Opinion

Green v. Fund Asset Management, L.P.

245 F.3d 214
2001 WL 261490

Court: Court of Appeals for the Third Circuit
Filed: Mar 16, 2001
On the bench: Roth, Garth, Stanton
Cited by: 1 cases
Authority: More cited than 40.1%

The opinion

Opinions of the United

2001 Decisions States Court of Appeals

for the Third Circuit

3-16-2001

Green v. Fund Asset Mgt

Precedential or Non-Precedential:

Docket 99-5734

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Filed March 16, 2001

UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

No. 99-5734

JACK GREEN, individually and as Trustee;

LAWRENCE P. BELDEN, Trustee;

STANLEY SIMON, Trustee

FUND ASSET MANAGEMENT, L.P.;

MERRILL LYNCH ASSET MANAGEMENT, L.P .;

MERRILL LYNCH & CO., INC.;

MERRILL LYNCH, PIERCE, FENNER &

SMITH INCORPORATED;

PRINCETON SERVICES, INC.; ARTHUR ZEIKEL;

TERRY K. GLENN; MUNIENHANCED FUND, INC.;

MUNIVEST FUND II INC.; MUNIYIELD FUND, INC.;

MUNIYIELD INSURED FUND, INC.;

MUNIYIELD INSURED FUND II, INC.;

MUNIYIELD QUALITY FUND, INC.;

MUNIYIELD QUALITY FUND II, INC.

Jack Green,

Lawrence P. Belden,

Stanley Simon,

Appellants

Appeal from the United States District Court

for the District of New Jersey

(D.C. Civil Action No. 97-cv-03502)

District Judge: Honorable Dickinson R. Debevoise

Argued on June 27, 2000

Before: ROTH and GARTH, Circuit Judges,

and STANTON,* District Judge

(Opinion filed: March 16, 2001)

Bruce I. Goldstein, Esquire

Alberto G. Santos, Esquire

Saiber, Schlesinger, Satz & Goldstein

One Gateway Center

Suite 1300

Newark, NJ 07102-5311

Lawrence M. Johnson, Esquire

(Argued)

Mahoney, Hawkes & Goldings

75 Park Plaza

The Heritage on the Garden

Boston, MA 02116

Attorneys for Appellants

Alan S. Naar, Esquire

Paul A. Rowe, Esquire

Greenbaum, Rowe, Smith, Ravin,

Davis & Himmel LLP

P.O. Box 5600

Woodbridge, NJ 07095

Attorneys for Appellees-Defendants

Fund Asset Management, L.P.,

Merrill Lynch Asset Management,

L.P., Merrill Lynch & Co., Inc.,

Merrill Lynch, Pierce, Fenner &

Smith Incorporated, Princeton

Services, Inc., Arthur Zeikel and

Terry K. Glenn

_________________________________________________________________

* Honorable Louis L. Stanton, District Court Judge for the Southern

District of New York, sitting by designation.

James N. Benedict, Esquire (Argued)

Mark Holland, Esquire

James F. Moyle, Esquire

Sean M. Murphy, Esquire

Danielle A. Prill, Esquire

Clifford Chance Rogers & Wells LLP

200 Park Avenue

New York, NY 10166

Attorneys for Appellees

Fund Asset Management, L.P.,

Merrill Lynch Asset Management,

L.P., Merrill Lynch & Co., Inc.,

Merrill Lynch, Pierce, Fenner &

Smith Incorporated, Princeton

Services, Inc., Arthur Zeikel and

Terry K. Glenn

Robert J. Del Tufo, Esquire

Frank E. Derby, Esquire

Skadden, Arps, Slate, Meagher &

Flom LLP

One Newark Center, 18th Floor

Newark, NJ 07102

Attorneys for Appellees

MuniEnhanced Fund, Inc.,

MuniVest Fund II, Inc., MuniYield

Fund, Inc., MuniYield Insured

Fund II, Inc., MuniYield Quality

Fund, Inc., and MuniYield Quality

Fund II, Inc.

OPINION OF THE COURT

ROTH, Circuit Judge:

The plaintiffs, shareholders in several investment

companies, filed an interlocutory appeal of the District

Court's dismissal of their state law claims for br each of

fiduciary duty and deceit. They claim that the District

Court erred in concluding that these claims ar e preempted

by S 36(b) of the Investment Company Act of 1940, as

amended (ICA). Because we conclude that the claims are

not preempted, we will reverse their dismissal and remand

this case to the District Court.

I. FACTS1

The plaintiffs are shareholders in seven investment

companies, the named defendants in this action:

MuniEnhanced Fund, Inc., MuniVest Fund II, Inc.,

MuniYield Fund, Inc., MuniYield Insur ed Fund, Inc.,

MuniYield Insured Fund II, Inc., MuniY ield Quality Fund,

Inc., and MuniYield Quality Fund II, Inc. (the Funds). The

plaintiffs invested more than $44,000 in the Funds between

May 22 and October 18, 1995. The named plaintif f, Jack

Green, has brought suit individually and in his capacity as

a trustee of seven trusts that invested in the Funds. The

other plaintiffs, Lawrence P. Belden and Stanley Simon, sue

solely as trustees of trusts that invested in the Funds.

Although not named in the caption, the complaint also

identifies as plaintiffs seven trusts that allegedly purchased

shares of the Funds. The plaintiffs have brought the case

as a putative class action, seeking to repr esent more than

100,000 investors in the Funds.

The Funds are closed-end investment companies, which

are registered with the Securities and Exchange

Commission (SEC) and publicly traded on the New Y ork

Stock Exchange. All of the Funds are incorporated under

the laws of Maryland and have their principal places of

business in Plainsboro, New Jersey. By investing in long-

term tax-exempt municipal bonds, the Funds' aim is to

provide shareholders with income that is exempt from

federal income taxes and to increase retur n to shareholders

through the use of leverage. The Funds gain leverage by

issuing shares of preferred stock that pay dividends based

upon prevailing short-term interest rates and investing the

proceeds from the sale of this preferred stock in longer-

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1. Because the facts of this case are not in dispute, the factual

background that follows is taken largely from an earlier District Court

opinion in this case. See Green v. Fund Asset Management, 19 F. Supp.

