In re Charles Schwab Corp. Securities Litigation

Filing 164

ORDER RE MOTIONS TO DISMISS OF SCHWAB DEFENDANTS, INDEPENDENT TRUSTEES, AND PRICEWATERHOUSECOOPERS; ORDER RE MOTION TO STRIKE by Judge Alsup granting in part and denying in part #115 Motion to Dismiss; granting in part and denying in part #116 Motion to Dismiss; denying #117 Motion to Strike ; granting #123 Motion to Dismiss (whalc2, COURT STAFF) (Filed on 2/4/2009)

1 2 3 4 5 6 7 8 9 10 IN RE: CHARLES SCHWAB CORPORATION SECURITIES LITIGATION. This Document Relates To All Cases. No. C 08-01510 WHA IN THE UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF CALIFORNIA

United States District Court

11
For the Northern District of California

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

/

ORDER RE MOTIONS TO DISMISS OF SCHWAB DEFENDANTS, INDEPENDENT TRUSTEES, AND PRICEWATERHOUSECOOPERS; ORDER RE MOTION TO STRIKE

INTRODUCTION In this putative class action, plaintiffs allege that defendants Charles Schwab Corporation and several affiliated entities and individuals violated federal securities laws and various state laws by misrepresenting the risk profile and assets of Schwab's YieldPlus Fund and by improperly changing the fund's investment policies. Defendants include the Schwab Corporation, certain subsidiaries and officers, the YieldPlus Fund's trustees and portfolio managers, and the fund's auditor, PricewaterhouseCoopers, LLP. The Schwab defendants, the fund's independent trustees, and PricewaterhouseCoopers have filed separate motions to dismiss. The Schwab defendants also move to strike portions of the operative complaint. For the reasons stated below, the motions to dismiss filed by the Schwab defendants and the independent trustees are GRANTED IN PART and DENIED IN PART. PricewaterhouseCoopers' motion to dismiss is GRANTED. Finally, the motion to strike is DENIED.

1 2 3 4 5 6 7 8 9 10

STATEMENT This action originated as multiple independent class actions filed by investors in Schwab's YieldPlus Fund ("fund"), a short-term fixed-income mutual fund. These actions were consolidated into the present class action, and an order dated July 2, 2008, appointed the following plaintiffs as lead plaintiffs: Kevin O'Donnell, James Coffin, John Hill, David and Gretchen Mikelonis, and Robert Dickson. Plaintiffs bring this action against (1) several Schwab corporate entities, and officers and employees of those entities; (2) the trustees of Schwab Investments who signed the registration statements at issue; and (3) PricewaterhouseCoopers LLP, the fund's auditor. Plaintiffs allege that defendants positioned the fund, via registration statements and other related documents, as an "ultra short term bond fund" which sought to keep its average portfolio duration below one year and to limit "principal risk" exposure, to preserve capital. Instead, plaintiffs allege, the fund took on significantly greater risk by extending its average portfolio duration beyond two years and by concentrating a significant portion of its portfolio in riskier assets such as mortgage-backed securities. Therefore, plaintiffs allege, investors were unwittingly exposed to significant risks, and as the nation's credit crisis unfolded, those risks lead to substantial losses. For the purposes of the motions to dismiss, the following well-pled allegations will be taken as true. Defendant The Charles Schwab Corporation was the parent corporation of the Charles Schwab financial services complex. Charles Schwab & Co., Inc., was the parent company of Schwab Investments and was the principal underwriter and distributor for shares of the fund. Charles Schwab Investment Management, Inc., was the asset management arm of the Charles Schwab Corporation; it oversaw the asset management and administration of the fund. Schwab Investments, a business trust organized under the laws of Massachusetts, was the registrant for the fund, the issuer of fund shares and performed trust services for the fund. Charles R. Schwab was the founder, Chairman, CEO and director of the Charles Schwab Corporation. Defendants Evelyn Dilsaver, Randall W. Merk and George Pereira were officers of the fund; each signed some or all of the registration statements at issue in this case. Kimon Daifotis was the head of 2

United States District Court

11
For the Northern District of California

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

1 2 3 4 5 6 7 8 9 10

fixed income portfolio management at Schwab Management, and Matthew Hastings worked with Mr. Daifotis and was primarily responsible for the fund's day-to-day management during the relevant period. (All of these defendants will be referred to collectively as the "Schwab Defendants.") The complaint also names as defendants seven trustees of Schwab Investments, each of whom also allegedly signed the registration statements at issue (collectively, "Independent Trustees"). Finally, defendant PricewatersCoopers LLP ("PwC") was the fund's auditor (Compl. ¶¶ 24­46).1 The Schwab YieldPlus Fund is an open-ended mutual fund organized as a Massachusetts business trust registered under the Investment Company Act. It offered two classes of shares: Investor Shares and Select shares. The latter had a higher minimum investment requirement but lower fees compared to the former (Compl. ¶ 47). Defendants annually filed similar registration statements with the SEC, on or about November 15 of each year. They marketed and sold fund shares to investors with annual prospectuses. These were also published on or about November 15 of each year. The prospectuses referred investors to various Statements of Additional Information ("SAIs"). These contained more detailed discussions of the fund's investment policies and risks. Investors were also referred to the fund's Certified Shareholder Reports (i.e., Annual Reports). Both were incorporated by reference into the prospectuses. Defendants also marketed the fund through various other written offering notices, circulars, advertisements, letters; they provided information about the fund on the Schwab website; and they marketed the fund with oral communications, including by investment managers, brokers and customer representatives (Compl. ¶¶ 48­52, 77­85). Plaintiffs aver that, through these documents and communications, defendants made several misrepresentations regarding the investment policies and risk profile of the fund. Defendant represented that the fund was an "ultra short term bond fund" and that defendants sought to keep the fund's average portfolio duration at one year or less. In fact, defendants

United States District Court

11
For the Northern District of California

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

All references to the "complaint" and citations to "Compl." refer to the First Consolidated Amended Complaint (Dkt. No. 104).

1

3

1 2 3 4 5 6 7 8 9 10

abandoned that duration objective and extended the average duration of the fund's investments beyond two years (Compl. ¶ 86a­c). Defendants also represented that the fund was similar to a money market fund with minimal changes in share price. Plaintiffs claim that these representations were false because the fund concentrated an increasing portion of its assets -- eventually more than 45 percent -- in risky mortgaged-backed and asset-backed securities (Compl. ¶ 86d). As a result of these misrepresentations, plaintiffs contend, that the fund was improperly categorized in the "ultrashort bond fund" category because it had too much credit and illiquidity risk. Similarly, plaintiffs contend that the fund utilized the wrong comparative index, the "Lehman Brothers U.S. Short Treasury: 9­12 months," when in fact the fund's profile was not comparable to that index (Compl. ¶¶ 86f­g). The complaint further claims that the fund mis-priced a material portion of its assets as those assets deteriorated in value and liquidity, thus overstating the value of the fund's holdings. And, the fund "obscured the true nature of the securities in the fund's portfolio by using inconsistent asset descriptions," for example, by classifying the exact same security in some reports as variable-rate and in other reports as not variable-rate (Compl. ¶¶ 86h, 87). Plaintiffs intend to seek the certification, under Rules 23(a) and Rule 23(b)(3), of two classes, the second of which contains two sub-classes: (1) a "securities" class consisting of all persons or entities who acquired shares of the fund traceable to a false and misleading registration statement and prospectus and who were damaged thereby between March 17, 2005 to March 17, 2008 (the date of filing of this lawsuit); and (2) a "state law class." The latter consists of two sub-classes: (2a) a "pre-breach class" consisting of persons or entities who owned shares of the fund at any time before the fund's investments in mortgage-backed securities exceeded 25% of its assets and by continuing to own shares suffered damages; and (2b) a "post-breach class" consisting of all persons or entities who acquired shares of the fund at any time after the fund's investments in mortgage-backed securities exceeded 25% of its assets and by continuing to own those shares suffered damages (Compl. ¶¶ 3, 122­28).

