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In re Blackrock Mutual Funds Fee Litigation

March 29, 2006


The opinion of the court was delivered by: McVerry, J.


Plaintiffs allege that defendant BlackRock, Inc., and its subsidiaries and affiliates, inappropriately used assets of BlackRock mutual funds to pay broker-dealers to market BlackRock mutual funds over other mutual funds. Plaintiffs seek to bring their claims as a class action pursuant to Federal Rules of Civil Procedure 23(a) and (b)(3) on behalf of a class, "consisting of all persons or entities who held one or more shares or like interests in any of [the] BlackRock Funds . . . between February 4, 1999 and November 7, 2003, inclusive." (Consolidated Amended Complaint ("Compl.") ¶ 108). No class has yet been certified. The Consolidated Amended Complaint names the following parties as defendants: BlackRock, Inc ("BlackRock"); Black Rock Advisors, Inc. ("BAI") and BlackRock Financial Management, Inc. ("BFM," with BAI the "Investment Adviser Defendants"); and Black Rock Distributors, Inc. ("BDI") (collectively, "defendants").*fn1

Before this court is the Defendants' Motion to Dismiss the Consolidated Amended Complaint ("Motion to Dismiss"). Defendants move to dismiss all counts of the complaint. For the reasons set forth below, the motion will be granted.

I. Background

The relevant facts, as alleged by plaintiffs in the complaint, are as follows: BlackRock, a Delaware corporation, is a publicly-traded investment management company with $294 billion of assets under management as of September 30, 2003. Compl. ¶ 17. BlackRock manages assets on behalf of individual and institutional investors through equity, fixed income, liquidity and alternative investment separate accounts and mutual funds, including the BlackRock funds that are the subject of this litigation. Id. PNC Financial Services Group, Inc. ("PNC") is a majority shareholder of BlackRock. Id. Defendant BlackRock Advisers, a wholly-owned subsidiary of BlackRock, is an investment adviser to the BlackRock Funds and provides management advice to the funds. Id. at ¶ 18. Defendant BFM, an affiliate of BlackRock Advisers (BlackRock Advisers and BFM, collectively, "Investment Adviser Defendants"), is a sub-adviser to the BlackRock Funds and is responsible for the day-to-day management of the funds. Id. at ¶ 19. Defendant BDI is a registered broker/dealer that has marketed and sold shares of the BlackRock Funds on a continuous basis. Id. at ¶ 22.

Nominal defendants, the BlackRock Funds, are open-ended management companies, whose assets consist of the capital invested by shareholders of the mutual funds. Id. at ¶ 23. All funds have a board of trustees that is responsible for representing the interests of the shareholders of the funds. Id. Every BlackRock Fund has BAI and/or BFM as its investment adviser or sub-adviser, and BDI as its principal underwriter and distributor. Id. at ¶ 25.

Plaintiffs allege that defendants used improper means to obtain a preferred marketing status at brokerage firms. Specifically, plaintiffs allege that, during the class period, BlackRock made payments to Morgan Stanley and other brokerages and in exchange the brokerages aggressively marketed BlackRock funds to unwitting investors. Id. at ¶ 27. Plaintiffs and defendants refer to this practice as acquiring "shelf-space." Plaintiffs allege that defendants obtained shelf-space at the brokerages through several payment methods, including (a) "directed brokerages," the practices of directing the trades of securities and other investments of the BlackRock Funds to the brokerages; (b) "revenue-sharing," paying cash and other inducements to the brokerages; and (c) paying excessive commissions in the form of "soft dollars." Id. at ¶ 27. Plaintiffs allege that BlackRock did not disclose the shelf-space payments to clients and that the payments created a material conflict of interest that caused brokers to direct clients to BlackRock Funds regardless of the funds' relative investment quality. ¶ 51, 57, 85-98.

An example of a shelf-space program in which plaintiffs allege BlackRock participated was the Morgan Stanley "Partners Program." Id. at ¶ 29. Under the Partners Program, Morgan Stanley adopted a broker "Incentive Compensation" payout grid that provided for up to 3% greater compensation for "asset-based products" over "transaction-based products." Id. at ¶ 32. Morgan Stanley classified Partners Program funds, including BlackRock, as "asset-based products." In exchange for these additional payouts, Morgan Stanley provided BlackRock Funds, and other Partners Program funds, with priority placement in the review of fund materials that were distributed to Morgan Stanley brokers; gave BlackRock access to Morgan Stanley's branch system at the branch managers discretion; gave BlackRock access to Morgan Stanley brokers; included BlackRock in Morgan Stanley broker events and invited BlackRock to participate in programs broadcast to brokers over Morgan Stanley's internal systems. ¶ 35. The Morgan Stanley Partners Program was the subject of a Securities and Exchange Commission ("SEC") investigation and Morgan Stanley has since been censured by the SEC and the National Association of Securities Dealers, Inc. (the "NASD") and has agreed to $50 million in fines. ¶ 43.