2d 227 (D.N.J. 1998).

term obligations that, under normal market conditions, pay

higher rates. As long as there is a spr ead between the

short-term rates paid by the Funds to holders of the

preferred stock and the longer-ter m rates received by the

Funds from investments, the fund managers ar e able to

provide the shareholders with higher yields.

Defendant Fund Asset Management, L.P., (F AM) serves as

the Funds' investment adviser and is responsible for

managing the Funds' investment portfolios and pr oviding

administrative services to the Funds. Pursuant to written

investment advisory agreements, the Funds pay F AM a fee

for its services based upon a percentage of the Funds'

weekly net assets. The MuniEnhanced Fund, Inc.,

prospectus describes its advisory fee as follows:

For the services provided by the Investment Adviser

[FAM] under the Investment Advisory Agr eement, the

Fund will pay a monthly fee at an annual rate of .50 of

1% of the Fund's average weekly net assets (i.e. , the

average weekly value of the total assets of the Fund,

minus the sum of accrued liabilities of the Fund and

accumulated dividends on the shares of pr eferred

stock). For purposes of this calculation, average weekly

net assets is determined at the end of each month on

the basis of the average net assets of the Fund for each

week during the month.

Green v. Fund Asset Management, 19 F . Supp. 2d 227, 229

(D.N.J. 1998) (Green I).2

Defendant Merrill Lynch Asset Management, L.P ., (MLAM)

is an affiliate of FAM. MLAM and FAM are organized under

the laws of Delaware and have their principal places of

business in Plainsboro, New Jersey. Defendant Princeton

Services, Inc., (PSI), a Delaware corporation with its

principal place of business in Plainsboro, New Jersey, is the

general partner of FAM and MLAM. PSI has a 1% interest

in FAM and MLAM. Defendant Merrill Lynch and Co., Inc.,

is FAM's and MLAM's sole limited partner and has a 99%

interest in FAM and MLAM. Merrill L ynch is a publicly

_________________________________________________________________

2. The prospectuses for the other Funds contain virtually identical

disclosures.

traded holding company that provides global investment,

financing, insurance, and related services through its

subsidiaries and affiliates. Merrill Lynch is a Delaware

corporation with corporate headquarters in New Y ork City.

Defendant Arthur Zeikel is the President and a director of

each of the Funds, President and Chief Investment Officer

of MLAM and FAM, President and a dir ector of PSI, and an

Executive Vice President of Merrill L ynch. Defendant Terry

Glenn is the Executive Vice President of each of the Funds

and Executive Vice President of F AM and MLAM.

Defendant Merrill Lynch, Pierce, Fenner & Smith

Incorporated (MLPFS), a securities broker -dealer and

investment bank, is a wholly owned subsidiary of Merrill

Lynch. MLPFS served as the principal underwriter for the

offerings of the Funds' common stock. MLPFS has also

entered into auction agent agreements with the Funds to

sell the Funds' preferred stock. The 1994 MuniYield

Insured Fund, Inc., annual statement describes the fees

generated by the preferred stock auctions as follows:

The Fund pays commissions to certain broker -dealers

at the end of each auction at an annual rate ranging

from 0.25% to 0.375%, calculated on the pr oceeds of

each auction. For the year ended October 31, 1994,

MLPFS, an affiliate of FAMI [FAM's predecessor],

received $591,736 as commissions.

Id.3 MLPFS is a Delawar e corporation and maintains its

corporate headquarters in New York City.

The plaintiffs brought this action seeking to remedy

alleged violations of state law and of S 36(b) of the

Investment Company Act of 1940 (the ICA), codified at 15

U.S.C. S 80a-35(b).4 In their complaint, plaintiffs allege that

defendants breached their disclosure obligations and

fiduciary duties under the ICA and under state law. The

_________________________________________________________________

3. Each of the Funds' annual statements contains virtually identical

disclosures.

4. Plaintiffs originally filed their complaint in the United States

District

Court for the District of Massachusetts on June 21, 1996. Defendants

filed a motion to transfer the case to the District of New Jersey pursuant

to 28 U.S.C. S 1404 and the motion for transfer was granted.

plaintiffs contend that the defendants "failed to explicitly or

sufficiently disclose" that the calculation of FAM's

management fee would include assets purchased with the

proceeds from the sale of preferr ed stock. They claim that

because the advisory fee is measured as a per centage of the

Funds' capitalization, including leverage, ther e is a strong

financial incentive for FAM to keep the Funds fully

leveraged at all times, even when it would be in the best

interest of shareholders to reduce or eliminate leverage. The

plaintiffs contend that FAM would lose approximately one-

third of its advisory compensation if it eliminated leverage.

They argue that the fee arrangement cr eates an inherent

conflict of interest, which was not disclosed in the Funds'

prospectuses, the Funds' filings with the SEC, or the

Funds' periodic reports to the shareholders. The plaintiffs

also allege that the defendants failed to disclose that the

issuing of the preferred stock was subject to a conflict of

interest; they find this conflict in the fact that FAM's

affiliate, MLPFS, received fees from the sale of the preferred

stock. In addition, plaintiffs claim that the defendants have

continually misled investors with respect to the advisory

fees, which are ultimately paid by the Funds' shareholders.

The plaintiffs seek both compensatory damages and

injunctive relief. They ask for an order permanently

enjoining the defendants from entering into any

compensation arrangement between the Funds and any

investment adviser under which "the compensation payable

to such investment advisor is determined by, dependent

upon, or measured or influenced by, the amount of

financial leverage of its common equity investment

maintained by such fund." Green I, 19 F. Supp. 2d at 230

(internal quotation marks omitted).

