United States District Court, N.D. California
November 8, 2005.
SUSAN STRIGLIABOTTI, et al., Plaintiffs,
FRANKLIN RESOURCES, INC., et al., Defendants.
The opinion of the court was delivered by: SUSAN ILLSTON, District Judge
ORDER PARTIALLY GRANTING AND PARTIALLY DENYING DEFENDANTS' MOTION
FOR JUDGMENT ON THE PLEADINGS
On November 4, 2005, the Court heard oral argument on
defendants' motion to dismiss, which was re-noticed as a motion
for judgment on the pleadings pursuant to Federal Rule of Civil
Procedure 12(c). After careful consideration of the arguments of
counsel and the papers submitted, the Court hereby GRANTS
defendant's motion to the extent it seeks dismissal of defendant
Franklin Templeton Services with respect to plaintiffs' claims
under Section 36(b) of the Investment Company Act, and DENIES the
remainder of defendant's motion.
1. Factual background
This action is brought by shareholders of several mutual funds
("Funds") created, sold, advised, and managed as part of the
Franklin Templeton fund family ("the Fund Complex").
Specifically, the Funds are Templeton Growth Fund, Franklin
Balance Sheet Investment Fund, Franklin Flex Cap Growth Fund,
Franklin Income Fund, Franklin Small-Mid Cap Growth Fund,
Franklin Biotechnology Discovery Fund, MutualShares Fund, and Franklin Utilities Fund. Third Am. Compl. ("Compl.") at
¶ 1.*fn1 Plaintiffs are nine individuals who bring suit both
in their own rights and for the use and benefit of the
aforementioned funds. Id. Plaintiff Susan Strigliabotti also
brings this case on behalf of a class consisting of all residents
of the State of California who were shareholders of the Templeton
Growth Fund, the Franklin Balance Sheet Investment Fund, and/or
the Franklin Flex Cap Growth Funds at any time from March 4, 2000
to the present. Id. at ¶ 45.*fn2
Defendants are Franklin Resources, Inc., Templeton Global
Advisors, Ltd., Franklin Advisory Services, LLC, Franklin
Advisers, Inc., Franklin Templeton Distributors, Inc., Franklin
MutualAdvisers, LLC, and Franklin Templeton Services, LLC. Id.
at ¶ 2. They are various investment advisors affiliated with a
single parent company, also a defendant, Franklin Resources, Inc.
("Franklin Resources"), a publicly traded company incorporated in
Delaware and headquartered in San Mateo, California. Id.
Plaintiffs allege that defendants receive advisory fees from
the Funds for investment advisory services and administrative
services, and these fees are based on a percentage of the net
assets of each of the Funds. Id. at ¶ 6. Defendants also charge
distribution fees for marketing, selling, and distributing mutual
fund shares to new shareholders under "Distribution Plans"
adopted pursuant to Rule 12b-1, 17 C.F.R. § 270.12b-1. Id. at ¶
9. These distribution fees are based on a percentage of the net
assets of each of the funds in the Fund Complex and amount to
more than $7 million annually. Id. Plaintiffs allege that the
advisory fees charged by defendants are higher than those for
other funds for which defendants perform equivalent services, and
that the distribution fees are excessive, in violation of Rule
12b-1 and § 36(b) of the Investment Company Act of 1940.
Plaintiffs specifically claim that, despite significant growth in
the Funds since 1983, they have not benefitted from the economies
of scale and instead have been charged advisory and distribution
fees that are disproportionately large in relation to the
services provided. Id. at ¶¶ 13-15.
Plaintiffs seek to either rescind the investment advisory
agreements and Distribution Plans and recover the total fees charged by defendants, or, in the alternative, to
recover the excess profits resulting from economies of scale
wrongfully retained by defendants, and any other excessive
compensation or improper payments received and retained by
defendants in breach of their fiduciary duty under § 36(b),
15 U.S.C. § 80a-35(b), and state law. Id. at ¶ 28. The Third
Amended Complaint alleges individual and derivative claims for:
(Count I) breach of fiduciary duty under § 36(b) for excessive
investment advisory fees; (Count II) breach of fiduciary duty
under § 36(b) for excess profits from economies of scale; and
(Count III) breach of fiduciary duty under § 36(b) for excessive
Rule 12b-1 distribution fees and extraction of additional
compensation for advisory services. The Complaint also alleges
individual, derivative, and class claims for: (Count IV) breach
of fiduciary duty under California law; (Count V) civil
conspiracy to breach fiduciary duty under California law; (Count
VI) common law aiding and abetting breaches of fiduciary duty by
Franklin Resources; (Count VII) "acting in concert" under §
876(b) of the Restatement (Second) of Torts; (Count VIII) breach
of Cal. Business & Professions Code § 17200; and (Count IX)
common law unjust enrichment.