United States District Court

11
For the Northern District of California

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

4

1 2 3 4 5 6 7 8 9 10

The complaint asserts eight counts. Count One alleges violations of Section 11 of the 1933 Act, 15 U.S.C. 77k, on behalf of the securities class. Count Two alleges violations of Section 12(a)(2) of the 1933 Act, 15 U.S.C. 77l, on behalf of the securities class. Count Three asserts control person liability under Section 15 of the 1933 Act predicated on the violations claimed in counts one and two. Count Four alleges intentional interference with contractual relations on behalf of the state pre-breach class. Count Five alleges violations of California's unfair competition laws on behalf of the state pre-breach class. Cal. Bus. & Prof. Code 17200 et seq. Count Six alleges intentional interference with contractual relations on behalf of the state post-breach class. Count Seven alleges violations of California's unfair competition laws on behalf of the state post-breach class. Count Eight alleges breach of fiduciary duty against all defendants except PwC (Compl. ¶¶ 129­187). ANALYSIS This order addresses four motions. Three groups of defendants have separately moved to dismiss: (1) the Schwab defendants, (2) the independent trustees, and (3) PwC. The Schwab defendants also move to strike portions of the First Consolidated Amended Complaint. 1. SCHWAB DEFENDANTS' MOTION TO DISMISS. A. The Section 11 Claim.

United States District Court

11
For the Northern District of California

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

Section 11 focuses specifically on misstatements or omissions in registration statements. It creates a private right of action for purchasers of securities, against certain enumerated defendants, where "any part of the registration statement, when such part became effective, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading." 15 U.S.C. 77k(a). The Ninth Circuit has described the elements of a Section 11 claim as follows: The plaintiff in a § 11 claim must demonstrate (1) that the registration statement contained an omission or misrepresentation, and (2) that the omission or misrepresentation was material, that is, it would have misled a reasonable investor about the nature of his or her investment. No scienter is required for liability under § 11; defendants will be liable for innocent or negligent material misstatements or omissions.

5

1 2 3 4 5 6 7 8 9 10

In re Daou Systems, Inc., 411 F.3d 1006, 1027 (9th Cir. 2005) (internal quotations and citations omitted). Although loss causation is not an element of the prima facie case under Section 11, that provision allows defendants to assert a lack of loss causation as an affirmative defense. See 15 U.S.C. 77k(e). Defendants contend that the complaint fails to state a claim under Section 11 because (1) it fails adequately to plead any misrepresentation with the specificity required by Rule 9(b), and (2) loss causation could not be proven under the facts alleged. Plaintiffs respond that the complaint need not satisfy Rule 9(b)'s pleading standards but rather only the more lenient standards of Rule 8 and that they will be able to establish loss causation under the circumstances alleged. (i) Misrepresentations and the Pleading Standard.

United States District Court

11
For the Northern District of California

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

The parties dispute whether plaintiffs' Section 11 claim should be analyzed under the notice pleading standards of Rule 8 or instead under Rule 9(b). The latter requires that "[i]n alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake." The applicability of Rule 9(b) hinges not on the elements of the claim but rather on the nature of the allegations themselves: "Rule 9(b) applies to `averments of fraud' in all civil cases in federal district court . . . in cases in which fraud is not an essential element of the claim, Rule 9(b) applies, but only to particular averments of fraud." Vess v. Ciba-Geigy Corp. USA, 317 F.3d 1097, 1103 (9th Cir. 2003). For example, "the plaintiff may allege a unified course of fraudulent conduct and rely entirely on that course of conduct as the basis of a claim. In that event, the claim is said to be `grounded in fraud' or to `sound in fraud,' and the pleading of that claim as a whole must satisfy the particularity requirement of Rule 9(b)." Id. at 1103­04. A typical example of that situation is where a plaintiff alleges that the same course of conduct constitutes both securities fraud under Section 10 as well as a violation of Section 11. In other cases, "a plaintiff may choose . . . to allege some fraudulent and some non-fraudulent conduct. In such cases, only the allegations of fraud are subject to Rule 9(b)'s heightened pleading requirements." Id. at 1104. 6

1 2 3 4 5 6 7 8 9 10

Where, as here, the plaintiff has not alleged that the same course of conduct constitutes both a Section 11 violation and a violation of other laws necessarily sounding in fraud such as Rule 10b-5, the "unified course of fraudulent conduct" test is essentially circular and is therefore uninstructive. Instead, courts examine the nature of the allegations themselves: "[f]raud can be averred by specifically alleging fraud, or by alleging facts that necessarily constitute fraud (even if the word "fraud" is not used). Under California law, the `indispensable elements of a fraud claim include a false representation, knowledge of its falsity, intent to defraud, justifiable reliance, and damages.'" Vess, 317 F.3d at 1105 (citations omitted). In such situations, only the allegations of fraudulent conduct must satisfy the heightened pleading requirements of Rule 9(b). In re Daou Systems, Inc., 411 F.3d at 1027. Moreover, "[t]he only consequence of a holding that Rule 9(b) is violated with respect to a § 11 claim would be that any allegations of fraud would be stripped from the claim. The allegations of innocent or negligent misrepresentation, which are at the heart of a § 11 claim, would survive." Ibid. (quoting Lone Star Ladies Inv. Club v. Schlotzsky's Inc., 238 F.3d 363, 368 (5th Cir. 2001)). Although Section 11 claims require a misrepresentation, they are not inherently fraudbased, unlike claims under Rule 10b-5. As stated, scienter is not required for claims under Section 11; defendants may be liable under Section 11 for negligent or even innocent misrepresentations. In re Daou Systems, Inc., 411 F.3d at 1027. Although Rule 9(b) does not ordinarily apply to Section 11 claims, "the particularity requirements of Rule 9(b) appl[ies] to claims brought under Section 11 when . . . they are grounded in fraud." In re Stac Electronics Securities Litigation, 89 F.3d 1399, 1404­05 (9th Cir. 1996). The complaint does not specifically allege fraud; indeed, it assiduously avoids use of the word. Moreover, it also generally avoids averments inherently suggestive of fraud such as that defendants "knowingly" or "intentionally" made the misrepresentations alleged. In their opposition brief, plaintiffs disclaim any allegation of fraud and contend that the complaint asserts merely negligent misrepresentations (Opp. at 3). The substance of the allegations themselves, however, must be examined.