The defendants filed a motion, pursuant to Federal Rule

of Civil Procedure 12(c), to dismiss the plaintiffs' state law

claims for breach of fiduciary duty and deceit. The

defendants contend that the plaintiffs' state law claims are

preempted by S 36(b) of the ICA, which cr eates a federal,

private right of action for breach of fiduciary duty by an

investment adviser or mutual fund management company

with respect to payment and compensation for services. The

District Court granted the defendants' motion and

dismissed the plaintiffs' state law claims. The District Court

did acknowledge, however, that the question presented, i.e.,

whether S 36(b) of the ICA preempts the plaintiffs' state law

claims for breach of fiduciary duty and deceit, was a close

one and a question of first impression in the courts of

appeals. For that reason, the District Court permitted the

plaintiffs to file an interlocutory appeal pursuant to 28

U.S.C. S 1292(b). Green v. Fund Asset Management, 53 F.

Supp. 2d 723, 731-32 (D.N.J. 1999) (Green II).

II. JURISDICTION & STANDARD OF REVIEW

The District Court had jurisdiction over the plaintiffs'

federal claim under 28 U.S.C. S 1331. The District Court

had jurisdiction over the plaintiffs' state law claims under

28 U.S.C. S 1367. We have jurisdiction over the plaintiffs'

appeal under 28 U.S.C. S 1292(b).

We have plenary review of the District Court's order

dismissing the plaintiffs' claims pursuant to Federal Rule of

Civil Procedure 12(c). See, e.g., Consolidated Rail Corp. v.

Portlight, Inc., 188 F.3d 93, 95-96 (3d Cir. 1999). We must

"view the facts presented in the pleadings and the

inferences to be drawn therefrom in the light most favorable

to the . . . non-moving party." Institute for Scientific Info.,

Inc. v. Gordon & Breach, Science Publishers, Inc., 931 F.2d

1002, 1004 (3d Cir. 1991). We will affirm the District

Court's judgment only if the plaintiffs would not be entitled

to relief under any set of facts that could be proved. See

Consolidated Rail Corp., 188 F.3d at 95-96.

III. DISCUSSION

The question we must answer on this appeal is as

follows: Does state law (in this case, common law

establishing liability for breach of fiduciary duty and deceit)

stand as an obstacle to the accomplishment and execution

of the full purposes and objectives which Congr ess had in

mind in enacting S 36(b) of the ICA?

Defendants argue that S 36(b) of the ICA, codified at 15

U.S.C. S 80a-35(b), preempts the plaintif fs' state law claims

for breach of fiduciary duty and deceit. Section 36(b) is a

lengthy and detailed statutory provision. It pr ovides that an

investment adviser of a registered investment company has

a fiduciary duty with respect to compensation for services.

An action may be brought in district court by a security

holder of the registered investment company against the

investment adviser for breach of that fiduciary duty

regarding compensation. In such an action, it is not

necessary to allege or prove personal misconduct on the

part of any defendant.5

_________________________________________________________________

5. The full text of 15 U.S.C. S 80a-35(b) provides:

For the purposes of this subsection, the investment adviser of a

registered investment company shall be deemed to have a fiduciary duty

with respect to the receipt of compensation for services, or of payments

of a material nature, paid by such registered investment company, or by

the security holders thereof, to such investment adviser or any affiliated

person of such investment adviser. An action may be brought under this

subsection by the Commission, or by a security holder of such registered

investment company on behalf of such company, against such

investment adviser, or any affiliated person of such investment adviser,

or any other person enumerated in subsection (a) of this section who has

a fiduciary duty concerning such compensation or payments, for breach

of fiduciary duty in respect of such compensation or payments paid by

such registered investment company or by the security holders thereof to

such investment adviser or person. With r espect to any such action the

following provisions shall apply:

(1) It shall not be necessary to allege or pr ove that any

defendant

engaged in personal misconduct, and the plaintif f shall have the

burden of proving a breach of fiduciary duty.

(2) In any such action approval by the boar d of directors of such

investment company of such compensation or payments, or of

contracts or other arrangements providing for such

compensation or payments, and ratification or appr oval of such

compensation or payments, or of contracts or other

arrangements providing for such compensation or payments, by

the shareholders of such investment company, shall be given

such consideration by the court as is deemed appr opriate under

all the circumstances.

(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

In order to determine whether S 36(b) preempts the

plaintiffs' state law claims for breach of fiduciary duty and

deceit, we must first determine what pr eemption theory is

applicable. Federal law preempts, and ther eby displaces,

state law in three different situations: (1) "express

preemption," (2) "field preemption" (which is also sometimes

referred to as "implied preemption"), or (3) "conflict

preemption." See, e.g., Orson, Inc. v. Miramax Film Corp.,

189 F.3d 377, 381-82 (3d Cir. 1999) (en banc).

Preemption is "express" when ther e is an explicit

statutory command that state law be displaced. See

Morales v. Trans World Airlines, Inc. , 504 U.S. 374, 382

(1992). An example of express preemption can be found in

the Employee Retirement Income Security Act of 1974

(ERISA) which states that the provisions of that Act "shall

supersede any and all State laws insofar as they may now

or hereafter relate to any employee benefit plan." 29 U.S.C.

S 1144(a). See Orson, 189 F.3d at 381. Preemption is

"implied," and state law may be displaced,"if federal law so

_________________________________________________________________

compensation or payments. No award of damages shall be

recoverable for any period prior to one year before the action

was instituted. Any award of damages against such recipient

shall be limited to the actual damages resulting from the breach

of fiduciary duty and shall in no event exceed the amount of

compensation or payments received from such investment

company, or the security holders thereof, by such recipient.

(4) This subsection shall not apply to compensation or payments

made in connection with transactions subject to section 80a-17

of this title, or rules, regulations, or or ders thereunder, or to

sales loads for the acquisition of any security issued by a

registered investment company.

(5) Any action pursuant to this subsection may be brought only in

an appropriate district court of the United States.

