Northstar Financial Advisors, Inc. v. Schwab Investments
781 F. Supp. 2d 926
N.D. Cal.2011Background
- Plaintiff Northstar filed a class action on August 28, 2008 on behalf of all persons who owned Schwab Total Bond Market Fund shares from August 31, 2007 onward.
- Northstar alleged the Fund deviated from its objective to track the Lehman Brothers U.S. Aggregate Bond Index by investing in high-risk non-U.S. CMOs and by exceeding a 25% concentration in any single industry through mortgage-backed securities and CMOs.
- The initial 2009 Order allowed an assignment to cure standing and leaves to amend; the case was stayed pending appeal of Judge Illston’s ruling about a private right of action under ICA §13(a).
- The Ninth Circuit later reversed, finding no private right of action under Section 13(a); Northstar filed a Second Amended Complaint removing §13(a) and naming Schwab Investments Trust, its Trustees, and the Investment Advisor as defendants.
- The Second Amended Complaint asserts claims for breach of fiduciary duty, breach of contract, breach of the covenant of good faith and fair dealing, and third-party beneficiary status, all under state law, with SLUSA preclusion at issue.
- The court applies Rule 12(b)(6) standards, granting in part and denying in part with leave to amend, and ultimately dismisses most claims as SLUSA-precluded, except possibly a Massachusetts-law fiduciary-duty claim and a third-party beneficiary theory, which may proceed only if not precluded.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Standing cured by post-complaint assignment | Northstar's standing was cured by the December 8, 2008 assignment per Judge Illston's order and the FAC constitutes a Rule 15(d) supplement. | Standing must be determined at filing; post-filing assignment cannot cure standing. | Plaintiffs' standing adequately cured; motion to dismiss for lack of standing denied. |
| SLUSA preclusion scope | Class claims are not premised on misrepresentations; SLUSA does not preclude. | The SAC rests on misrepresentations and omissions in connection with the Fund's shares; SLUSA precludes. | All claims are SLUSA-precluded except the fiduciary-duty claim to the extent based on Massachusetts law; leave to amend granted. |
| Delaware carve-out applicability | Massachusetts law may allow a non-precluded fiduciary-duty claim under SLUSA carve-out. | Delaware carve-out only applies to Massachusetts-law claims and does not rescue broader claims; most claims remain precluded. | No basis to apply carve-out to preserve non-Massachusetts claims; carve-out leaves only Massachusetts-law fiduciary-duty claims potentially non-precluded. |
| Contract formation | The 1997 Proxy Statement and subsequent disclosures formed an enforceable contract with investors to maintain Fund objectives. | Prospectuses/disclosures do not automatically become contract terms; plaintiffs failed to plead contract formation. | Contract claim dismissed with prejudice for failure to plead a valid contract. |
| Breach of covenant of good faith and fair dealing | Covenant implied in contract could be violated by deviation from Fund objectives. | No valid contract, so no implied covenant against conduct not grounded in a contract. | Dismissed with prejudice. |
| Fiduciary duty and third-party beneficiary theories | Trusts under Massachusetts law may give direct standing for fiduciary-duty claims; Investment Advisor Agreement may confer third-party beneficiary status. | Derivative nature or lack of contract precludes direct fiduciary claims; third-party-beneficiary status uncertain and must be pled with specificity. | Fiduciary-duty claim contingent on non-SLUSA basis; derivative questions unresolved; third-party-beneficiary claim discussed with leave to amend but remains limited. |
Key Cases Cited
- Bell Atl. Corp. v. Twombly, 550 U.S. 544 (U.S. 2007) (plausibility standard for pleading a claim)
- Ashcroft v. Iqbal, 129 S. Ct. 1937 (U.S. 2009) (facially plausible claim required; not all allegations accepted)
- Proctor v. Vishay Intertechnology Inc., 584 F.3d 1208 (9th Cir. 2009) (SLUSA preclusion encompasses misrepresentations in connection with securities)
- McKesson HBOC, Inc. v. New York State Common Ret. Fund, 339 F.3d 1087 (9th Cir. 2003) (contract formation from prospectus disclosures requires more than mere offers to vote)
- Cohen v. Stratosphere Corp., 115 F.3d 696 (9th Cir. 1997) (prospectus not an offer; no contract formed)
- Dabit v. Merrill Lynch, 547 U.S. 71 (U.S. 2006) (SLUSA preemption under broad construction of 'in connection with')
- Laplidus v. Hecht, 232 F.3d 679 (9th Cir. 2000) (injuries affecting all fund shareholders are derivative under Massachusetts law)
- Astra USA, Inc. v. Santa Clara County, 588 F.3d 1237 (9th Cir. 2009) (third-party beneficiary and contract considerations under federal common law)