Plaintiffs allege that BlackRock paid excessive brokerage commissions and inappropriately directed brokerage business to broker-dealers in violation of section 12 of Chapter 2d - Investment Companies and Advisers ("ICA"), 15 U.S.C. §80a-12, because the payments were not made pursuant to a valid SEC Rule 12b-1 plan, 17 C.F.R. § 270.12b-1. ¶ 52-53, 64-72. Rule 12b-1 prohibits mutual funds from directly or indirectly distributing or marketing their own shares unless the funds meet certain conditions. See 17 C.F.R. § 270.12b-1. For example, Rule 12b-1 provides that payments for marketing must be made pursuant to a written plan "describing all material aspects of the proposed financing of distribution." Id. at 270.12b-1(b).

Rule 12b-1 further provides that a registered open-end management company "may implement or continue a plan pursuant to paragraph (b) . . . only if the board of directors who vote to approve such implementation or continuation conclude, in the exercise of reasonable business judgment, and in light of their fiduciary duties under state law and section 36(a) and (b) of the [ICA] that there is a reasonable likelihood that the plan will benefit the company and its shareholders." Id. at 270.12b-1(e). Plaintiffs argue that there was not a "reasonable likelihood" that the plan would benefit the shareholders. Compl. at ¶ 68. Specifically, plaintiffs argue that "the BlackRock Funds['] marketing efforts were creating diminished marginal returns under circumstances where increased fund size correlated with reduced liquidity and fund performance." Id. at ¶ 68.

Plaintiffs further allege that the Investment Adviser defendants exceeded the "safe harbor" provision of section 28(e) of the Securities and Exchange Act, 15 U.S.C. § 78bb(e), when they paid excessive commissions in the form of "soft dollars." Section 28(e)'s "safe harbor" provision carves out an exception to the general rule that financial advisers have a fiduciary duty to their clients to obtain the best possible execution price for their trades. 15 U.S.C. § 78bb(e). Section 28(e) allows an investment adviser to cause an account to pay a broker an amount of commission for effecting a securities transaction in excess of the commission another broker might have charged, as long as the adviser "determined in good faith that such amount of commission was reasonable in relation to the value of the brokerage and research services provided by such . . . broker . . . viewed in terms of either that particular transaction or his overall responsibilities with respect to the accounts as to which he exercises investment discretion." 15 U.S.C. § 78bb(e)(1). The commission amounts that brokerages charge investment advisers in excess of the purchase and sales charges are known as "soft dollars." ¶ 58. Plaintiffs allege that BlackRock "far exceeded the bounds of the Section 28(e) safe harbor by making payments in the guise of Soft Dollars to pay overhead costs." ¶ 61.

II. Standard of Review

The court will dismiss a claim pursuant to Federal Rule of Civil Procedure 12(b)(6) if it "appears beyond doubt that plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Worldcom, Inc. v. Graphnet, Inc., 343 F.3d 651, 653 (3d Cir. 2003) (quoting Conley v. Gibson, 355 U.S. 41, 45-46 (1957)). In considering a motion to dismiss for failure to state a clam upon which relief can be granted, the court is required to accept as true all allegations in the complaint and all reasonable inferences that can be drawn from them after construing them in the light most favorable to the non-movant. Jordan v. Fox, Rothschild, O'Brien & Frankel, 20 F.3d 1250, 1261 (3d Cir. 1994) (citing Rocks v. City of Philadelphia, 868 F.2d 644, 645 (3d Cir.1989)). A court need not, however, "accept as true unsupported conclusions and unwarranted inferences." Doug Grant, Inc. v. Greate Bay Casino Corp., 232 F.3d 173,183-84 (internal quotations and citations omitted).