(6) No finding by a court with respect to a breach of fiduciary

duty

under this subsection shall be made a basis (A) for a finding of

a violation of this subchapter for the purposes of sections 80a-

9 and 80a-48 of this title, section 78o of this title, or section

80b-3 of this title, or (B) for an injunction to pr ohibit any

person from serving in any of the capacities enumerated in

subsection (a) of this section.

thoroughly occupies a legislative field as to make

reasonable the inference that Congr ess left no room for the

States to supplement it." Cipollone v. Liggett Group, Inc.,

505 U.S. 504, 516 (1992) (internal quotation marks

omitted). Finally, as we stated in Orson, state law may be

displaced under conflict preemption principles if the state

law in question presents a conflict with federal law in one

of two situations: when it is impossible to comply with both

the state and the federal law, or when the state law"stands

as an obstacle to the accomplishment and execution of the

full purposes and objectives of Congress." Orson, 189 F.3d

at 382 (quoting Jones v. Rath Packing Co., 430 U.S. 519,

525 (1977)).

In this case, the defendants do not contend thatS 36(b)

expressly preempts the plaintiffs' state law claims for

breach of fiduciary duty and deceit,6 nor do they assert that

S 36(b) of the ICA, or even the entire ICA itself, impliedly

preempts these claims.7 The preemption theory that the

_________________________________________________________________

6. The defendants would be precluded fr om making such an argument

because neither S 36(b), nor any other section of the ICA, contains an

"explicit statutory command" indicating that federal law preempts and

thereby displaces state law.

7. The defendants would be precluded fr om making such an argument

since it is well-settled that neither the ICA alone nor all federal

securities

laws taken together occupy the field of corporate law or securities law.

See, e.g., Burks v. Lasker, 441 U.S. 471, 477 (1979) (discussing the ICA

and noting that while "in certain areas[the Supreme Court has] held

that federal statutes authorize the federal courts to fashion a complete

body of federal law, [c]orporation law . . . is not such an area"); Baker,

Watts & Co. v. Miles & Stockbridge, 876 F .2d 1101, 1107 (4th Cir. 1989)

(en banc) ("It is well-settled that federal law does not enjoy complete

preemptive force in the field of securities[; s]tate securities laws exist

every state, the District of Columbia, and Puerto Rico, and, `far from

preempting the field,' Congress has expr essly preserved the role of the

states in securities regulation.") (citations omitted). Such state

securities

laws are commonly referred to in the securities industry as "Blue Skies"

laws. The instant case, moreover, is distinguishable from the recent

decision in Buckman Co. v. Plaintiffs' Legal Committee, No. 98-1768,

2/21/01, ___ U.S. ___ (2001), ___ S.Ct. ___ (2001), in which the Supreme

Court found state common law fraud claims relating to a medical device

impliedly preempted by the Medical Device Amendments to the Food,

Drug and Cosmetic Act. Although the Buckman Court acknowledged that

defendants claim is applicable is conflict pr eemption. In

doing so, the defendants do not argue that"it is impossible

to comply with both the state and federal law." 8 Instead,

they assert the other prong of conflict pr eemption: that

state law in this case "stands as an obstacle to the

accomplishment and execution of the full purposes and

objectives of Congress." The District Court was persuaded

by the defendants' arguments and dismissed the claims,

concluding that they were preempted byS 36(b) under the

theory of "conflict preemption." W e conclude, however, that,

when plaintiffs' state law claims are pr operly analyzed

under the Supreme Court's "conflict pr eemption"

jurisprudence, they are not preempted byS 36(b).

In arguing for conflict preemption, the defendants have

attempted to analogize this case to earlier cases. However,

as the District Court recognized, none of the cases they cite

are controlling; the cited cases dealt with the proposition

that, with respect to other sections of the ICA, S 36(b) is the

exclusive remedy for grievances concerning mutual fund

service fees. Green II, 53 F. Supp. 2d at 728-29 (citing

numerous cases). The District Court also corr ectly noted

that, while "defendants cite the unpublished decision in

Batra v. Investors Research Corp., No. 89-0528-CV-W-6,

1990 WL 165242 (W.D. Mo. May 3, 1990), and a

_________________________________________________________________

a presumption against federal preemption of a state law cause of action

exists when a field is traditionally occupied by the states, the fraud

action was not subject to such a presumption because the defendant

manufacturer was accused of making fraudulent r epresentations to the

Food and Drug Administration during the course of the product approval

process. The Court held that the prevention of fraud against federal

agencies cannot be regarded as a field traditionally occupied by the

states. Buckman, ___ U.S. ___ at___. Unlike the plaintiffs in Buckman,

the plaintiffs in the case at bar allege not fraud against a federal

agency,

but rather violations of state and federal securities laws.

8. The defendants would be precluded fr om making such an argument

because no direct conflict exists between state law and federal law in

this case. Cf., e.g., Florida Lime & Avocado Growers, Inc. v. Paul, 373

U.S. 132, 143 (1963) ("That would be the situation here if, for example,

the federal orders forbade the picking and marketing of any avocado

testing more than 7% oil, which the Califor nia test excluded from the

State any avocado measuring less than 8% oil content.").

subsequent unpublished decision in a related case, Batra v.

Investors Research Corp., No. 91-0190-CV -W-6, 1992 WL

280790 (W.D. Mo. Apr. 2, 1992) (" Batra II"), as authority for

their preemption argument, . . . these decisions concern the

exercise of pendent jurisdiction[, and n]either decision

expressly holds that Section 36(b) preempts state common

law remedies." Id. at 729 (citing several cases).

The plaintiffs and the defendants have also attempted to

analogize this case to several Supreme Court pr eemption

cases, all of which address the issue of "express

preemption," not "conflict preemption," and thus are

inapposite. See, e.g., Freightliner Corp. v. Myrick, 514 U.S.

280, 284 (1995); Pilot Life Ins. Co. v. Dedeaux , 481 U.S. 41,

45-48 (1987); Jones v. Rath Packing Co., 430 U.S. 519,

531-33 (1977).