2. Procedural background
Plaintiffs filed their complaint on March 4, 2004, and filed a
First Amended Complaint on June 3, 2004. Defendants filed a
motion to dismiss the First Amended Complaint pursuant to Federal
Rule of Civil Procedure 12(b)(6). In that motion to dismiss,
defendants contended, inter alia, that plaintiffs' claims in
Counts I, II, and III under Section 36(b) of the Investment
Company Act of 1940 were deficient because the complaint
contained vague allegations that did not sufficiently detail the
excessiveness of fees charged in relation to services provided.
In an order filed March 7, 2005, the Court rejected that argument
and held that plaintiffs had sufficiently pled their claims under
Section 36(b). The Court also dismissed certain claims without
leave to amend and dismissed other claims with leave to amend.
Plaintiffs filed a Second Amended Complaint on March 21, 2005.
That complaint made a few substantive changes in response to the
Court's March 7, 2005 order. Defendants filed an answer to the
Second Amended Complaint on April 11, 2005. Pursuant to a
stipulated order by the Court, plaintiffs filed a Third Amended
Complaint on August 17, 2005. The Third Amended Complaint is
identical to the Second Amended Complaint except for the addition
of class action allegations based on California law (Counts IV through IX), and the deletion of claims related to two funds.
On September 29, 2005, defendants filed a motion to dismiss the
Third Amended Complaint pursuant to Rule 12(b)(6). After
plaintiffs filed their opposition to the motion to dismiss, in
which they argue, inter alia, that the motion to dismiss is
procedurally improper, defendants filed an answer to the Third
Amended Complaint on October 20, 2005. Defendants also re-noticed
their Rule 12(b)(6) motion as an alternative motion for judgment
on the pleadings pursuant to Rule 12(c).
Defendants' instant motion contends that plaintiffs' Section
36(b) claims must be dismissed because plaintiffs have failed to
plead any facts that the fees charged to any particular fund
were excessive in relation to any particular fund. Defendants
also contend that plaintiffs' newly asserted California class
claims must be dismissed either for lack of jurisdiction
(assuming dismissal of the federal claims), or dismissed because
they are preempted by the Securities Litigation Uniform Standards
Act ("SLUSA"). Plaintiffs oppose defendants' motion on the
grounds that it is an improper "second bite at the apple" in
violation of Rule 12 and barred by the law of the case. On the
merits, plaintiffs contend they have adequately pled claims under
Section 36(b), and that their state law claims are not preempted
"After the pleadings are closed but within such time as not to
delay the trial, any party may move for judgment on the
pleadings." Fed.R.Civ.Proc. 12(c). Rules 12(b)(6) and 12(c)
are substantially identical. See William W. Schwarzer, A.
Wallace Tashima & James M. Wagstaffe, Federal Civil Procedure
Before Trial § 9:319. Under either provision, a court must
determine whether the facts alleged in the complaint, to be taken
for these purposes as true, entitle the plaintiff to a
legalremedy. Id. If the complaint fails to articulate a legally
sufficient claim, the complaint should be dismissed or judgment
granted on the pleadings.
