Second Circuit Rules for Mutual Fund Trustees in Suit Alleging Breach of Fiduciary Duty in Approving Successor Advisory Contracts Following Sale of Fund Adviser


The U.S. Court of Appeals for the Second Circuit affirmed the dismissal on a motion for summary judgment of a derivative suit against the independent trustees of a mutual fund group in which the plaintiff shareholder alleged that the trustees had breached their fiduciary duty in approving new advisory agreements for the funds with the funds’ adviser following its sale.  The Second Circuit’s decision follows seven years of litigation encompassing five prior court decisions – two from the U.S. District Court for the Southern District of New York, two decisions from the Second Circuit, and one from the Supreme Judicial Court of Massachusetts (the “SJC”) addressing a question of Massachusetts law certified by the Second Circuit.

Prior Decisions.  The shareholder originally filed the complaint in 2006 in the District Court, having previously made demand on the trustees.  The independent trustees had begun, but not completed, an investigation into the demand’s allegations at the time the suit was filed.  Upon completing their investigation, the independent trustees rejected the shareholder’s demand. The District Court subsequently dismissed the complaint on the grounds that the trustees were independent and had rejected the demand, and that dismissal was therefore required under the Massachusetts statutory codification of the business judgment rule, which it applied to the funds by virtue of their organization as series of a Massachusetts business trust.  The shareholder appealed to the Second Circuit, which in late 2009 certified a question to the SJC regarding the effect under the statutory codification, if any, of the timing of the rejection of demand relative to the commencement of a lawsuit.  In 2010, the SJC ruled that under the Massachusetts codification a corporation may rely on the business judgment rule to obtain dismissal of derivative litigation regardless of whether the demand is rejected before or after commencement of the lawsuit, and clarified that the derivative suit provisions in the Massachusetts statute apply not only to Massachusetts corporations, but also to Massachusetts business trusts, a form of organization used by many mutual funds.  (The SJC decision was discussed in the August 31, 2010 Financial Services Alert.)  In 2011, the Second Circuit remanded the case to the District Court, on the ground that the District Court should have converted the motion to dismiss into a motion for summary judgment.  On remand in 2012, the District Court granted summary judgment in favor of the independent trustees.

Current Decision.  In its most recent appeal to the Second Circuit, the plaintiff argued that material disputes about the trustees' independence precluded summary judgment.  The Second Circuit rejected all of the plaintiff's arguments and held that none of (i) the trustees’ approval of various fund practices that the plaintiff deemed questionable, (ii) the trustees' receipt of substantial compensation for their board service, (iii) the trustees' investigation of their own conduct in response to the shareholder demand, or (iv) the naming of the trustees themselves as defendants cast doubt on the trustees' independence when they rejected the demand.

Halebian v. Berv, 2013 WL 5977962 (2d Cir. Nov. 12, 2013)(summary order).

Goodwin Procter represented the business trust and its independent trustees.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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