We conclude that prior case law is not on point. We are

left, therefore, to determine, guided by the Supreme Court's

"conflict preemption" jurisprudence, whether state law,

specifically common law establishing liability for breach of

fiduciary duty and deceit, "stands as an obstacle to the

accomplishment and execution of the full purposes and

objectives of Congress" as set forth inS 36(b) of the ICA.

The Supreme Court has held on multiple occasions that,

when analyzing preemption issues, "because the States are

independent Sovereigns in our federal system, we have long

presumed that Congress does not cavalierly pre-empt state-

law causes of action." Medtronic, Inc. v. Lohr, 518 U.S. 470,

485-86 (1996). We start with an assumption that the

historic police powers of the States will not be pr eempted

unless that was the "clear and manifest purpose of

Congress." Id. Moreover , in making our analysis, the

"purpose of Congress is the ultimate touchstone in every

pre-emption case." Id. (inter nal quotation marks omitted).

See, e.g., Chicago & Northwestern T ransp. Co. v. Kalo Brick

& Tile Co., 450 U.S. 311, 317-18 (1981); New York State

Dep't of Soc. Servs. v. Onondaga County Dep't of Soc.

Servs., 413 U.S. 405, 414-15 (1973); Florida Lime &

Avocado Growers, Inc. v. Paul, 373 U.S. 132, 141-43 (1963).

Thus, in deciding whether state law stands as an

obstacle to the accomplishment and execution of the full

purposes and objectives of Congress, as set forth in S 36(b),

we must focus on and attempt to discern the intent of

Congress in enacting S 36(b). Further more, because S 36(b)

represents congressional legislation in a field which the

States have traditionally occupied9 -- tort actions for

breach of fiduciary duty and fraud -- we must, as the

Court stated in Medtronic, "start with the assumption that

the historic police powers of the States," in this case the

power of states to hold investment company management

liable for improper compensation arrangements,"were not

to be superseded . . . unless that was the clear and

manifest purpose of Congress." Medtr onic, 518 U.S. at 485.

In arguing that state law "stands as an obstacle to the

accomplishment and execution of the full purpose and

objectives of Congress," and thus that the plaintiffs' state

law claims "conflict" with and are pr eempted by S 36(b), the

defendants rely heavily upon and quote extensively from

the legislative history of S 36(b) of the ICA. Because

congressional intent is "the ultimate touchstone in every

pre-emption case," we will examine that legislative history

to discern the intent of Congress in enacting S 36(b).

In its own review of the legislative history, the District

Court found that "Congress enacted the ICA because it had

concluded that the nationwide activities of investment

companies called for federal regulation and, more relevant

_________________________________________________________________

9. See, e.g., Baggett v. First National Bank, 117 F.3d 1342, 1352 (11th

Cir. 1997) ("[C]auses of action for br eaches of fiduciary duties are

traditionally creatures of state law, and under Cort, it would be

inappropriate to infer a cause of action for such based solely on federal

law."); Gruber v. Price Waterhouse, 911 F.2d 960, 962 (3d Cir. 1990)

("The complaint asserted claims pursuant to section 11 of the Securities

Act of 1933, section 10(b) of the Securities Act of 1934 and rule 10b-5,

and common law fraud and deceit."); Pin v. T exaco, Inc., 793 F.2d 1448,

1452 (5th Cir. 1986) ("As to Texaco, the complaint alleges nothing more

than corporate mismanagement and breaches offiduciary duty that are

traditionally a matter of state regulation."); Data Probe Acquisition

Corp.

v. Datatab, Inc., 722 F.2d 1, 4 (2d Cir . 1983) ("The gravamen of the

claim

advanced here is a breach of management'sfiduciary duty to

shareholders, a matter traditionally committed to state law, which, if

entertained, would unquestionably embark us on a course leading to a

federal common law of fiduciary obligations.").

to the issue at hand, enacted Section 36(b) because the

existing remedies for improper compensation arrangements

had been ineffective." Green II , 53 F. Supp. 2d at 730. We

agree with this conclusion. A careful survey of the relevant

legislative history clearly and unequivocally indicates that

Congress enacted S 36(b) because it deter mined that

existing remedies for improper compensation arrangements

were inadequate to protect mutual fund investors.

The District Court quoted the Senate Report,

accompanying the final version of the 1970 Amendments,

which states that "the unique structure of mutual funds

has made it difficult for the courts to apply traditional

fiduciary standards in considering questions concerning

management fees." S. REP. NO. 91-184 (1970), reprinted in

1970 U.S.C.C.A.N. 4897, 4898 (Senate Report). Id. at 727-

28. The court then added that the "Senate Report . . . noted

that the provisions contained in the ICA as originally

passed in 1940 concerning the regulation of management

fees and other charges to the investor `did not provide any

mechanism by which the fairness of management contracts

could be tested in court'." Id., quoting Senate Report at

4901. The Senate Report went on to conclude that under

general rules of law, advisory contracts that had been

ratified by the shareholders or approved by disinterested

directors could not be upset except upon a showing of

"corporate waste":

As one court put it, the fee must "Shock the conscience

of the court." Such a rule may not be an impr oper one

when the protections of arm's-length bar gaining are

present. But in the mutual fund industry wher e, these

marketplace forces are not likely to operate as

effectively, your committee has decided that the

standard of "corporate waste" is unduly r estrictive and

recommends that it be changed. Id.

The District Court then cited the conclusion in the

Senate Report that the express statutory r equirement of

"reasonableness" be eliminated and a specific "fiduciary

duty" be "imposed on mutual fund investment advisers with

respect to management fee compensation." Green II, 53

F.Supp. 2d at 728 (citing Senate Report at 4902). The

"fiduciary duty" standard would make it easier for a

shareholder to prevail in an action against an investment

adviser who had entered into an improper or unfair

compensation arrangement.10

The defendants acknowledge that Congress enacted

S 36(b) and implemented the "breach offiduciary duty"

standard because it concluded that the "corporate waste"

standard previously applied in most states was largely

ineffective in preventing improper compensation

arrangements. However, neither the District Court nor the

defendants point to any language, either in the legislative

history of S 36(b) or in the statute itself, that suggests that

Congress intended to preempt state law claims for breach

of fiduciary duty or deceit when it enacted S 36(b).