While Rule 12(c) of the Federal Rules of Civil Procedure does
not expressly provide for partial judgment on the pleadings,
neither does it bar such a procedure; it is common to apply Rule
12(c) to individual causes of action. Moran v. Peralta Community
College Dist., 825 F.Supp. 891, 893 (N.D. Cal. 1993); Schwarzer
et al., § 9:340 (1997) (common practice to permit "partial
judgment on the pleadings"). DISCUSSION
1. Section 36(b) claims
Plaintiffs bring Counts I, II, and III under Section 36(b) of
the Investment Company Act of 1940. Defendants' motion attacks
these claims on the ground that plaintiffs have failed to plead
any specific facts that the fees charged for each of the eight
funds at issue are excessive. Instead, defendants contend, the
Complaint simply contains a generalized attack on the Franklin
Fund Complex, and that even if plaintiffs' allegations were true,
they would not prove that the fees charged to any particular fund
were excessive under Section 36(b). Defendants also contend that
defendants Franklin Resources and Franklin Templeton should be
dismissed with prejudice because the Third Amended Complaint
still does not allege that these defendants were "recipients" of
compensation or payments as required by Section 36(b).
A. Sufficiency of allegations for Section 36(b) claims
The parties dispute the propriety of defendants' second motion
under Rule 12(b)(6) given the fact that defendants answered
plaintiffs' Second Amended Complaint. In an effort to avoid
plaintiffs' argument that the motion is procedurally improper,
defendants have also filed an answer to the Third Amended
Complaint and re-noticed the motion as an alternative motion for
judgment on the pleadings under Rule 12(c), which can be filed
any time after an answer is filed. Thus, although plaintiffs are
correct that defendants' motion is not properly filed pursuant to
Rule 12(b)(6), defendants may pursue their motion under Rule
Plaintiffs also contend that defendants' challenges to their
Section 36(b) claims are foreclosed by the law of the case. The
Court agrees. Defendants acknowledge that their present arguments
regarding plaintiffs' Section 36(b) claims are a "refined"
version of their earlier arguments. Defendants' Second Motion to
Dismiss at 1. A comparison of the first motion to dismiss with
the current motion shows that both motions rely on the same case
law and advance the same general attack on plaintiffs' Section
36(b) claims. For example, defendants' first motion contended
that the Section 36(b) claims were deficient because
"[p]laintiffs simply name a number of Funds on whose behalf they
claim to be proceeding, and list a series of defendants they
claim received `excessive or inappropriate compensation.'"
Defendants' First Motion to Dismiss at 2. Defendants further
contended that "plaintiffs ask the Court to assume that
whatever services any defendant rendered to any Fund, of whatever nature or quality, producing whatever
results, under whatever circumstances, must have been worth
less than the Fund paid, whatever that amount may have been."
Id. at 3 (emphasis in original).
Defendants' instant challenge to plaintiffs' Section 36(b)
claims is essentially the same, but with a different emphasis.
Whereas defendants previously argued that the complaint lacked
specific allegations regarding the excessiveness of fees in
relation to services provided, defendants' current arguments
focus on the lack of such specific allegations for each fund. The
fact that defense counsel believes that the previous motion to
dismiss was erroneously decided, and erroneously presented by his
co-counsel,*fn3 is not a persuasive reason for the Court to
exercise its discretion to revisit an issue that "must have been
decided explicitly or by necessary implication in the previous
disposition." Lower Elwha Band of S'Kallams v. Lummi Indian
Tribe, 235 F.3d 443, 452 (9th Cir. 2000). Accordingly, the Court
holds that the law of the case doctrine bars defendants' instant
motion for judgment on the pleadings with respect to plaintiffs'
Section 36(b) claims.
B. Franklin Resources and Franklin Templeton Services as
Defendants also argue that Franklin Resources and Franklin
Templeton Services should be dismissed with prejudice because
plaintiffs have failed to allege that either is "the recipient of
such compensation or payments," as Section 36(b) requires.
Plaintiffs' opposition essentially concedes that the Third
Amended Complaint does not contain any such allegation against
Franklin Templeton Services, and indeed states that "in the Third
Amended Complaint, plaintiffs intended to include defendant
Franklin Templeton Services as a defendant in the state class
action allegations only." Plaintiffs' Opposition at 15 n. 8.
Accordingly, defendants' motion for judgment on the pleadings on
Counts I, II and III with respect to defendant Franklin Templeton
Services is GRANTED.
With respect to defendant Franklin Resources, plaintiffs
contend that they have sufficiently amended the complaint to
include allegations that Franklin Resources is a recipient of
compensation or payments under Section 36(b). The Third Amended
Complaint alleges, inter alia, that "Franklin Resources
receives compensation from each of the funds identified herein
and earns investment management fee revenues by providing, inter alia, investment advisory services pursuant to
investment management agreements with each fund." Compl. at ¶ 5.