United States District Court

11
For the Northern District of California

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

7

1 2 3 4 5 6 7 8 9 10

Defendants claim that, while fraud is not specifically pled, the allegations necessarily constitute fraud. Defendants first cite several allegations that defendants "misrepresented" various facts or circumstances. Those allegations alone are uninstructive on the issue because Section 11 requires a misrepresentation, but as stated Section 11 is concerned as much with negligent or innocent conduct as with fraud. The gist of defendants' argument is that "it is hard to comprehend how Schwab allegedly could have systematically misstated the maturity dates, prices, and descriptions of the securities in the fund, and exceeded a known concentration limit for over a year, without doing so intentionally" (Br. at 6). This order is unable to hold that the conduct alleged necessarily sounds in fraud. Other explanations are certainly possible. Indeed, although the complaint does not specifically plead negligence (plaintiffs make that argument only in their opposition brief), it alleges a potentially non-fraudulent cause of the misrepresentations -- that the misstatements arose from breakdowns in internal controls (Compl. ¶¶ 92, 94). Assuming that material misstatements occurred, is possible that many of the defendants were unaware of the fund's increasing risk and deviations from stated investment policies, and/or were merely negligent in failing to recognize and prevent them. The Ninth Circuit has applied Rule 9(b) to Section 11 claims where the plaintiff pled both fraud and non-fraud bases for liability based on the same course of conduct. In re Daou Systems, Inc., 411 F.3d at 1027. See also In re Stac Electronics Securities Litigation, 89 F.3d at 1404­05 & n.2 (in that situation, "nominal" efforts to disclaim fraud were "unconvincing"). No published Ninth Circuit decision has been found, however, applying Rule 9(b)'s particularity requirement to a Section 11 claim where, as here, the underlying conduct was not also alleged to have constituted fraud. Courts generally apply Rule 8 to Section 11 claims where only nonfraud bases for liability are pled or where such claims are adequately distinguished from fraud claims. See, e.g., In re Suprema Specialties, Inc. Securities Litigation, 438 F.3d 256, 270­73 (3d Cir. 2006); Romine v. Acxiom Corp., 296 F.3d 701 (8th Cir. 2002); In re Exodus Communications, Inc. Securities Litigation, 2005 WL 2206693 (N.D. Cal. 2005) (unpublished) (Chesney, J.). The Ninth Circuit has reached the same result in unpublished opinions. Safron 8

United States District Court

11
For the Northern District of California

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

1 2 3 4 5 6 7 8 9 10

Capital Corp. v. Leadis Technology, Inc., 274 Fed.Appx. 540 (9th Cir. 2008); Knollenberg v. Harmonic, Inc., 152 Fed.Appx. 674 (9th Cir. 2005). This order declines to characterize the claims as necessarily sounding in fraud where plaintiffs have not expressly pled fraud and have pled non-fraud bases for liability. For these reasons, Rule 8 governs the claim; defendants motion to dismiss the Section 11 claim for failure to satisfy Rule 9(b) is denied. (ii) Loss Causation.

As stated, loss causation is not an element of the prima facie case under Section 11, but defendants may assert a lack of loss causation as an affirmative defense. See 15 U.S.C. 77k(e). District courts have dismissed Section 11 claims on the pleadings where it was apparent on the face of the complaint that the plaintiffs would be unable to establish loss causation. See, e.g., In re DNAP Securities Litigation, 2000 WL 1358619, *3 (N.D. Cal. 2000) (unpublished) (Alsup, J.); In re Countrywide Financial Corp. Securities Litigation, 2008 WL 5100124, at *25 (C.D. Cal. 2008) (Pfaelzer, J.). Defendants contend that this is such a case. Defendants reasoning is as follows. Plaintiffs are investors in a mutual fund rather than in an individual security. The price of shares in a mutual fund -- the fund's net asset value -- is determined entirely by the value of the assets in the fund's portfolio: "the value of a mutual fund share is calculated according to a statutory formula. Share price is a function of `Net Asset Value,' the pro-rata share of assets under management, minus liabilities such as fees." In re Morgan Stanley and Van Kampen Mut. Fund Securities Litigation, 2006 WL 1008138, at *9 (S.D. N.Y. 2006). Thus, even if the fund misrepresented its investment policies and/or risk profile, those misrepresentations could not have caused plaintiffs' losses because the misrepresentations did not cause the decline in the value of the portfolio's asset holdings. Surface appeal aside, defendants restrict the concept of loss causation is too narrowly. Loss causation is "a causal connection between the material misrepresentation and the loss." Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 342 (2005). The concept of loss causation is analogous to the common-law doctrine of proximate cause: "Dura culls from the common law the black letter law that a fraud plaintiff must show that he acted on the basis of the fraud and suffered pecuniary loss as a result of so acting." Merrill Lynch & Co. Inc. v. 9

United States District Court

11
For the Northern District of California

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

1 2 3 4 5 6 7 8 9 10

Allegheny Energy, Inc., 500 F.3d 171, 183 (2d Cir. 2007) (citation omitted). Although the loss causation inquiry often hinges on the timing of purchases and sales in relation to the typical inflation-disclosure-deflation cycle, loss causation is not limited to that scenario. See In re Mutual Funds Inv. Litigation, 2008 WL 5412407, at *4 (D. Md. 2008). Indeed, although Dura addressed that scenario, the decision explained that it "need not, and d[id] not, consider other proximate cause or loss-related questions." Dura Pharmaceuticals, 544 U.S. at 346. Moreover, the Ninth Circuit has explained that "[a] plaintiff is not required to show that a misrepresentation was the sole reason for the investment's decline in value' in order to establish loss causation." In re Daou Systems, 411 F.3d at 1025 (citations omitted). Defendants' narrow formulation of loss causation would effectively insulate mutual fund companies from claims for a wide range of material misrepresentations regarding fund policies, risks and investment decisions. Defendants would immunize a scheme that purported to invest in low-risk government bonds but in fact invested in legitimate but high-risk treasure-hunting expeditions. Loss causation, however, is not limited to the common "corrective disclosure-price drop" scenario. As courts in other circuits have explained, a plaintiff may establish loss causation by alleging "that the subject of the fraudulent statement or omission was the cause of the actual loss suffered;" that defendants' "misstatements and omissions concealed the price-volatility risk (or some other risk) that materialized and played some part in diminishing the market value of" the security. Lentell v. Merrill Lynch & Co., 396 F.3d 161, 173, 177 (2d Cir. 2005) (citation omitted; emphasis in original). That is: the loss must be caused by the "materialization of the concealed risk." [citing Lentell, 396 F.3d at 173.] Thus, "the Second Circuit has made clear that in order `[t]o plead loss causation, the complainant must allege facts that support an inference that [defendants'] misstatements and omissions concealed the circumstances that bear upon the loss suffered such that plaintiffs would have been spared all or an ascertainable portion of that loss absent the fraud.'" In re Mutual Funds Inv. Litigation, 568 F. Supp. 2d 349, 359 (D. Md. 2008) (citations omitted).