In their Consolidated Amended Complaint, plaintiffs state nine causes of action against defendants under the Investment Company Act of 1940 ("ICA"), 15 U.S.C. § 80a-1 et seq; the Investment Advisers Act of 1940 ("IAA"), 15 U.S.C. § 80b-1 et seq.; the Pennsylvania Unfair Trade Practices and Consumer Protection Law ("PUTP" and "CPL"), 73 P.S. § 201-1 et seq.; and state common law for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, and unjust enrichment. Plaintiffs assert eight direct claims: (1) against the Investment Adviser Defendants for violating of section 34(b) of the ICA, 15 U.S.C. § 80a-33(b); (2) against the Investment Adviser Defendants and BDI for violating section 36(a) of the ICA, 15 U.S.C. § 80a-35(a); (3) against the Investment Adviser Defendants and BDI for violating section 36(b) of the ICA, 15 U.S.C. § 80a-35(b); (4) against BlackRock, as a "control person" of BDI , for violating section 48(a) of the ICA, 15 U.S.C. § 80a-47(a); (5) a state law claim against Black Rock, the Investment Adviser Defendants and BDI for violating the CPL; (6) a common law claim against the Investment Adviser Defendants for breach of fiduciary duty; (7) a common law claim against all defendants for aiding and abetting a breach of fiduciary duty; and (8) a common law claim against all defendants for unjust enrichment. Plaintiffs also state a derivative claim on behalf of the BlackRock Funds against the Investment Adviser Defendants under section 215 of the IAA,15 U.S.C. § 80b-6.

III. Discussion

A. Whether There is an Implied Private Right of Action Under Sections 34(b), 36(a) and 48(a) of the ICA (Counts I, II and IV)

In Count I, plaintiffs assert a claim on behalf of the class alleging that defendants violated section 34(b) of the ICA by making materially false and misleading statements in registration reports and prospectuses. In Count II, plaintiffs allege, again on behalf of the class, that defendants violated section 36(a) of ICA by breaching its fiduciary duty to the class. In Count IV, plaintiffs allege, also on behalf of the class, that defendant BlackRock, as a "control person" of defendant BDI, caused BDI to commit violations of sections 36(a) and 36(b) of the ICA in violation of section 48(a) of the ICA.*fn2

Sections 34(b), 36(a) and 48(a) do not explicitly provide for a private right of action.*fn3

Absent any explicit provision for a private right of action, plaintiffs may bring claims only if Congress clearly intended to create a private right of action. See Alexander v. Sandoval, 532 U.S. 275, 286 (2001) ("Like substantive federal law itself, private rights of action to enforce federal law must be created by Congress.")

A statute may create an implied private right of action only if it indicates that Congress intended to create both a private right and a private remedy under the statute. Gonzaga Univ. v. Doe, 536 U.S. 273, 283-84 (2002), Alexander, 532 U.S. at 286; Bonano v. East Caribbean Airline Corp., 365 F.3d 81, 84 (1st Cir. 2004). In determining whether Congress intended to create a private right of action under a statute, a court must begin with the text and structure of the statute. Sandoval, 532 U.S. at 288. A private right of action may be inferred by "rights-creating" language. Gonzaga Univ., 536 U.S. at 283-84; Sandoval, 532 U.S. at 288-89. Where Congress has created a method of enforcing substantive rules, it may be inferred that Congress did not intend to provide other methods of enforcement. Sandoval, 532 U.S. at 290; Bonano, 365 F.3d at 85. Further, "Congress's explicit provision of a private right of action to enforce one section of a statute suggests that omission of an explicit private right to enforce other sections was intentional." Olmsted v. Pruco Life Insurance Co., 283 F.3d 429 (2d Cir. 2002).

Sections 34(b), 36(a) and 48(a) do not contain private rights creating language. Section 42 of the ICA, 15 U.S.C. § 80a-41, provides a method for the SEC to enforce all provisions of the ICA, thus implying that Congress did not wish to provide for other modes of enforcement. Section 36(a) specifically authorizes the SEC, not shareholders, to take enforcement action.

15 U.S.C.A. § 80a-47(a).

Further, the fact that section 36(b) of the ICA specifically provides for a private action implies that Congress did not wish to provide for private enforcement of other sections of the ICA. There is no evidence that Congress intended to create a private right of action under sections 34(b), 36(a) and 48(a) and several other courts that have considered the issue have reached the same conclusion.*fn4

Plaintiffs argue that sections 34(b) and 36(a) imply private rights of action because they are "for the protection of investors." Plaintiffs' Brief in Opposition to Defendants' Motion to Dismiss ("Pl. Br.") at 40. This argument is not persuasive. For a statute to create an implied private right of action, the text "must be 'phrased in terms of the persons benefitted.'" Gonzaga Univ., 536 U.S. at 283 (quoting Cannon v. University of Chicago, 441 U.S. 677, 692, n. 13 (1979)). If a statute focuses on the person regulated, rather than the individuals protected, it does not create any "implication of ...

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