The Court holds the Third Amended Complaint adequately alleges
that Franklin Resources receives compensation within the meaning
of Section 36(b).
2. State law claims (Counts IV-IX)
Defendants contend that plaintiffs' state law claims, Counts IV
through IX, are preempted under SLUSA and thus should be
dismissed. SLUSA provides, in pertinent part,
(b) Class action limitations
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 material fact
in connection with the purchase or sale of a covered
(2) that the defendant used or employed any
manipulative or deceptive device or contrivance in
connection with the purchase or sale of a covered
15 U.S.C. § 77p(b); see also 15 U.S.C. § 78bb(f)(1).
Plaintiffs do not dispute that this is a "covered class action"
involving a "covered security." Instead, the parties' debate
centers on whether plaintiffs' state law claims are (1) based on
allegations of a fraudulent scheme or an untrue statement or
omission of material fact on the part of defendants, (2) "in
connection with the purchase or sale" of a covered security.
Plaintiffs contend that the gravamen of their state law claims is
not a claim for fraud, but instead a claim that defendants were
under a duty to charge only reasonable fees for the services they
provided; that they breached this duty by charging unreasonable
and excessive fees; and that by reason of these overcharges,
plaintiffs and other investors were damaged.
A. Fraud or misrepresentation
Defendants cite paragraphs 54, 55, 73, 93, 98, 111, 119, 121
and 122 of the Third Amended Complaint for their contention that
plaintiffs have alleged that defendants have omitted or
misrepresented material facts in connection with the purchase or
sale of covered securities. A review of these paragraphs
demonstrates that plaintiffs have alleged that defendants have
omitted or misrepresented facts. See e.g., ¶ 73 ("[T]he soft
dollar arrangements are concealed from the shareholders of the
Funds in breach of Defendants' fiduciary duty); ¶ 121 ("Documents circulated by Class Defendants
are unfair and misleading in that they represent implicitly or
expressly that the fees charged by or on behalf of Class
Defendants are fair and proper when they are exorbitant and
excessive. In effect, Class Defendants have masked the true
extent of the fees they charge, thereby lulling investors into a
false sense of security that they are trustworthy
fiduciaries. . . .").
Plaintiffs contend that although there are various allegations
in the complaint that mention certain misrepresentations and
omissions made by defendants, these allegations do not go to the
heart of their complaint. Plaintiffs' Opposition at 17. However,
this argument ignores the plain language of SLUSA, which preempts
claims alleging "an untrue statement or omission of material
fact" in connection with the purchase or sale of a covered
security. 15 U.S.C. § 77p(b). Plaintiffs contend that their
claims are not dependent in any way on proving fraud or
misrepresentation, and in the event the Court concludes that
plaintiffs have alleged "an untrue statement or omission of
material fact" under SLUSA, plaintiffs seek leave to amend their
state law claims.
B. "In connection with the purchase or sale of securities"
However, even if plaintiffs have alleged misrepresentations or
omissions on the part of defendants, such acts must be "in
connection with the purchase or sale of securities" in order for
plaintiffs' state law claims to be preempted. Id. Courts
interpreting SLUSA's "in connection" requirement have looked to
the case law interpreting nearly identical language as used in
Section 10(b) and Rule 10b-5 of the Securities and Exchange Act
of 1934.*fn4 See Falkowski v. Imation Corp.,
309 F.3d 1123, 1129 (9th Cir. 2002), as amended, 320 F.3d 905 (9th Cir.
The Supreme Court recently interpreted this language in SEC v.
Zandford, 535 U.S. 813 (2002), an action under Section 10(b) and
Rule 10b-5. The Court held that the requisite connection is
established where a "fraudulent scheme" and a securities
transaction "coincide." Id. at 825. The Court noted that
although this language should be interpreted "flexibly to
effectuate its remedial purposes," it "does not transform every
breach of fiduciary duty into a federal securities violation." Id. at
819, 825 n. 4. Following Zandford, the Ninth Circuit analyzed
the "in connection with" requirement and held:
The fraud in question must relate to the nature of
the securities, the risks associated with their
purchase or sale, or some other factor with similar
connection to the securities themselves. While the
fraud in question need not relate to the investment
value of the securities themselves, it must have more
than some tangential relation to the securities
Falkowski, 309 F.3d 1130-31 (quoting Ambassador Hotel Co. v.
