Northstar Financial Advisors Inc. v. Schwab Investments, 779 F.3d 1036

Background

Schwab Total Bond Market Fund's shareholders (1997 vote) adopted two "fundamental" investment objectives: (1) seek to track the Lehman Brothers U.S. Aggregate Bond Index via indexing strategy; and (2) limit investment concentration to <25% in any one industry unless required to track the index. Those objectives were reflected in the Fund's registration statement and prospectuses.
Northstar Financial Advisors (initially a non-shareholder) sued as lead plaintiff on behalf of two classes alleging managers deviated from those fundamental objectives (2007–2009) and caused investor losses.
Procedural history: Ninth Circuit previously held no private right under §13(a) ICA. District court dismissed several pleadings (including contract claims) on SLUSA and standing grounds; Northstar later obtained a post‑filing assignment from a shareholder and filed a supplemental/ amended complaint.
The district court permitted supplementation; defendants moved to dismiss. The panel majority reviews standing, breach of contract, breach of fiduciary duty (direct vs. derivative), and third‑party beneficiary status of the Investment Advisory Agreement (IAA).
The SEC separately sued and alleged Schwab improperly reclassified non‑agency mortgage‑backed securities to avoid the 25% concentration limit; a consent judgment required disgorgement and distribution to harmed investors.

Issues

Issue	Plaintiff's Argument	Defendant's Argument	Held
Standing: May a post‑filing assignment cured by a supplemental pleading confer standing?	Northstar: Rule 15(d) supplementation may correct standing defects by alleging a post‑complaint assignment from a shareholder.	Schwab: Standing must exist at filing; post‑filing assignment cannot cure jurisdictional defect.	Held: Supplemental pleading under Rule 15(d) can cure the defect here; Northstar has standing.
Breach of contract: Do the proxy/registration/prospectus statements form an enforceable contract between Fund/Trust and shareholders?	Northstar: Shareholder vote adopting fundamental policies and SEC filings created contractual obligations; buying/holding shares accepted those terms.	Schwab: SEC disclosure documents are regulatory, not contractual; shareholder ratification doesn't create bilateral contracts with shareholders.	Held: Reversed dismissal — allegations suffice that the Fund’s registered fundamental policies and prospectus obligations formed a contract with shareholders.
Breach of fiduciary duty: Can investors sue trustees/adviser directly or must claims be derivative?	Northstar: Trustees of a Massachusetts business trust owe fiduciary duties to beneficiaries (shareholders); alleged breaches (deviating from fund fundamentals) directly injured shareholders.	Schwab: Mutual‑fund trustees resemble corporate directors; duties run to the trust/corporation, so claims must be derivative.	Held: Vacated dismissal — fiduciary duty claims may proceed as direct claims here; district court to consider remaining defenses.
Third‑party beneficiary: Are shareholders intended beneficiaries of the IAA between Trust and Adviser?	Northstar: IAA was approved by shareholders and designed to discharge Trust’s duties to shareholders; shareholders are intended beneficiaries entitled to enforce the IAA.	Schwab: IAA benefits the contracting parties; inurement clause and lack of explicit naming defeat third‑party beneficiary status.	Held: Reversed dismissal — shareholders plausibly alleged they are intended third‑party beneficiaries of the IAA.

Key Cases Cited

Northstar Fin. Advisors, Inc. v. Schwab Invs., 615 F.3d 1106 (9th Cir. 2010) (prior Ninth Circuit interlocutory ruling rejecting private §13(a) ICA cause of action)
Lapidus v. Hecht, 232 F.3d 679 (9th Cir. 2000) (SEC filings/prospectuses can create contract rights actionable by shareholders)
McKesson HBOC, Inc. v. New York State Common Ret. Fund, Inc., 339 F.3d 1087 (9th Cir. 2003) (prospectus did not create a contract with shareholders in merger context; distinguishable)
Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031 (Del. 2004) (clarified direct vs. derivative action test for corporate claims)
Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90 (1991) (Congress requires shareholder approval of adviser contracts, reflecting shareholders' substantial interest in adviser selection)
Mathews v. Diaz, 426 U.S. 67 (1976) (supplemental pleadings may cure jurisdictional conditions satisfied while action was pending)
Rockwell Int’l Corp. v. United States, 549 U.S. 457 (2007) (jurisdiction is assessed by reference to the operative complaint)
Grupo Dataflux v. Atlas Global Group, L.P., 541 U.S. 567 (2004) (time‑of‑filing rule in diversity jurisdiction context)