Second Circuit Affirms District Court Holding in Edwards v. Sequoia Fund, Inc.

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The Second Circuit, in Edwards v. Sequoia Fund, Inc.,1 affirmed the dismissal of a claim alleging that a mutual fund breached a contract – its Statement of Additional Information (“SAI”), which forms part of its registration statement – when the fund allegedly violated its industry concentration limit. Of note, the Second Circuit avoided ruling on the district court's primary holding that the SAI was not an enforceable contract, declining to extend Northstar Financial Advisors, Inc. v. Schwab Investments et. al,2 a previous holding by the Ninth Circuit that a mutual fund prospectus could form an enforceable contract. Although the Second Circuit's affirmance arguably leaves the district court's decision on that issue undisturbed, its decision to avoid the issue presented by Northstar – that a mutual fund's registration statement could form an enforceable contract – underscores both the controversy over that holding and its potential continued potency.

In Northstar, the Ninth Circuit held that shareholders could sue a mutual fund, its adviser, and trustees under state-law contract claims on the grounds that the fund’s prospectus was a contract. In so holding, Northstar found the elements of offer and acceptance were present on the facts presented there because the fund’s fundamental investment objective and industry concentration limit were altered and submitted to the shareholders via a proxy for approval.3 Notably, however, in an opinion issued on September 14, 2018, the Ninth Circuit upheld the dismissal of those claims on remand as precluded under the Securities Litigation Uniform Standards Act (“SLUSA”).4

The Edwards case is essentially a Northstar copycat, focusing instead on the SAI. Following the Northstar holding, the plaintiffs in Edwards brought breach of contract claims alleging that the Fund entered into a contract with its shareholders to observe its industry concentration policy, and that the Fund breached this contractual promise when, due to a passive increase in the value of its healthcare investments, the value of those assets came to exceed 25% of its overall assets. Plaintiffs allege that the Fund violated the concentration policy at least three times in 2015: (1) on March 31, 2015, when 27.3% of the Fund’s net assets became concentrated in the healthcare industry, with the Fund holding 26% of its net assets in Valeant Pharmaceuticals International, Inc., a healthcare company, alone; (2) on June 30, 2015, when 30% of the Fund’s net assets were concentrated in the healthcare industry, with the Fund holding 28.7% of its net assets in Valeant alone; and (3) on September 30, 2015, when 26% of the Fund’s net assets became invested in the healthcare industry. Defendants moved to dismiss the claim arguing that the concentration policy could not form the basis of a contract and, even if it could, that the plaintiffs did not allege a breach of the concentration policy. In dismissing plaintiffs’ complaint, the district court agreed that the SAI was not a contract. Unlike in Northstar, where the policies at issue were approved by the shareholders and the SAI was subsequently updated to reflect this approval, in Edwards, the concentration policy had not been changed. There was no offer, intent to be bound, or meeting of the minds. The district court also cited two factually similar cases,5 which Northstar had distinguished, where courts dismissed breach of contract claims premised on mandatory disclosures where there was no express agreement. Consequently, the district court limited Northstar to its peculiar facts and found, absent a shareholder vote approving the policies at issue, there was no meeting of the minds of the parties with respect to the SAI in this case.

Additionally, the district court held that even if there had been a valid contract, the plaintiffs did not adequately allege that the concentration policy was violated. The Investment Company Act of 1940 (the “1940 Act”)6 requires a fund’s SAI to include investment restrictions, such as a concentration policy. Pursuant to these regulations, Defendant Sequoia Fund adopted an investment policy that it may not concentrate its assets, as concentration was defined under the 1940 Act and attendant regulations and guidance. While neither the 1940 Act nor any rule promulgated pursuant to the 1940 Act directly addresses the issue, the SEC has twice provided guidance on concentration policies. Specifically, in 1983, the SEC adopted Form N-1A, the registration form for open-ended investment companies, and provided guidelines for preparing and filing Form N-1A (the “1983 Guidance”).7 One such guide provided for under the 1983 Guidance is Guide 19, which states the SEC’s position that investment “of more than 25 percent of the value of the registrant’s assets in any one industry represents concentration.” Guide 19, however, allows for concentration by “passive increase,” meaning “when securities of a given industry come to constitute more than 25 percent of the value of the registrant’s assets by reason of changes in value of either the concentrated securities or the other securities.”

Plaintiffs contended, however, that subsequent guidance issued by the SEC in 1998 (the “1998 Guidance”) rescinded the 1983 Guidance (or, at least left it ambiguous) concerning whether “passive” investment gains could be counted for concentration purposes. The 1998 Guidance noted that the SEC had “taken the position…that a fund investing more than 25% of its assets in an industry is concentrating in that industry.”8 Further, the 1998 Guidance states that the SEC “continues to believe that 25% is an appropriate benchmark to gauge the level of investment concentration that could expose investors to additional risk.”9 The district court was unmoved by Plaintiffs’ contention that the 1983 Guidance had been rescinded. The court held that the 1998 Guidance continued to allow for the 1983 Guidance’s definition of concentration by passive increase, as it made no mention of, nor provided any indication of, rescission of the 1983 Guidance, and therefore concluded that the complaint failed to allege a breach of the Fund’s concentration policy.

On appeal, the Second Circuit did not address the Northstar premise, but rather “assume[d], without deciding,” that Plaintiffs plausibly alleged the existence of a contract that included the Fund’s concentration policy as an enforceable term that could not be changed without any shareholder vote. In other words, at issue here was only whether the Fund failed to perform under the contract by breaching the concentration policy. In assessing whether there was a breach, the Second Circuit first reviewed the concentration policy, including the SEC guidance incorporated therein, for ambiguity.

The Second Circuit concluded that while not expressly speaking to the issue of passive increases, the 1998 Guidance was not ambiguous and the relevant part of the 1983 Guidance on the treatment of passive investment gains for determining concentration remained undisturbed. The Second Circuit emphasized that the agency would not adopt a major change such as rescinding the prior exception for passive increases “sub silentio” in a guidance document that cites and repeatedly indicates continuity with prior guidance on the very issue in question.

Thus, the Second Circuit’s decision purposefully neglects to address the Northstar implications of the district court’s holding, which limited the impact of Northsar by declining to expand Northstar beyond its peculiar facts. Instead, the Second Circuit deliberately chose not to analyze whether the SAI was in fact a contract, and simply assumed, without deciding, that the SAI was a contract in order to assess whether there was a breach. Because the Court opted not to issue an opinion on the validity of the SAI as a contract premise, the district court’s holding is arguably left undisturbed.


1) No. 18 Civ. 3467 (2d Cir. Sept. 9, 2019).

2) 779 F.3d 1036 (9th Cir. 2015).

3) Id. at 1054-55.

4) Northstar Fin. Advisors, Inc. v. Schwab Investments, 904 F.3d 821, 831-33 (9th Cir. 2018).

5) In re Charles Schwab Corp. Sec. Litig., 2009 WL 1371409 (N.D. Cal. May 15, 2009); Stichting Pensioenfonds ABP v. Credit Suisse Grp. AG, 966 N.Y.S.2d 349 (N.Y. Sup. 2012).

6) 15 U.S.C. §§ 80a‐1 et seq.

7) 1983 Guidance, 48 Fed. Reg. 37,928, 37,958 (Aug. 22, 1983).

8) 1998 Guidance, 63 Fed. Reg. at 13,927 n.99.

9) See Registration Form Used by Open‐End Management Investment Companies, 48 Fed. Reg. 37,928, 37,962 (Aug. 22, 1983).

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