Wei-Chuan Inv., 189 F.3d 1017, 1026 (9th Cir. 1999)).
Defendants contend that plaintiffs' claims are preempted under
Falkowski because "[b]y allegedly not disclosing all the facts
about the alleged conflict of interest and the lack of a basis
for the costly Distribution Plans, defendants allegedly failed to
disclose a risk to investors that the returns on their
investments in the Funds would be reduced by the excessive fees
that defendants would continue to charge." Defendants' Reply at
8. However, defendants' argument misses the point because in
order to be preempted by SLUSA, plaintiffs' claims must be "in
connection with the purchase or sale" of securities; plaintiffs'
allegations that defendants charge excessive fees in relation to
the advisory services performed does not turn on the purchase or
sale of a security.
Further, most of the cases cited by defendants are
distinguishable because the claims at issue more directly
involved sales or purchases of securities. See, e.g., Prof'l
Mgmt. Assocs. Inc. Employees' Profit Sharing Plan v. KPMG LLP,
335 F.3d 800, 803 (8th Cir. 2003) (preempting claims alleging
plaintiffs relied on defendant's false financial reports when
buying and retaining stock); In re Enron Corp. Securities
Derivative & ERISA Litig., 284 F. Supp. 2d 511, 636 (S.D. Tex.
2003) (preempting claims that plaintiffs were fraudulently
induced into purchasing and retaining employee stock options);
Feitelberg v. Merrill Lynch & Co., 234 F. Supp. 2d 1043, 1052
(N.D. Cal. 2002) (preempting claims that plaintiffs purchased
stock in reliance on defendant's unfair and/or deceptive company
ratings); Kenneth Rothschild Trust v. Morgan Stanley Dean
Witter, 199 F. Supp. 2d 993, 999 (C.D. Cal. 2002) (preempting
claims alleging defendant failed to pay interest on monies
temporarily deposited in mutual fund prior to purchase of CD);
Prager v. Knight/Trimark Corp., 124 F. Supp. 2d 229, 234
(D.N.J. 2000) (preempting claims alleging defendant improperly
used information about retail customers' trades for its own
profit before executing customers' trades). The only cases cited by defendants that are somewhat similar to
the instant one are the Third Circuit's decision in Rowinski v.
Salomon Smith Barney, 398 F.3d 294 (3rd Cir. 2005), and a New
Jersey district court case In re Lord Abbett Mutual Funds Fee
Litigation, 385 F. Supp. 2d 471 (D.N.J. 2005). In Rowinski, an
investor brought a state-court class action against an investment
brokerage firm alleging that the firm had disseminated biased
analyses of certain securities in order to favor the firm's
investment banking clients. The plaintiff alleged that Salomon
Smith Barney breached the parties' services contract, unjustly
enriched Solomon Smith Barney, and violated state consumer
protection law. After Salomon Smith Barney removed the case to
federal court, the district court dismissed the plaintiff's
claims based on SLUSA preemption, and the Third Circuit affirmed,
holding that the complaint alleged a fraudulent scheme coinciding
with the purchase or sale of securities:
Salomon Smith Barney systematically misrepresented
the value of securities to the investing public in
order to curry favor with investment banking clients
and reap hundreds of millions of dollars in
investment banking fees. For this purported scheme to
work, investors must purchase the misrepresented
securities. Absent purchases by duped investors and a
corresponding inflation in the share price, Salomon
Smith Barney's biased analysis would fail to benefit
its banking clients and, in turn, would fail to yield
hundreds of millions of dollars in investment banking
fees. The scheme, in other words, necessarily
`coincides' with the purchase or sale of securities.
Id. at 302 (citing Zandford, 535 U.S. at 825).