United States District Court

11
For the Northern District of California

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

10

1 2 3 4 5 6 7 8 9 10

It is insufficient, of course, "for an investor to allege only that it would not have invested but for the fraud. Such an assertion alleges transaction causation, but it does not allege loss causation." Ray v. Citigroup Global Markets, Inc., 482 F.3d 991, 995 (7th Cir. 2007). Loss causation, however, can be established where a plaintiff proves that "it was the very facts about which the defendant lied which caused its injuries." Ibid. (citing Caremark, Inc. v. Coram Healthcare Corp., 113 F.3d 645, 648 (7th Cir.1997)). In that instance, the loss is caused because "the failure to disclose th[e] fact caused [the] injury through [the plaintiff's] undervaluation of the risk it was undertaking in accepting the [investment]." Caremark, 113 F.3d at 648. Here, plaintiffs certainly alleged that the subject of the fraudulent statements caused their losses -- that defendants misrepresented or failed to disclose portfolio risks, the materialization of which caused (or exacerbated) the losses. Similarly, if defendants misrepresented the scope of the fund's risks, and the undisclosed risks exacerbated the losses, then plaintiffs' resulting undervaluation of risks might be deemed to have caused some portion of their losses. Other causation theories also conceivable. For example, defendants explain that the fund investors' losses were exacerbated through a "run on the fund" scenario: as losses mounted, more an more investors sought to withdraw their investments, forcing the fund to liquidate assets at low prices, which in turn contributed to the share-price decline (Br. at 5). If investors' realization that they had assumed more risk than had been previously disclosed contributed to the investor redemptions, then the fraud caused at least a portion of plaintiffs' losses. In any event, it is not apparent on the face of the complaint that plaintiffs could not establish loss causation. B. Section 12(a)(2) Claim.

United States District Court

11
For the Northern District of California

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

Section 12 allows purchasers of securities to sue "[a]ny person who . . . offers or sells a security . . . by means of a prospectus or oral communication," containing a material misstatement or misleading omission. 15 U.S.C. 77l(a)(2). Defendants move to dismiss the Section 12(a)(2) claim on the grounds that (1) the complaint fails adequately to allege any

11

1 2 3 4 5 6 7 8 9 10

material misrepresentations or omissions; (2) plaintiffs would be unable to establish loss causation; and (3) defendants are not statutory "sellers" within the meaning of Section 12(a)(2). (i) Misrepresentations & Loss Causation.

Defendants do not allege that the misrepresentation and loss causation inquiries are in any way different for the Section 12 claim than they were for the Section 11 claim; defendants simply incorporate their Section 11 arguments by reference. As with Section 11, fraud is not an element of a Section 12(a)(2) claim. See Miller v. Thane Intern., Inc., 519 F.3d 879, 886 (9th Cir. 2008). Therefore, as explained, the Section 12(a)(2) claim must satisfy Rule 9(b) only to the extent that the factual allegations sound in fraud. The allegations underlying the Section 12 claim are the same as those underlying the Section 11 claim. Therefore, plaintiffs Section 12 claims, like the Section 11 claims, do not sound in fraud and Rule 8 rather than Rule 9(b) applies. Similarly, a lack of loss causation is an affirmative defense rather than an element of the claim under Rule 12(a)(2). 15 U.S.C. 77l(b). A Section 12 claim will be dismissed where it is evident on the face of the complaint that loss causation could not be established. In re Merrill Lynch & Co., Inc. Research Reports Securities, 289 F. Supp. 2d 429, 437 (S.D. N.Y. 2003). For the reasons stated above, it is not evident on the face of the complaint that plaintiffs would be unable to establish loss causation. (ii) Were Defendants Statutory "Sellers"?

United States District Court

11
For the Northern District of California

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

As stated, Section 12(a)(2) claims may be asserted only against a defendant who "offers or sells a security." The Supreme Court has ruled that the phrase "offers or sells" includes not only traditional sellers -- individuals who pass title to another -- but also certain individuals who engage in the solicitation of sales: The person who gratuitously urges another to make a particular investment decision is not, in any meaningful sense, requesting value in exchange for his suggestion or seeking the value the titleholder will obtain in exchange for the ultimate sale . . . . [L]iability extends only to the person who successfully solicits the purchase, motivated at least in part by a desire to serve his own financial interests or those of the securities owner.

12

1 2 3 4 5 6 7 8 9 10

Pinter v. Dahl, 486 U.S. 622, 647 (1988). As the Ninth Circuit has explained, "plaintiff must allege that the defendants did more than simply urge another to purchase a security; rather, the plaintiff must show that the defendants solicited purchase of the securities for their own financial gain." In re Daou Systems, Inc., 411 F.3d 1006, 1029 (9th Cir. 2005).2 Defendant Schwab Investments is alleged to have been the issuer of the funds (Compl. ¶ 28). Defendant Charles Schwab & Co. is alleged to have been the distributor and principal underwriter (Compl. ¶ 26). Defendants virtually concede that those two defendants are proper parties. Defendants argue, however, that only those two defendants could have passed title to plaintiffs, and only Charles Schwab & Co., the broker-dealer, could be deemed to have solicited investments in the fund. Defendants claim that the allegations against all other defendants are insufficient. In opposition, plaintiffs rely predominantly on their allegation that defendants Charles A. Schwab, Dilsaver, Merk and Pereira (as well as the independent trustees, as discussed infra), signed offering documents such as registration statements. Plaintiffs supplement that allegation with other general averments, for example, that defendants were "participants" in the distribution of the fund's shares; that defendants "offered and sold" the funds shares; and that defendants "actively solicited the sale of the fund's shares" (Compl. ¶¶ 138, 140­141). The complaint adds that defendant Daifotis "participated in the written or oral communications used to market the fund" and that defendant Hastings similarly "participated in the marketing of the fund" (Compl. ¶¶ 40­41). The Ninth Circuit has not addressed whether simply alleging that a defendant signed a registration statement -- possibly combined with other generalized allegations of solicitation

United States District Court

11
For the Northern District of California

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

Pinter addressed a claim under Section 12(a)(1), but the Ninth Circuit has clarified that the same inquiry governs claims under Section 12(a)(2). Moore v. Kayport Package Exp., Inc., 885 F.2d 531, 535­36 (9th Cir. 1989).

