we find that the complaint alleges a fraudulent scheme coinciding with the
purchase or sale of securities. At its heart, the complaint
alleges that false statements or omissions were made at the point
of sale of mutual funds in order to induce unwitting investors
into the Dreyfus Funds. The whole purpose and effect of the
alleged schemes was to boost sales of the Dreyfus funds in order
to increase commissions, fees, and charges. Without a sale of a
security, the scheme would have been an exercise in futility.
See Rowinski, 398 F.3d at 302.
Second, we find that plaintiffs allege that defendants
disseminated their misrepresentations or omissions in a medium
upon which a reasonable investor would rely, namely, the
prospectus and other sales and marketing materials at brokerage
houses, and other points of sale. Id. Third, we find that not
all of the defendants have a relationship with plaintiffs that
necessarily involves the purchase or sale of securities. Id.
While the Distributor Defendants necessarily involve a buy-sell
transaction, the Director Defendants do not. In this case,
evaluation of this factor is not particularly telling.
Finally, because plaintiffs seek recovery of marketing fees,
brokerage fees, and other fees that were calculated based on
sales commissions, we find that their desired recovery connects
their claims to the sale or purchase of securities. Id. at 303.
Looked at another way, without increased purchases of Dreyfus Funds as a result of defendants' fraudulent schemes, these fees
would presumably not have been objectionable to plaintiffs.
Plaintiffs want to recover the fees because they were allegedly
inflated due to defendants' sales and marketing schemes.
On balance, we conclude that plaintiffs' state law claims
allege actions that were taken "in connection with the purchase
or sale of a covered security". Regardless of how plaintiffs have
defined their Proposed Class or worded their pleadings, their
complaint is about sales and marketing schemes that were used to
steer unwitting investors into the Dreyfus Funds in order to
boost defendants' fees and charges. The state law claims are
preempted by SLUSA. We dismiss Counts VI, VII, VII, IX, and
Premier's Motion to Dismiss [doc. no. 22] is granted. All
claims against Premier have been dismissed. Similarly, all claims
against the Director Defendants have been dismissed. Their Motion
to Dismiss [doc. no. 25] is granted. The Nominal Defendant's
Motion to Dismiss [doc. no. 33] is also granted.
Parent Companies', Dreyfus Service Corporation's, and
Investment Advisor Defendants' Motion to Dismiss [doc. no. 29] is
granted, in part, and denied, in part. Plaintiffs have adequately pled a claim under section 36 (b) of the ICA against the
Investment Advisor Defendants and Dreyfus Service Corporation.
However, we note that this claim is limited, by statute, to the
one year time period prior to the date that this suit was filed.
The section 48(a) claim survives to the extent it is based
thereon. All other claims against these defendants have been
dismissed. These defendants' motions for leave to file notice of
supplemental authority [doc. nos. 56, 58] are granted.
The appropriate order follows. ORDER
Therefore, this 28th day of September, 2005, IT IS HEREBY
ORDERED that Premier's Motion to Dismiss [doc. no. 22] is
IT IS FURTHER ORDERED that Director Defendants' Motion to
Dismiss [doc. no. 25] is granted;
IT IS FURTHER ORDERED that Nominal Defendant's Motion to
Dismiss [doc. no. 33] is granted;
IT IS FURTHER ORDERED that Parent Companies', Dreyfus Service
Corporation's, and Investment Advisor Defendants' Motion to
Dismiss [doc. no. 29] is granted, in part, and denied, in part;
IT IS FURTHER ORDERED that Parent Companies', Dreyfus Service
Corporation's, and Investment Advisor Defendants' Motion for
Leave to File Notice of Supplemental Authority [doc. nos. 56, 58]
are granted. IT IS HEREBY ORDERED that Counts I, II, VI, VII, VIII, IX, and
X are dismissed with prejudice, Count V is dismissed without
prejudice, and Count III cannot be asserted against the Director
Defendants or Premier, but can be asserted against the Investment
Advisor Defendants and Dreyfus Service Corporation.
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