In the Lord Abbett case, plaintiffs were shareholders in
mutual funds who brought a class and derivative action
challenging broker compensation practices employed by Lord Abbett
pursuant to which brokers were allegedly compensated excessively
as an incentive for them to steer new investors into Lord Abbett
mutual funds. 385 F. Supp. 2d at 474. Relying on Rowinski, the
court in Lord Abbett held that the plaintiffs' claims were
preempted by SLUSA:
The gravamen of Plaintiffs' Complaint in this case is
that Lord Abbett made improper, undisclosed, and
excessive payments to brokers to induce them to
aggressively market the Funds, which practices caused
Fund shareholders to suffer a decline in net asset
value per share despite also causing overall Fund
growth (which growth, coincidentally, boosted Lord
Abbett's management fees). For this scheme to work
and cause harm to Plaintiffs, however, new investors
must purchase shares of the Fund. This scheme,
therefore, like the scheme in Rowinski, necessarily
"coincides" with the purchase or sale of securities.
Id. at 484.
Here, plaintiffs allege that defendants charge excessive fees
in relation to the advisory services they provide to the Funds,
and they do not allege that they were induced into purchasing or
selling any securities, or that defendants' actions led them to hold on to their
securities longer than they would have otherwise. The only
transactions that are described or referred to in the complaint
are the following:
"Another example is where Defendants use fund
assets, in violation of Rule 12b-1, to participate in
pay-to-play schemes such as `directed brokerage,'
where the Defendants cause the Funds to make payments
over and above the payments permitted under the
Funds' 12b-1 plan limits. Defendants direct the
Funds' brokerage business to brokerage firms and pay
them above market rates to promote Defendants' mutual
funds over other funds sold by the brokerage firms.
On information and belief, payments are also
improperly channeled to employee benefit fund
fiduciaries and/or advisors to compensate them for
selecting Franklin Templeton funds on their
retirement plan menus. These payments are illegal and
improper under federal law and the common law." ¶ 56.
"Other, easier to quantify, benefits include `soft
dollars' payable from broker-dealers. Essentially,
`soft dollars' are credits furnished to Defendants
from broker-dealers and other securities-industry
firms in exchange for routing the Funds' securities
transaction orders and other business to paying
firms. These soft dollar credits should be used to
purchase research and other goods or services that
benefit the shareholders of the Funds. On information
and belief, however, the soft-dollar arrangements
benefit Defendants and result in increased costs to
the shareholders of the Funds with little to no
corresponding benefits to the shareholders of the
Funds. On information and belief, the soft dollar
arrangements are concealed from the shareholders of
the Funds in breach of Defendants' fiduciary duty." ¶
"The distribution fees charged and received by
Defendants or their affiliates were designed to, and
did, extract additional compensation for Defendants'
advisory services in violation of Defendants'
fiduciary duty under § 36(b). When Defendants first
initiated the Distribution Plans, they represented
that the distribution fees were being collected in
order to, at least in part, grow the assets of the
Funds in order to reduce the cost to Plaintiffs and
the shareholders of the Funds of providing advisory
services. Although the distribution fees may have
contributed to the growth in assets of the Funds, the
resulting economies ofscale benefits only Defendants,
and not Plaintiffs or the Funds." ¶ 93.*fn5
The transactions at issue in the instant case are between
defendants and third parties, and do not involve any purchase or
sale of securities by plaintiffs (or class members) themselves.
The gravamen of plaintiffs' complaint does not concern the
purchase or sale of securities by the third parties; the "scheme"
challenged by plaintiffs does not turn on the purchase or sale of
securities, although the purchase or sale of securities may be
tangentially related. Instead, plaintiffs allege that defendants
have engaged in transactions that should have reduced defendants'
costs in providing advisory services to the Funds, but that
defendants did not pass these savings along to plaintiffs and the
Funds and instead defendants kept the savings as additional
compensation for themselves. Here, to the extent plaintiffs
allege defendants misrepresented or omitted facts, such
allegations do not have more a "tangential relation to the
securities transaction." Falkowski, 309 F.3d 1130-31. Accordingly, the Court concludes that plaintiffs' state law
claims are not preempted by SLUSA, and hereby DENIES defendants'
motion to dismiss these claims.
For the foregoing reasons and for good cause shown, the Court
hereby PARTIALLY GRANTS and PARTIALLY DENIES defendant's motion.
[Docket No. 127].
IT IS SO ORDERED.
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