2

13

1 2 3 4 5 6 7 8 9 10

activity -- will suffice to state a Section 12 claim. Other courts faced with such claims have reached varying results.3 In Pinter, the Supreme Court left little doubt that mere participation in a solicitation or sale will not suffice: "[Section] 12's failure to impose express liability for mere participation in unlawful sales transactions suggests that Congress did not intend that the section impose liability on participants' collateral to the offer or sale. When Congress wished to create such liability, it had little trouble doing so." Pinter, 486 U.S. at 650 & n.27. The decision further explained that "[t]he `purchase from' requirement of § 12 focuses on the defendant's relationship with the plaintiff-purchaser." Id. at 651. Courts have extrapolated from these statements a requirement that the defendant be alleged to have had some "direct" role in the solicitation of the plaintiff, although the Ninth Circuit has not explained precisely what that direct role may entail. See In re Daou Systems, 411 F.3d at 1029 (asking whether "defendants were `directly involved' in the actual solicitation of a securities purchase"). See also In re Westinghouse Securities Litigation, 90 F.3d 696, n.19 (3d Cir. 1996) (Alito, J.) (direct and active participation in solicitation is necessary for solicitation liability); In re Alliance Equipment Lease Program Securities Litigation, 2002 WL 34451621, at *7­8 (S.D. Cal. 2002) (collecting cases).

United States District Court

11
For the Northern District of California

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

3 Compare Degulis v. LXR Biotechnology, Inc., 928 F. Supp. 1301, 1315 (S.D.N.Y. 1996) ("Although signing the registration statement need not constitute active solicitation . . . it is, at this stage of the proceedings, a sufficient allegation to permit Plaintiffs to present evidence that, alone or in tandem with other acts, the signatures constituted active solicitation"); In re Sirrom Capital Corp. Securities Litigation, 84 F. Supp. 2d 933, 945 (M.D. Tenn. 1999) ("A Prospectus itself is considered a solicitation document. Thus, the Defendants who actually signed the Registration Statements may be said to have solicited the public to purchase the stock") (citations omitted); In re National Golf Properties, Inc., 2003 WL 23018761 (C.D. Cal. 2003) (same); DeMaria v. Andersen, 153 F. Supp. 2d 300, 308 (S.D.N.Y. 2001) (similar); In re Portal Software, Inc. Securities Litigation, 2006 WL 2385250, at *4 (N.D. Cal. 2006) (allegations of signing registration statement combined with other averments of solicitation sufficed); In re Deutshce Telekom AG Securities Litigation, 2002 WL 244597, at *5 (S.D.N.Y. 2002) (those who sign registration statement, but not prospectus, are considered solicitors); with In re Harmonic, Inc., Securities Litigation, 2006 WL 3591148, at *13 (N.D. Cal. 2006) ("Nor is the addition of the claim against Ley that he signed the prospectus sufficient to qualify him as a `seller' . . . . While district courts are split on this issue, as demonstrated by the cases cited by the parties herein, the circuits that have addressed the issue have determined that simply signing a registration statement or prospectus provides an insufficient legal basis for relief"); Rosenzweig v. Azurix Corp., 332 F.3d 854, 871 (5th Cir. 2003) (similar); In re Infonet Services Corp. Securities Litigation, 310 F. Supp. 2d 1080, 1101 (C.D. Cal. 2003) (similar; applying Rule 9(b)).

14

1 2 3 4 5 6 7 8 9 10

This order finds that plaintiffs adequately pled solicitation. Plaintiffs alleged more than mere participation. As many courts have found, the registration statement is itself a solicitation document. Although the act of signing a registration statement, alone, may not always suffice, it is at least suggestive of solicitation activity. As stated, the complaint also alleges that defendants "actively solicited the sale of the fund's shares" and that certain defendants were involved in marketing the fund. Whether or not defendants actually solicited plaintiffs' sales is a factual question which should generally be left to the jury; at this stage plaintiffs' need only satisfy Rule 8(a)'s lenient pleading standards. In re Westinghouse Securities Litigation, 90 F.3d at 717. For these reasons, the complaint adequately pleads that defendants were statutory "sellers" under Section 12(a)(2). C. Section 15 Claim.

United States District Court

11
For the Northern District of California

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

Section 15 of the Securities Act of 1933 imposes joint and several liability upon every person who controls any person liable under Sections 11 or 12 of the Act. 15 U.S.C. 77o; In re Daou Systems, Inc., 411 F.3d 1006, 1029­30 (9th Cir. 2005). To state a control person claim, plaintiff must establish (1) a primary violation of the pertinent federal securities laws, and (2) that defendants exercised actual power or control over the primary violator. See Howard v. Everex Systems, Inc., 228 F.3d 1057, 1065 (9th Cir. 2000). See also 17 C.F.R. 230.405 (defining "control"). "Whether [the defendant] is a controlling person is an intensely factual question, involving scrutiny of the defendant's participation in the day-to-day affairs of the corporation and the defendant's power to control corporate actions." Howard, 228 F.3d at 1065.4 The complaint asserts control-person claims against several defendants: The Charles Schwab Corporation, Charles Schwab & Co., Inc., Schwab Investment Management, Schwab Investments, Charles R. Schwab, Dilsaver, Merk and Pereira.5 As explained, the corporate

4 Although Howard addressed control-person liability under Section 20 of the Exchange Act rather than Section 15 of the Securities Act, and Section 15 and Section 20(a) are separate bases of liability, the Ninth Circuit has held that the analysis is identical. Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1578 (9th Cir. 1990). 5

Control-person claims are also asserted against the independent trustees, as discussed infra.

15

1 2 3 4 5 6 7 8 9 10

defendants are alleged to have been the issuer of the fund's shares, the underwriter and distributer of those shares, and parent companies of those two entities, respectively. The individual defendants are alleged to have been officers of the fund. Each of the individual defendants is alleged to have signed the registration statements at issue. Defendants argue that the complaint fails to convey how the alleged control persons exercised actual power and control over the fund, asserting that the fund is "completely separate" from Schwab and its subsidiaries. This assertion is a factual rebuttal inappropriate for a motion to dismiss. Defendants may ultimately establish that the fund is "completely separate" from Schwab and its subsidiaries, but that is not the only, or indeed the most natural, inference drawn from the allegations in the complaint. Defendants are on fair notice of the claims; plaintiffs are at least entitled to seek to prove that the alleged "parent company of the Charles Schwab financial services complex," the "parent company of [the asset management company] and the principal underwriter and distributor for [the] shares," the entity that "over[saw] the asset management and administration of the [fund]," and the registrant and issuer of the shares, were each in a position to exercise actual power and control over the contents of the registration statements and reports at issue (Compl. ¶¶ 25­28). Defendants also take issue with the complaint for failing to explain how the individual defendants -- officers of the fund -- exercised control over the corporate entities, which are parents of the fund. Defendants, evidently, would require plaintiffs to establish that the control persons exercised power and control over all primary violators. No authority suggesting such a burden has been cited. At this stage, as explained above, Section 11 and Section 12 claims remain against all of the Schwab defendants. It is a plausible inference, for example, that individuals who were officers of the fund (and other Schwab entities, in some cases) and who signed the registration statements were in a position to exercise power and control over Schwab Investments and/or the fund's portfolio managers, Daifotis and Hastings. Defendants' motion to dismiss the Section 15 claims is therefore denied.

United States District Court

11
For the Northern District of California

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

16

1 2 3 4 5 6 7 8 9 10

D.

Are the State Claims Preempted?

