Corporate & Securities Law

By Jim Hamilton

2nd Circuit Affirms Fund Conflicts Dismissal

The 2nd Circuit upheld the dismissal of actions brought by shareholders of two mutual funds affiliated with Morgan Stanley. According to the complaints, the Morgan Stanley broker-dealers affiliated with the funds suffered from internal conflicts of interest. Because the fund managers relied on these broker-dealers? stock research, the broker-dealer conflicts allegedly increased the risk to investors in the funds. In re Morgan Stanley Information Fund Securities Litigation

The district court (SD NY) found that the shareholders failed to plead the existence of any material omissions or misstatements, and the 2nd Circuit agreed. The appeals panel, relying in part on an amicus brief filed by the SEC, held that the funds were not required to disclose on Form N-1A that they invested in companies which might have an investment banking relationship with fund affiliates. The instructions to the form were not independent sources of disclosure, advised the SEC. Rather, they were intended to provide funds with general guidance as to the nature of the information they should provide in responding to specific disclosure items.

The SEC also advised the court that it considered the breakdown of the "Chinese Wall," or "information barrier," between Morgan Stanley and the funds to be a "generic" risk rather than a specific risk that the funds' investment objectives included enhancing an affiliated entity?s investment banking business. While funds would be required to disclose such particular intentions, the Commission advised that "the danger that analyst reports (whether from affiliated or unaffiliated analysts) will be tainted by undisclosed conflicts of interest or actual corruption is but one of an indefinitely large number of factors that could cause a fund (or any other investor) to purchase overpriced securities, and it would not be useful to investors to require an attempt to set all of those forth in the prospectus."

In addition to rejecting the investor claims based specifically on Form N-1A, the court also dismissed the allegations based on the general Securities Act disclosure requirements. According to the court,

plaintiffs have not alleged that the Funds? managers pursued an undisclosed objective or investment strategy when making investment decisions for the Funds. Therefore, the Funds? disclosures about these topics were not misleading. Similarly, in light of our holding that plaintiffs have not identified any undisclosed ?principal risks? relating to the Funds, it cannot be said that the Offering Documents? risk disclosures were misleading because they omitted the generic risks relied on by plaintiffs.

Full post as published by Jim Hamilton's World of Securities Regulation on January 28, 2010 (boomark / email).