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Jerry Smit, Individually and On Behalf of All Others Similarly Situated v. Charles Scwhab & Co.

March 8, 2011


The opinion of the court was delivered by: Lucy H. Koh United States District Judge

United States District Court For the Northern District of California


Defendants have moved to dismiss Plaintiff's First Amended Complaint (FAC) pursuant to Federal Rule of Civil Procedure 12(b)(6). This Motion was heard on March 3, 2011. Having 20 considered the parties' briefing and arguments on this Motion, the Court grants-in-part and denies-21 in-part defendants' Motion. 22

I. Introduction

This action is related to another action pending before this Court, Northstar Financial Advisors Inc. v. Schwab Investments, No. 08-cv-04119 LHK ("Northstar"). In Northstar, the 25 plaintiff asserted a putative class action on behalf of investors in the Schwab Total Bond Market Fund (the Fund). Initially, the Northstar complaint alleged a claim for violation of Section 13(a) of 27 the Investment Company Act of 1940 (ICA). This claim was sustained by Judge Illston (to whom 28 this case was previously assigned), but on interlocutory appeal the Ninth Circuit held that there is 2 no implied private right of action under this Section. See Northstar Fin. Advisors, Inc. v. Schwab 3 Invs., 615 F.3d 1106, 1122 (9th Cir. 2010). Before the Ninth Circuit's decision, Northstar asserted 4 an individual claim under California's Unfair Competition Law (UCL) based on the underlying 5 alleged violation of the ICA. Cal. Bus. and Prof. Code §§ 17200 et seq.; see Northstar Dkt. No. 75 (Northstar FAC). Northstar's claim was later withdrawn and the parties agreed that if Northstar re-7 asserted it, it would be subject to binding arbitration pursuant to an agreement between Northstar 8 and the Northstar defendants. See Northstar Dkt. No. 102, April 16, 2009. Northstar filed a

On September 3, 2010, Plaintiff Smit filed a complaint asserting a UCL claim based on the alleged violation of Section 13(a) of the ICA (essentially the individual UCL claim that was 12 asserted and then withdrawn in Northstar) on behalf of a putative class of Schwab Total Bond Market Fund investors. See Dkt. No. 1 (Compl.). The factual allegations in the initial and 14 amended Smit complaints were largely duplicative of those in the Northstar FAC.

track the Lehman Brothers U.S. Aggregate Bond Index (the Index) in two ways. First, Plaintiff 17 alleged that the Fund deviated from this objective by investing in high risk non-U.S. agency 18 collateralized mortgage obligations (CMOs) that were not part of the Lehman Index and were 19 substantially more risky than the U.S. agency securities and other instruments that comprised the Index. Compl. ¶ 3, FAC ¶ 3. Second, Plaintiff alleged that the Fund deviated from its investment 21 objectives which prohibited any concentration of investments greater than 25% in any industry by 22 investing more than 25% of its total assets in U.S. agency and non-agency mortgage-backed 23 securities and CMOs. Id. ¶¶ 4. Plaintiff alleged that defendants made these changes without first 24 holding a shareholder vote, as required by Section 13 of the ICA. Id. ¶ 2. Plaintiff alleged that 25 defendants' deviation from the Fund's investment objective exposed the Fund and its shareholders 26 to tens of millions of dollars in losses due to a sustained decline in the value of non-agency 27 mortgage-backed securities. The Funds' deviation from its stated investment objective caused it to 28

Second Amended Complaint (Northstar SAC) on September 28, 2010.

Briefly, Plaintiff alleged that defendants deviated from the Fund's investment objective to incur a negative total return of 4.80% for the period August 31, 2007 through February 27, 2009, 2 compared to a positive return of 7.85% for the Index over that period. Id. ¶¶ 5.

opposing that motion, Plaintiff Smit filed the FAC on December 2, 2010. The FAC names Charles Management, Inc. (the Investment Advisor) as defendants. Defendants withdrew their original 7 motion to dismiss and filed the Motion considered here on January 5, 2011. The Court heard oral 8 argument on March 3, 2011.

On November 10, 2010, defendants moved to dismiss the first Smit complaint. In lieu of Schwab & Co., Inc., Schwab Investments (the Trust), and Charles Schwab Investment

II. Legal Standard

Under Federal Rule of Civil Procedure 12(b)(6), a district court must dismiss a complaint if it fails to state a claim upon which relief can be granted. To survive a motion to dismiss, the 12 plaintiff must allege "enough facts to state a claim to relief that is plausible on its face." Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007). This "facial plausibility" standard requires the 14 plaintiff to allege facts that add up to "more than a sheer possibility that a defendant has acted 15 unlawfully." Ashcroft v. Iqbal, 129 S. Ct. 1937, 1949 (2009). In deciding whether the plaintiff has 16 stated a claim, the Court must assume the plaintiff's allegations are true and draw all reasonable 17 inferences in the plaintiff's favor. Usher v. City of Los Angeles, 828 F.2d 556, 561 (9th Cir. 1987).