Defendants contend that all of the complaint's state-law claims are preempted by the Securities Litigation Uniform Standards Act ("SLUSA"). The preemption provision states: No covered class action based upon the statutory or common law of any State or subdivision thereof may be maintained in any State or Federal court by any private party alleging-(1) an untrue statement or omission of a material fact in connection with the purchase or sale of a covered security; or (2) that the defendant used or employed any manipulative or deceptive device or contrivance in connection with the purchase or sale of a covered security. 15 U.S.C. 77p, 78bb (emphasis added).6 Plaintiff does not dispute that this action is a "covered class action" regarding a "covered security." See Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71, 82 n.6 (2006) (defining the terms). Plaintiff argues, however, that the state claims do not allege "untrue statements or omissions" and are not related to the purchase or sale of the covered securities, i.e., a securities transaction. This order agrees. The state claims are not, in substance, predicated on misrepresentations or omissions. Rather, each of those claims asserts a violation arising from an allegedly unauthorized change of the fund's concentration policy, which expressly limited concentration to 25 percent of assets in any single "industry." Plaintiff alleges that the violations occurred when the fund changed its concentration policy by ceasing to define mortgage-backed securities as an "industry," without a shareholder vote, thereby permitting the fund to invest far more than 25 percent of its assets in mortgage-backed securities and other such assets. Plaintiff alleges that both a contract between Schwab and its investors, as well as the Investment Company Act, required the shareholder vote. Plaintiff also asserts a fiduciaryduty claim predicated on self-dealing and requests leave to amend in order to assert a fiduciary claim based on voting rights. None of these claims are predicated on a misrepresentation -- plaintiffs readily agree that Schwab properly disclosed the change in its concentration policy but argue that the change was nevertheless improper.
SLUSA amended the 1933 Act and the 1934 Act in nearly identical ways. Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71, 82 n.6 (2006).
6

United States District Court

11
For the Northern District of California

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

17

1 2 3 4 5 6 7 8 9 10

Defendants argue to the contrary by citing allegations of misrepresentations in the complaint which underpin the federal securities claims. For example, defendants cite the allegations that Schwab misrepresented the nature of the fund as an "ultra-short bond fund" and misrepresented the fund's portfolio duration. True, those allegations are incorporated by reference into the state claims but are really irrelevant thereto. When applying SLUSA, courts ignore extraneous allegations and focus on the gravamen of the complaint: "when an allegation of misrepresentation in connection with a securities trade, implicit or explicit, operates as a factual predicate to a legal claim, that ingredient is met. To be a factual predicate, the fact of a misrepresentation must be one that gives rise to liability, not merely an extraneous detail." LaSala v. Bordier et Cie, 519 F.3d 121, 141 (3d Cir. 2008). Because the state claims are not predicated upon a misrepresentation in connection with a securities transaction, those claims are not preempted. E. Intentional Interference with Contractual Relations Claims.

United States District Court

11
For the Northern District of California

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

Counts Four and Six of the complaint assert claims for intentional interference with contractual relations on behalf of the state pre-breach and post-breach classes, respectively, against all corporate defendants and several individual defendants. Plaintiffs' theory is as follows: the registration statement, prospectus and SAIs constituted a contract; the fund's investment policies, including the above-discussed 25 percent concentration policy, were a term of that contract; the SAI's also provided that those investment policies could not be changed without a shareholder vote; the fund, therefore, violated one or both of those contract terms when it began concentrating assets in mortgage-backed securities (Compl. ¶¶ 151­170). In order to state a claim for intentional interference with contractual relations under California law, a plaintiff must plead: (1) a valid contract between plaintiff and a third party; (2) defendant's knowledge of this contract; (3) defendant's intentional acts designed to induce a breach or disruption of the contractual relationship; (4) actual breach or disruption of the contractual relationship; and (5) resulting damage. Quelimane Co. v. Stewart Title Guaranty

18

1 2 3 4 5 6 7 8 9 10

Co., 19 Cal. 4th 26, 55 (1998).7 Moreover, as the third-party requirement suggests, the claim may not be asserted against parties to the contract: "a stranger to a contract may be liable in tort for intentionally interfering with the performance of the contract . . . . However, the tort cause of action for interference with a contract does not lie against a party to the contract." Applied Equipment Corp. v. Litton Saudi Arabia Ltd., 7 Cal. 4th 503, 513­14 (1994) (emphasis added). Defendants move to dismiss the claims on the grounds that (1) plaintiffs failed to plead the existence of a contract; (2) defendants are not proper parties; (3) the fund did not breach the alleged contract in the manner claimed; and (4) the complaint fails adequately to plead intentional interference. This order finds that the complaint fails adequately to plead the existence of a contract. Under California law, a valid contract requires (1) [p]arties capable of contracting; (2) [t]heir consent; (3) [a] lawful object; and (4) [a] sufficient cause or consideration. Cal. Civ. Code § 1550. The complaint fails to plead facts from which the existence of a contract could plausibly be inferred. For example, the complaint never identifies the parties to the alleged contract; in fact, it offers contradictory averments on the subject. The complaint first avers that "the Registration Statement, Prospectus and SAIs constituted a contract between each investor and Schwab" (Compl. ¶ 151). The complaint identifies "Schwab" as defendant Charles Schwab & Co. (Compl. ¶ 26). The complaint, however, later claims that it was the "defendant Fund" who was the party to, and breached, the contract. In their briefing, plaintiffs do little to clarify the matter, variously asserting that the "Fund," or Schwab Investments, or all who signed the prospectus (including most or all of the individual defendants), are parties to the contract (Opp. at 20­22). For similar reasons, the defendants deemed strangers to the contract, and therefore proper parties for this claim, are a moving target. The claim is asserted against Schwab Investments and most of the individual defendants, but in opposition plaintiffs admit that most of them are parties to the contract (Opp. at 22). The complaint also fails to provide notice of other basic characteristics of the alleged contract, such as the contract's lawful object and the
7

United States District Court

11
For the Northern District of California

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

The parties agree that California law governs the claim.

19

1 2 3 4 5 6 7 8 9 10

nature of the consideration provided by the parties. The complaint fails to afford defendants notice of the nature claims asserted against it. The complaint, therefore, fails to state a claim for intentional interference with contractual relations. Without having the circumstances of a contract properly pled, this order need not and cannot address whether, in other circumstances, the registration statements and other documents might form the basis for a contract, an issue which the parties dispute. Plaintiffs request leave to amend in order to assert breach-of-contract claims against certain defendants. The intentional interference claim is dismissed without prejudice, and plaintiffs will be permitted to move for leave to amend in the manner described below. F. Section 17200 Claims.