Because Congress had found that the "corporate waste"

standard was inadequate to meet the problem, it sought to

provide mutual fund shareholders with additional

protection from improper compensation arrangements.

Nevertheless, the fact that the prior remedy might be less

effective does not mean that it stands as an obstacle to "the

accomplishment and execution of the full purpose and

objective of Congress." Even though the common law is less

effective than S 36(b), it may still be the remedy of choice in

certain situations. The creation of a gr eater protection does

not mean that the lesser protection is an obstacle if a

complainant elects to employ it. Moreover , the "lesser

protection," even if it is more difficult for a complainant to

prove a breach of the standard of car e, may offer a greater

range of targets and of remedies. Defendants have not

demonstrated that Congress intended to eliminate common

law access to these targets or these r emedies.

Our conclusion that S 36(b) does not pr eempt the

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10. Inherent in the discussion of br each of fiduciary duty vs. corporate

waste is the concept that stockholder ratification or disinterested

director approval of an advisory contract eliminated the breach of

fiduciary duty standard in an attack on the terms of the advisory

contract. See, e.g., Saxe v. Brady, 184 A.2d 602 (Del. Ch. 1962) (holding

that where stockholders ratified investment adviser contract, interested

parties were relieved of burden of pr oving fairness of transaction; under

corporate waste standard, plaintiffs had not sustained burden of

establishing that fees were legally excessive.)

plaintiffs' state law claims is reinfor ced by cases, involving

other aspects of corporate governance, which hold that the

presence of a federal remedy to relieve a problem does not

preclude the recourse to a common law r emedy which is

directed at the same problem. An example is CTS Corp. v.

Dynamics, Corp., 481 U.S. 69 (1987), a securities

law/corporate law case discussing the potential pr eemptive

effect of the Williams Act. In holding that the Williams Act

did not preempt an Indiana state law r egulating corporate

takeovers, the Court stated:

The Indiana Act operates on the assumption, implicit

in the Williams Act, that independent shar eholders

faced with tender offers often are at a disadvantage. By

allowing such shareholders to vote as a gr oup, the Act

protects them from the coercive aspects of some tender

offers. . . . In such a situation under the Indiana Act,

the shareholders as a group, acting in the corporation's

best interest, could reject the of fer, although individual

shareholders might be inclined to accept it. The desire

of the Indiana Legislature to protect shareholders of

Indiana corporations from this type of coer cive offer

does not conflict with the Williams Act. Rather, it

furthers the federal policy of investor protection.

CTS Corp., 481 U.S. at 82-83 (emphasis added).

This conclusion can be stated in another way: The

creation of a federal remedy, in the field of securities law,

does not necessarily eradicate existing state law r emedies

or require that the federal remedy be exclusive. See, e.g.,

Medtronic, Inc. v. Lohr, 518 U.S. 470, 495-501 (1996)

(holding that S 360(k) of the Medical Device Amendments of

1976 does not preempt overlapping state tort law).

The defendants contend, nevertheless, that the strict

limitations of S 36(b) demonstrate that the plaintiffs' state

law claims should be preempted. The defendants point out

that, unlike the plaintiffs' state law claims:

(1) Section 36(b) expressly limits the parties against

whom relief can be sought, see 15 U.S.C. S 80a-

35(b)(3) (2000);11

_________________________________________________________________

11. While S 36(b) authorizes suit only against the "recipient" of the

alleged excessive compensation and expressly forbids bringing suit

(2) Section 36(b) limits the type and amount of r elief

a shareholder may recover, see id.;12

(3) Section 36(b) precludes shareholders from suing

for advisory fees paid more than one year prior to

the filing of the complaint, see id.; 13

(4) Section 36(b) imposes upon the plaintif f the

burden of proving that the investment adviser

breached his or her fiduciary duty, see 15 U.S.C.

S 80a-35(b)(1);14

(5) Section 36(b) requires plaintif fs to bring suit in

federal district court, see 15 U.S.C. S 80a-35(b)(5);15

(6) Section 36(b) creates no cause of action for the

investment fund itself--only the Securities and

Exchange Commission and shareholders of the

investment fund may bring suit against an

investment adviser for breach of fiduciary duty;16

and

_________________________________________________________________

against other parties, the plaintiffs in this case have sued numerous

parties under state law, many of which are not"recipient[s]" (as defined

by S 36(b)) of the alleged excessive compensation.

12. Plaintiffs are seeking compensatory damages with respect to their

state law claims.

13. As the District Court noted, this one-year statute of limitations is

significantly shorter than the corresponding six-year statute of

limitations for common law breach of fiduciary duty claims brought

under New Jersey law. See N.J. STAT. ANN. S 2A:14-1 (West 1999).

14. As the District Court noted, under the common law, a fiduciary who

allegedly breached his or her fiduciary duty must justify his or her

conduct. See, e.g., Gedes v. Anaconda Copper Mining Co., 254 U.S. 590,

599 (1921).

15. A plaintiff seeking to bring a br each of fiduciary duty claim under

state law would not have to bring his claim in federal district court and

indeed would be unable to bring his claim in federal district court unless

jurisdiction was provided for under 28 U.S.C.S 1367 (supplemental

jurisdiction) or 28 U.S.C. S 1332 (diversity jurisdiction).

16. At common law, the shareholder's suit for breach of fiduciary duty is

a derivative suit; the shareholder's right to bring suit is derived from

the

corporation's right to bring suit.

(7) At least one Court of Appeals has concluded that

S 36(b) creates an equitable cause of action and

thus plaintiffs suing under S 36(b) ar e not entitled

to a jury trial, see Krinsk v. Fund Asset

Management, Inc., 875 F.2d 404, 414 (2d Cir.