However, the court is not required to accept as true "allegations that are merely conclusory, 19 unwarranted deductions of fact, or unreasonable inferences." In re Gilead Scis. Sec. Litig., 536 20 F.3d 1049, 1055 (9th Cir. 2008). Leave to amend must be granted unless it is clear that the 21 complaint's deficiencies cannot be cured by amendment. Lucas v. Dep't. of Corr., 66 F.3d 245, 22

III. Application

a. ICA 13(a) and 48(a) as Predicates for UCL Claim

Defendants argue that because there is no implied private right of action under the ICA § 13(a) or § 48(a), these statutes cannot serve as the violation underlying a UCL claim. Although 248 (9th Cir. 1995). 23

Defendants' argument has appeal, the Court finds that this outcome would be inconsistent with case law holding that even statutes with no private right of action can serve as the basis for a UCL 2 claim. See Stop Youth Addiction, Inc. v. Lucky Stores, Inc., 17 Cal. 4th 553, 572 (1998). In Stop Youth Addiction, the California Supreme Court held that a private party could state a UCL claim 4 based on an alleged violation of a penal code provision, even though there was no private right to 5 enforce the penal code directly. Id. The court found that "even though a specific statutory 6 enforcement scheme exists, a parallel action for unfair competition is proper pursuant to applicable 7 provisions of the [UCL]." Id. (internal citations omitted). The court relied on language from the UCL itself: "[u]nless otherwise expressly provided, the remedies or penalties provided by this 9 chapter [i.e., ch. 5, Enforcement, Bus. & Prof. Code, § 17200- 17209] are cumulative to each other 10 and to the remedies or penalties available under all other laws of this state." Stop Youth Addiction, Cal. 4th at 573.

No. 10-CV-01455-LHK, 2010 U.S. Dist. LEXIS 106600 at *44 (N.D. Cal. Oct. 5, 2010) (finding 15 that plaintiff could assert a Lanham Act claim as the predicate for a UCL claim, even though the 16 plaintiff had no standing under the Lanham act; the standing requirement did not impose an No. 06CV2705 JAH(CAB), 2007 U.S. Dist. LEXIS 81686 at *12-*13 (S.D. Cal. Nov. 2, 2007) (FIFRA) because the legislative history revealed that Congress had considered and "express[ly]" 21 rejected a private right of action under the Act). Despite the statute's focus on state laws, courts (including this Court) have read the "express bar" requirement to apply to federal laws as well. See, e.g., Ferrington v. McAfee, Inc., "express, absolute bar" which would prohibit enforcement via the UCL); Hartless v. Clorox Co., (dismissing a UCL claim brought under the Federal Insecticide, Fungicide, and Rodenticide Act

In Northstar, the Ninth Circuit found that there is no implied right of action under the ICA § 13(a).*fn1 Northstar, 615 F.3d at 1118. This decision was based not on an express rejection of such 24 a right, but instead on the lack of an explicit intent to create such a right. Id. "[N]othing in the 25 language or context of . . . [the 1970 and 2007 ICA] amendments demonstrates a clear congressional intent to allow private lawsuits to enforce the statute's provisions." Id. Although 2 defendants correctly point out that the Ninth Circuit found that enforcement of the ICA was "exclusively" granted to the SEC, this finding was not based on any express language in the ICA 4 itself or in its legislative history. Without an express bar prohibiting private enforcement of the ICA § 13(a), the Court concludes that a UCL claim can proceed on the basis of an alleged violation 6 of this statute.

Additional authorities cited by defendants and not already addressed are not helpful to the analysis here. In Levy v. JP Morgan Chase, No. 10CV1493 DMS, 2010 U.S. Dist. LEXIS 118232 9 at *11 (S.D. Cal. Nov. 5, 2010), the Court held that "to the extent [the] Plaintiff allege[d] a 10 violation of [the UCL based on the Federal Trade Commission Act]," the Plaintiff had failed to "allege factual content sufficient to state a claim" for violation of the UCL based on violation of 12 the Federal Trade Commission Act.) Thus, the dismissal appears to be based on a failure to meet 13

Rule 8's pleading requirements rather than on a finding that a FTCA claim could never serve as the 14 basis for a UCL claim. Likewise, in Ballard v. Chase Bank USA, No. 10cv790 L(POR), 2010 U.S. § 2923.6 could not form the "borrowed" claim underlying a UCL claim because it implied no 17 private right of action. However, it stated this holding in a short paragraph of the order without 18 citation to any contrary authority, including Stop Youth Addiction.*fn2

Dist LEXIS 130097 at *7-9 (S.D. Cal. Dec. 9, 2010), the court decided that California Civil Code

Therefore, defendants' motion to dismiss the FAC because it asserts the ICA §§ 13(a) and 48(a) as the basis for a UCL claim is DENIED.

Federal to State courts" of lawsuits asserting securities law violations in the wake of the Private Securities Litigation Reform Act of 1995 (PSLRA). Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71, 82 (2006) (internal citation omitted). In order to avoid the PSLRA's 7 requirements, plaintiffs began asserting what were essentially federal securities law claims as state 8 law causes of action in state court. Id. Congress sought to end this practice by amending the SLUSA prohibits class actions brought on behalf of more than 50 people ("covered class actions"), if the action is based on state law and alleges a) a misrepresentation or omission of a 12 material fact in connection with the purchase or sale of a covered security; or b) that the defendant 13 used or employed any manipulative or deceptive device or contrivance in connection with the 14 purchase or sale of a covered security. 15 U.S.C. §§ 77p, 78bb; Proctor v. Vishay Intertechnology Inc., 584 F.3d 1208, 1221-22 (9th Cir. 2009). The complaint need not allege scienter, reliance, or 16 loss causation in order for SLUSA preclusion to apply. See Anderson v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 521 F.3d 1278, 1285-87 (10th Cir. 2008). In addition, the state law claims 18 need not contain a "specific element" of misrepresentation in order to be precluded by SLUSA.

Proctor, 584 F.3d at 1222, n.13. Plaintiff disputes the final two elements of SLUSA preclusion: 20 first, that the FAC alleges misrepresentations or omissions of material fact, and second, that any 21 such misstatements or omissions are alleged to have been made "in connection with" the purchase 22 or sale of the Fund shares.

defendants. Plaintiff listed a number of Registration Statements and Prospectuses in which 26 defendants represented that the Fund would "seek[] to track ...

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