United States District Court

11
For the Northern District of California

Counts Five and Seven assert violations of California's unfair competition laws on behalf of the state pre-breach and post-breach classes, respectively. The complaint asserts that defendants engaged in "unlawful" business acts and practices by violating federal law, including Sections 13(a) and 48(a) of the Investment Company Act. 15 U.S.C. 80a-13, 80a4 7 ( a ) .8 Section 13(a) proscribes various conduct, including the following: (a) No registered investment company shall, unless authorized by the vote of a majority of its outstanding voting securities-- . . . (3) deviate from its policy in respect of concentration of investments in any particular industry or group of industries as recited in its registration statement, deviate from any investment policy which is changeable only if authorized by shareholder vote, or deviate from any policy recited in its registration statement pursuant to section 80a-8(b)(3) of this title. 15 U.S.C. 80a-13(a)(3) (emphasis added). Section 48(a), in turn, provides, "[i]t shall be unlawful for any person, directly or indirectly, to cause to be done any act or thing through or by means of any other person which it would be unlawful for such person to do under the provisions of this subchapter or any rule, regulation, or order thereunder." 15 U.S.C. 80a-47(a).

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

Private rights of action the ICA itself are limited. See, e.g., Bellikoff v. Eaton Vance Corp., 481 F.3d 110 (2d Cir. 2007); Olmsted v. Pruco Life Ins. Co. of N.J., 283 F.3d 429, 433 (2d Cir. 2002); Potomac Capital Markets Corp. v. Prudential-Bache Corporate Dividend, 726 F.Supp. 87 (S.D.N.Y. 1989).

8

20

1 2 3 4 5 6 7 8 9 10

Defendants move to dismiss the claim on the grounds that (1) they did not in fact violate their concentration policy, and (2) California's unfair competition laws do not apply to violations of these provisions. Regarding the former, defendants emphasize that the fund's change in investment policy -- the decision to no longer deem mortgage-backed securities an "industry" in order to allow concentration in those assets -- was properly disclosed. This argument misses the crux of plaintiffs' claim. The problem, plaintiffs assert, is not a misrepresentation but rather that defendants changed the policy without a majority vote of the shareholders, as (they allege) was legally required. Defendants have provided no authority addressing whether the fund's amended definition constituted a "deviat[ion] from its policy in respect of concentration of investments in any particular industry or group of industries." This order, therefore, is unable to conclude on the pleadings that defendants did not violate or improperly amend the investment policy. Defendants' second claim relies on a decision of the California Court of Appeals. Bowen v. Ziasun Technologies, Inc., 116 Cal. App. 4th 777 (2004). Bowen analyzed the purpose of California's unfair business practices provision and ruled, for the first time, that "[S]ection 17200 does not apply to securities transactions." Id. at 788. Relying on Bowen, defendants argue that plaintiffs cannot predicate a Section 17200 claim on securities violations. The reach of the ruling, however, is far from certain. As a recent decision in this district explained, "[t]he California courts have expressly held that federal securities laws do not preempt Section 17200 generally . . . . In addition, Bowen and the cases on which it rests all dealt with fraud in the sale of securities . . . . Moreover, even the broad language of the Bowen case is limited to "securities transactions," and does not encompass all situations where securities are somehow implicated but not purchased or sold. Strigliabotti v. Franklin Resources, Inc., 2005 WL 645529 (N.D. Cal. 2005) (Illston, J.) (citations omitted). California decisions have since interpreted Bowen narrowly. Overstock.com, Inc. v. Gradient Analytics, Inc., 151 Cal. App. 4th 688, 715 & n.20 (2007) (also noting that the Attorney General has filed an amicus brief arguing that Bowen was wrongly decided); Adams v. Fiserv, 2008 WL 3890036, *8 (Cal. App. 4th 2008). Plaintiffs' Section 21

United States District Court

11
For the Northern District of California

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

1 2 3 4 5 6 7 8 9 10

17200 claims do not concern fraud in the sale of securities and, indeed, are not predicated upon violations of the 1933 or 1934 Acts. This order is unwilling to dismiss the claims on the pleadings based on Bowen. G. Breach of Fiduciary Duty Claim.

Count Eight of the complaint alleges breach of fiduciary duty against all defendants except PwC. It avers that each defendant was a fiduciary of the fund, and that each had inside information regarding the alleged misrepresentations and were therefore aware that the fund's value would decline due to the risky nature of its holdings. The claim avers that other funds within the Schwab family had invested in the YieldPlus Fund, and that defendants caused those other funds to withdraw, at the expense of members of the class. Defendants assert two challenges to the claim: (1) that the claim must be asserted derivatively, not directly; and (2) that the complaint fails to state a claim under Rule 9(b). As both sides recognize, because the fund is a Massachusetts trust, plaintiffs' fiduciaryduty claim should be analyzed under Massachusetts law. See Batchelder v. Kawamoto, 147 F.3d 915, 920 (9th Cir. 1998) (discussing the "internal affairs" doctrine). Under Massachusetts law, "if the wrong underlying claim results in harm to a plaintiff shareholder only because the corporate entity has been injured, with the plaintiff's injury simply being his proportionate share of the entity's injury, the harm to the shareholder is indirect and his cause of action is derivative." Forsythe v. Sun Life Fin., Inc., 417 F. Supp. 2d 100, 113 (D. M.A. 2006). Defendants contend that the claim must be asserted derivatively because plaintiffs have identified no injury distinct from other shareholders; rather, defendants contend, the alleged injury arises from the decline in value of the fund generally. Courts have on occasion permitted claims to be brought directly (as a shareholder) rather than derivatively (on behalf of the corporation) where unequal treatment is asserted. See, e.g., Frank v. LoVetere, 363 F. Supp. 2d 327 (D. Conn. 2005) (direct fiduciary claim stated for unequal shareholder treatment). Where such claims have been permitted, however, the plaintiffs were able to identify some unique injury not common to all shareholders. For example, share buy-backs on preferential terms may improperly divert funds from the company 22

United States District Court

11
For the Northern District of California

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

1 2 3 4 5 6 7 8 9 10

to certain shareholders but not to others. Plaintiffs here, however, identify no theory of individual injury and therefore fail to establish that their claim may be directly asserted. The fiduciary-duty claim is dismissed without prejudice, but plaintiff will be permitted to move for leave to amend including, as requested, to propose a fiduciary claim based on a violation of voting rights.9 For all of the above-stated reasons, the Schwab defendants' motion to dismiss is granted in part and denied in part. 2. INDEPENDENT TRUSTEES' MOTION TO DISMISS.

The independent trustees of the YieldPlus Fund have also moved to dismiss the complaint. As stated, defendant Schwab Investments is a Massachusetts business trust. The YieldPlus fund, defendants explain, is a series of that trust. Schwab Investments is the issuer and registrant of the fund's shares. The trust is governed by nine trustees. Two of those, including defendant Charles R. Schwab, are affiliated with Schwab entities; the remaining trustees are not alleged to have been otherwise-affiliated with Schwab (see Compl. ¶¶ 28­31; 34­40). Those seven trustees were represented by the fund to be independent of Schwab and to qualify as "disinterested" under the Investment Company Act of 1940 (Taylor Exh. B at 43­46).10 The seven "independent trustees" move to dismiss. They challenge five instances where, they allege, the complaint improperly "lumped" them into claims along with the other defendants. Specifically, they challenge the following claims: (1) that they were statutory "sellers" under Section 12(a)(2); (2) that they were"control persons" under section 15; (3) that they intentionally interfered with a contract between plaintiffs and Schwab; (4) that they committed an "unlawful act" under Section 17200; and (5) that they breached their fiduciary duties.