1989).17

Focusing on these procedural differ ences between a

common law cause of action and one under S 36(b), the

defendants reason that the differ ences reflect Congress's

intent to preempt state law claims and, as a consequence,

demonstrate that state law "stands as an obstacle to the

accomplishment and execution of the full purpose and

objectives of Congress." If, however , procedural differences

were sufficient both to indicate congr essional intent to

preempt overlapping state law and to demonstrate that

state law "stands as an obstacle to the accomplishment and

execution of the full purpose and objectives of Congress,"

federal law would preempt overlapping state law every time

federal law did not exactly mirror all the state law or state

laws in question. This argument finds no support in

relevant federal case law and is actually contrary to the

Supreme Court's preemption jurisprudence. See, e.g.,

Medtronic, Inc. v. Lohr, 518 U.S. 470, 495-96 (1996); Florida

Lime & Avocado Growers, Inc. v. Paul, 373 U.S. 132, 141-43

(1963). In short, establishing that federal law overlaps state

law is, by itself, insufficient to establish that federal law

preempts state law.

Indeed, if we were to accept the defendants' ar gument

that procedural differences both indicate congressional

intent to preempt the plaintiffs' state law claims and

demonstrate that state law "stands as an obstacle to the

accomplishment and execution of the full purpose and

objectives of Congress," then the '33 Act and the '34 Act

would also, by definition, preempt much state law in the

areas of corporate and securities law since many of the

procedural and substantive requirements of the '33 Act and

the '34 act differ markedly from the corr esponding

procedural and substantive requirements of corporate and

_________________________________________________________________

17. Presumably, a plaintiff seeking damages for common law fraud or

deceit is entitled to a jury trial.

securities law in most states. However, as noted above, it is

well-settled that the '33 Act and the '34 Act do not preempt

overlapping state law except where the overlapping state

law "stands as an obstacle to the accomplishment and

execution of the full purpose and objectives of Congress" or

where it is impossible to comply with both state and the

federal law. The '33 Act and the '34 Act are just two of

many possible examples of federal laws that do not

generally preempt overlapping state law. As the Supreme

Court noted in Medtronic in r egard to the potential

preemptive effect of S 360(k) of the Medical Device

Amendments of 1976:

Nothing in S 360(k) denies Florida the right to provide

a traditional damages remedy for violations of

common-law duties when those duties parallel federal

requirements. Even if it may be necessary as a matter

of Florida law to prove that those violations were the

result of negligent conduct, or that they cr eated an

unreasonable hazard for users of the pr oduct, such

additional elements of the state-law cause of action

would make the state requirements narr ower, not

broader, than the federal requir ement. While such a

narrower requirement might be"different from" the

federal rules in a literal sense, such a dif ference would

surely provide a strange reason for finding pre-emption

of a state rule insofar as it duplicates the federal rule.

The presence of a damages remedy does not amount to

the additional or different "r equirement" that is

necessary under the statute; rather, it mer ely provides

another reason for manufacturers to comply with

identical existing "requirements" under federal law.

Medtronic, 518 U.S. at 495 (emphasis added).

In this case, as in Medtronic, we ar e presented with

overlapping state and federal laws that impose dif ferent

procedural requirements upon plaintif fs seeking to bring

suit. However, here, as in Medtr onic, state law furthers "the

accomplishment and execution of the full purpose and

objectives of Congress." Neither the language of S 36(b) nor

the accompanying legislative history indicates, or even

suggests, that the plaintiffs' state law claims stand "as an

obstacle to the accomplishment and execution of the full

purpose and objectives of Congress."18 This fact is fatal to

the defendants' preemption arguments, especially in light of

the presumption against preemption in situations where

Congress has "legislated . . . in a field which the States

have traditionally occupied." See, e.g., Medtronic, 518 U.S.

at 484-86.

While the defendants argue that the pr ocedural

differences in question both indicate congressional intent to

preempt the plaintiffs' state law claims and demonstrate

that state law in this case "stands as an obstacle to the

accomplishment and execution of the full purpose and

objectives of Congress," we find it mor e likely that these

differences demonstrate a congressional attempt to limit the

relief available to plaintiffs underS 36(b). In enacting S 36(b)

in 1970, Congress not only created a federal, private right

of action previously unavailable under federal law,

Congress also radically altered the legal standard under

which the fairness and corresponding legality of mutual

fund compensation arrangements had been evaluated.

Consistent with Congress's intent in enactingS 36(b), the

legal standard under which mutual fund compensation

arrangements are evaluated under S 36(b) is markedly more

"plaintiff-friendly" than the "corporate waste" standard

applied by most state courts prior to 1970. In or der to

temper the radical change in the legal standar d under

which the fairness and corresponding legality of mutual

fund compensation agreements would be evaluated under

S 36(b), Congress instituted various pr ocedural limitations.

These procedural limitations are the same procedural

differences highlighted by the defendants as evidence that

state law in this case "stands as an obstacle to the

accomplishment and execution of the full purpose and

objectives of Congress."

_________________________________________________________________

18. Defendants argue in their brief that the ICA generally and S 36(b)

specifically demonstrate a "Congressional desire to replace . . .

ineffective

state laws with a `national' uniform standard." Brief for Appellees at 13

(emphasis added). As a threshold matter , we note that the defendants

have cited no authority that indicates or even suggests that a desire for

uniformity alone gives rise to "conflict preemption" of state law by

federal

law.

Although the defendants argue to the contrary, we

conclude that these procedural differ ences and limitations

do not indicate that state law in this case "stands as an

obstacle to the accomplishment and execution of the full

purpose and objectives of Congress," but rather show that

Congress realized that S 36(b)'s sweeping change in the

legal standard, under which the fairness of mutual fund

compensation agreements would be evaluated, necessitated

corresponding limitations in the relief available.

