Federal Judge Peter Sheridan, who sits in New Jersey, has ruled that the holder of a variable annuity has standing to bring a claim under Section 36(b) of the Investment Company Act of 1940 for allegedly excessive compensation paid to the investment adviser to the underlying mutual funds. Sivolella v. AXA Equitable Life Insurance Co., No. 3:11-cv-04194 (D.N.J. Sept. 25, 2012). The defendants had moved to dismiss the case, arguing that the plaintiff does not have standing because she is not a "security holder" of the mutual funds, as required by Section 36(b). Under the defendants' theory, the only permissible plaintiff, other than the Securities and Exchange Commission, would be the insurance company that is the record holder of the fund shares.
Section 36(b) of the 1940 Act provides that investment advisers have a fiduciary duty with respect to the receipt of compensation for services that they provide to mutual funds and allows civil actions to be brought by the SEC or by a security holder on behalf of a mutual fund. The plaintiff was an investor in a variable annuity, which is a contract between an investor and an insurance company pursuant to which the insurance company promises to make periodic payments to the contract owner or beneficiary, starting immediately or at some future time. The insurance company placed the plaintiff's premiums in a separate account owned by the insurance company and registered as a unit investment trust under the 1940 Act. The UIT's assets then were invested in mutual funds selected by the plaintiff. It was these mutual funds that allegedly paid excessive advisory fees, and the defendants argued that the plaintiff's indirect relationship to the mutual funds was insufficient to make her a "security holder."
The court noted the broad definition of "security" in the securities laws and concluded that it makes little sense to construe "security" broadly and limit the reach of "holders" to entities that lack any economic interest or stake in the transaction. Rather, it found, the plaintiff had all of the economic stake in these transactions: "Plaintiff and similarly situated investors are responsible for and paid all of the challenged fees. Plaintiff and other investors bear the full risk of poor investment performance. Plaintiff and other investors have the right to instruct AXA how to vote their shares. Assets held in a separate account are immune from claims of AXA's creditors, while being vulnerable to claims of the investors' creditors. And when Plaintiff decides to withdraw her investment in the AXA Funds, she, not AXA, pays the taxes on that investment." The court distinguished this from a fund-of-funds case, in which the plaintiffs do not enjoy the incidents of ownership in the underlying funds.
I have placed the court's order on the FundLaw website (free registration with Yahoo Groups may be required), and it can be accessed at
John M. Baker <JMB@...
Stradley Ronon Stevens & Young, LLP http://www.stradley.com
1250 Connecticut Avenue, NW, Suite 500
Washington, DC 20036
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