United States District Court

11
For the Northern District of California

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

It is therefore unnecessary to determine whether Rule 9(b) would apply to the claim or whether the claim would satisfy the pleading standards of Rule 9(b).
10

9

The Court takes judicial notice of the November 2007 SAI.

23

1 2 3 4 5 6 7 8 9 10

The third and fifth grounds for the independent trustees' motion to dismiss are granted, for the same reasons that the Schwab defendants' motion was granted on those claims. The remaining grounds for the motion will be discussed in turn. A. "Sellers" under Section 12(a)(2).

As explained, Section 12(a)(2) claims may be asserted only against those who "offer[ed] or s[old] a security." The independent trustees contend that the complaint failed adequately to plead that they sold or solicited the sale of a security under this provision. The motion must be denied. Although not all of the complaints' solicitation averments apply to the independent trustees, the most material of those allegations equally apply. The Schwab defendants' motion was denied because the complaint averred that they had signed the registration statements, documents inherently utilized for the solicitation of securities sales, and more generally that defendants "actively solicited the sale of the fund's shares." Those allegations also apply to the independent trustees. Although plaintiffs eventually must point to facts establishing that defendants were actually and directly involved in solicitation or sales, at this stage they need only satisfy Rule 8(a)'s lenient pleading standards. In re Daou Systems, 411 F.3d at 1029; In re Westinghouse Securities Litigation, 90 F.3d at 717. For these reasons, the motion is denied. B. Control Person Liability.

United States District Court

11
For the Northern District of California

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

Defendants contend that, as independent trustees, they are not alleged to have had dayto-day decisionmaking or control responsibilities in the company. They emphasize that their role as trustees was similar to that of outside directors, a role which has been held, in and of itself, insufficient to establish control-person liability.11 Howard v. Everex Sys., 228 F.3d 1057, 1067 (9th Cir. 2000) (board member held not a control person where the plaintiff alleged he "reviewed and approved" financial statements but made "no showing that [the defendant] . . . exercised any specific control over the preparation and release of the financial statements"). Where a board member is alleged to have signed the registration statements at issue, however,

Defendants draw an analogy between their role as independent trustees and the role of board members in a corporation, and plaintiffs do not argue that the analogy is inapposite.

11

24

1 2 3 4 5 6 7 8 9 10

courts have presumed that the director exercised actual authority and control, at least over the contents of and/or release of those statements. See, e.g., In re Alstom SA Secs. Litig., 406 F. Supp. 2d 433, 487 (S.D.N.Y. 2005) ("courts have held that officer or director status alone does not constitute control . . . . In contrast, if that same officer or director has signed financial statements containing materially false or misleading statements, courts have held that control as to the financial statements is sufficiently pled") (collecting cases); In re Philip Servs. Corp. Secs. Litig., 383 F. Supp. 2d 463, 485 (S.D.N.Y. 2004) (directors who also signed registration statement controlled those who wrote the report); In re Enron Corp. Sec., Derivative & ERISA Litigation, 258 F. Supp. 2d 576, 598 (S.D. Tex. 2003) (same, for outside director and auditcommittee member). It makes sense that the authority to sign and certify the contents of a registration statement implies the authority to effectuate changes to that statement by withholding certification -- for example, where misrepresentations are known or suspected. Otherwise, the certification authority is meaningless. The motion, therefore, is denied. C. Section 17200.

United States District Court

11
For the Northern District of California

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

The independent trustees challenge the Section 17200 claims on one ground not raised by the Schwab defendants: that the independent trustees are not alleged to have played any specific role in the "unlawful acts" alleged -- to reiterate, the allegedly improper alteration of the investment concentration policy without shareholder approval. Defendants first contend that the claim should be analyzed under Rule 9(b) because it is grounded in fraud. The claim, however, is not grounded in fraud. The claim does not rely on any misrepresentation, much less fraud. In fact, as stated, plaintiffs admit that the challenged change in investment policy was disclosed; they assert that it was otherwise unlawful because not approved by the shareholders. The claim, therefore, is governed by Rule 8. Defendants are unable to prevail under the pleading standards of Rule 8. At least one potential theory of liability can plausibly be inferred from the allegations incorporated into the claim by reference: the independent trustees are alleged to have signed and approved the registration statement which disclosed (by reference) the challenged change in the fund's investment policy. Moreover, as trustees of the fund, defendants may plausibly be inferred to 25

1 2 3 4 5 6 7 8 9 10

have had a role overseeing the investment policies of the fund. This order is unwilling to conclude at this stage of the proceedings that the complaint fails to put defendants on notice of their alleged role in the challenged conduct. The motion, therefore, is denied. For these reasons, the independent trustees' motion to dismiss is granted in part and denied in part. 3. PRICEWATERHOUSECOOPERS' MOTION TO DISMISS.

PricewaterhouseCoopers, the fund's auditor, independently moves to dismiss the Section 11 claim against it. PwC attacks the Section 11 claim on two grounds: (1) timeliness, and (2) for failure adequately to plead a misrepresentation or omission against PwC.12 A. Timeliness.

United States District Court

11
For the Northern District of California

Claims under Section 11 of the 1933 Act must be "brought within one year after the discovery of the untrue statement or the omission, or after such discovery should have been made by the exercise of reasonable diligence." 15 U.S.C. 77m. Under this provision, the limitations period begins to run with either actual or inquiry notice. In re Stac Electronics Securities Litigation, 89 F.3d 1399, 1411 (9th Cir. 1996). To assess inquiry notice, the Ninth Circuit applies an "inquiry-plus-reasonable-diligence" test -- that is, "inquiry notice triggers an investor's duty to exercise reasonable diligence and [] the . . . statute of limitations period begins to run once the investor, in the exercise of reasonable diligence, should have discovered the facts underlying the alleged fraud." Betz v. Trainer Wortham & Co., 519 F.3d 863, 876 (9th Cir. 2008) (quotation and citation omitted). The first prong, "inquiry notice," is satisfied when: there exists sufficient suspicion of fraud to cause a reasonable investor to investigate the matter further . . . . The facts constituting inquiry notice must be sufficiently probative of fraud-sufficiently advanced beyond the stage of a mere suspicion . . . to incite the victim to investigate.

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

The complaint also asserts a claim against PwC under Section 12(a)(2), and PwC moves to dismiss the claim. Plaintiffs do not oppose dismissal of the Section 12(a)(2) claim (Opp. at 21 n.10). PwC's motion to dismiss the Section 12 claim is therefore granted.

12

26

1 2 3 4 5 6 7 8 9 10

Ibid. (quotation and citation omitted). If the plaintiff had inquiry notice, courts ask whether the investor, in the exercise of reasonable diligence, should have discovered the facts constituting the alleged fraud, an objective standard. Ibid. Plaintiffs added PwC as a defendant for the first time in the First Consolidated Amended Complaint, filed October 2, 2008. PwC argues that