In addition, we note that the defendants' reliance on

recent the Supreme Court preemption decisions in United

States v. Locke, 120 S. Ct. 1135 (2000), Geier v. American

Honda Motor Co., 120 S. Ct. 1913 (2000), Nor folk Southern

Ry. v. Shanklin, 120 S. Ct. 1467, 1477 (2000), and Crosby

v. National Foreign Trade Council, 2000 WL 775550 (June

19, 2000) is misplaced. The Supreme Court's holding in

Locke that Title II of the Ports and W aterways Safety Act

(PWSA) preempts conflicting state law was based primarily

on the doctrine of stare decisis. Many of the issues raised

in Locke were raised, analyzed and addr essed by the

Supreme Court in Ray v. Atlantic Richfield Co., 435 U.S.

151 (1978). To the extent that the subsequent enactment of

the Oil Pollution Act (OPA) modified or amended the Ports

and Waterways Safety Act, the relevant statutory history

explicitly states that the OPA "does not disturb the

Supreme Court's decision in Ray v. Atlantic Richfield Co.,

435 U.S. 151 (1978)." Locke, 120 S. Ct. at 1147 (quoting

H.R. CON. REP. NO. 101-653, at 122 (1990)). More

importantly, Locke is distinguishable fr om the case now

before us because Congress, in enacting the OPA and

PWSA, did not "legislate[ ] . . . in afield which the States

have traditionally occupied." Thus, the pr esumption against

preemption present in this case did not exist in Locke.

Locke, 120 S. Ct. at 1147-48.

In Geier, the Supreme Court held that the petitioners'

state tort claim, based on a lack of an automobile airbag,

conflicted with the objectives of Federal Motor V ehicle

Safety Standard 208 and therefore was preempted by the

National Traffic and Motor Vehicle Safety Act of 1966. See

Geier, 120 S. Ct. at 1922. However, Geier, like Locke, is

distinguishable from the case before us because the Court

in Geier relied upon federal statutory language and the

corresponding legislative history, concluding that state law

stood "as an obstacle to the accomplishment and execution

of the full purpose and objectives of Congress."

Similarly, the Supreme Court's recent opinions in Norfolk

Southern Ry. v. Shanklin, 120 S. Ct. 1467, 1477 (2000) and

Crosby v. National Foreign Trade Council, 2000 WL 775550

(June 19, 2000) are distinguishable. The Court in Norfolk

held that the Federal Railroad Safety Act of 1970, in

conjunction with various regulations pr omulgated under

the act, preempted state law tort claims stemming from a

railroad's failure to maintain adequate warning devices at

crossings where federal funds were used to install such

warning devices. See Norfolk, 120 S. Ct. at 1474-77.

However, the Supreme Court's holding in Norfolk, like its

holding in Locke, was based primarily on the doctrine of

stare decisis. See Norfolk, 120 S. Ct. at 1474-77; CSX

Transp., Inc. v. Easterwood, 507 U.S. 658 (1993). Moreover,

Norfolk addressed the issue of "express preemption," not

"conflict preemption" and thus is inapposite to the case

now before us.

The Court in Crosby also held that a Massachusetts law

barring state entities from buying goods and services from

companies doing business in Burma was pr eempted by a

subsequent federal law imposing mandatory and

conditional economic sanctions on Burma. In contrast to

Norfolk, Crosby clearly pr esented a question of "conflict

preemption." However, like Locke and Geier, Crosby is

distinguishable because the Court in Crosby relied upon

the language of three clear and unambiguous federal

statutory provisions in concluding that state law stood "as

an obstacle to the accomplishment and execution of the full

purpose and objectives of Congress." In addition, in

enacting the federal statutory provisions at issue in Crosby,

Congress sought to affect national for eign policy: not "a

field which the States have traditionally occupied." Thus,

the presumption against preemption pr esent in this case

did not exist in Crosby.

Finally, we note that the party claiming preemption bears

the burden of demonstrating that federal law pr eempts

state law. See, e.g., Silkwood v. Kerr-McGee Corp., 464 U.S.

238, 255 (1984); Buzzard v. Roadrunner T rucking, Inc., 966

F.2d 777, 780 (3d Cir. 1992). Her e, the defendants bear the

burden of demonstrating that S 36(b) of the ICA preempts

the plaintiffs' state law claims for br each of fiduciary duty

and deceit. In order to prevail under a theory of "conflict

preemption," the defendants must demonstrate that the

state law at issue in this case "stands as an obstacle to the

accomplishment and execution of the full purpose and

objective of Congress" as set forth in S 36(b). Because we

conclude that the defendants have failed to make this

showing, we hold that the plaintiffs' state law claims are

not preempted by S 36(b).

IV. CONCLUSION

In arguing that the plaintiffs' state law claims for breach

of fiduciary duty and deceit are preempted by S 36(b) of the

ICA, the defendants fail to point to any language, either in

S 36(b) itself or in the accompanying legislative history that

demonstrates that Congress intended S 36(b) to preempt,

and thereby displace, the plaintiffs' state law claims. The

defendants also fail to demonstrate how state law in this

case "stands as an obstacle to the accomplishment and

execution of the full purpose and objectives of Congress."

We hold, therefore, that the plaintiffs' state law claims are

not preempted by S 36(b). We will reverse the District

Court's grant of judgment and remand this case to the

District Court for further proceedings.19

_________________________________________________________________

19. In so ruling, we note that the disposition of this appeal does not

hinge on the merits of plaintiffs' state law claims. Rejection of the

defendants' arguments in favor of preemption in no way suggests that

the plaintiffs should ultimately prevail on the merits. We hold only that

S 36(b) of the ICA does not preempt the plaintiffs' state law claims for

breach of fiduciary duty and deceit.

STANTON, District Judge, Dissenting:

For the reasons stated in the District Court's opinion,

Green v. Fund Asset Management, L.P. , 53 F.Supp.2d 723

(D.N.J. 1999) which I would affirm, I r espectfully dissent.

A True Copy:

Teste:

Clerk of the United States Court of Appeals

for the Third Circuit

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