Edwards v. Sequoia Fund, Inc. ( 2019 )

18‐3467‐cv
Edwards v. Sequoia Fund, Inc.
UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
August Term 2018
(Argued: June 13, 2019 Decided: September 9, 2019)
Docket No. 18‐3467‐cv
THOMAS EDWARDS AND MICHAEL FORTUNE, individually and on behalf of all
others similarly situated,
Plaintiffs‐Appellants,
v.
SEQUOIA FUND, INC., A Maryland Corporation,
Defendant‐Appellee.
ON APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE SOUTHERN DISTRICT OF NEW YORK
Before:
LEVAL, POOLER, AND CHIN, Circuit Judges.
Appeal from a judgment of the United States District Court for the
Southern District of New York (Daniels, J.) dismissing claims against defendant‐
appellee mutual fund pursuant to Federal Rule of Civil Procedure 12(b)(6).
Plaintiffs brought a putative class action on behalf of shareholders alleging that
the mutual fund breached a contractual obligation not to concentrate its
investments in a single industry. The district court granted the motion to
dismiss, holding that there was no enforceable contract and, even assuming there
was a binding contract, there was no breach. Plaintiffs appeal, contending that
the district court erred in both respects. We agree with the district courtʹs
alternative holding.
AFFIRMED.
FELICIA S. ENNIS (Alan M. Pollack, on the brief), Robinson
Brog Leinwand Greene Genovese & Gluck, P.C.,
New York, New York, and Raymond Farrow and
Mark A. Griffin, Keller Rohrback L.L.P., Seattle,
Washington, on the brief, for Plaintiffs‐Appellants.
ROBERT A. SKINNER (Amy D. Roy and Lee S. Gayer, on
the brief), Ropes & Gray LLP, Boston,
Massachusetts, and New York, New York, for
Defendant‐Appellee.
___________
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CHIN, Circuit Judge:
Defendant‐appellee Sequoia Fund, Inc. (the ʺFundʺ), a mutual fund,
adopted an investment policy that it may not concentrate its assets, as
concentration is defined in the Investment Company Act of 1940 (the ʺ1940 Actʺ),
15 U.S.C. §§ 80a‐1 et seq., and attendant regulations and guidance. In 1998, the
Securities and Exchange Commission (the ʺSECʺ) adopted guidance defining
ʺconcentrationʺ as having ʺmore than 25 percent of the value of [the fundʹs] assets
in any one industry.ʺ See Registration Form Used by Open‐End Management
Investment Companies, 48 Fed. Reg. 37,928, 37,962 (Aug. 22, 1983) (ʺ1983
Guidanceʺ). The Fund disseminated the investment policy annually in its
prospectus and registration statement filed with the SEC.
Plaintiffs‐appellants Thomas Edwards and Michael Fortune
(ʺPlaintiffsʺ), shareholders of the Fund, brought this putative class action alleging
that the Fund entered into a contract with its shareholders to observe that policy,
and that the Fund breached this contract when, due to an increase in the value of
its healthcare assets, the value of those assets came to exceed 25% of its overall
assets. The district court granted the Fundʹs motion to dismiss pursuant to
Federal Rule of Civil Procedure 12(b)(6), holding that there was no enforceable
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contract and, even assuming there was an enforceable contract, there was no
breach.
On appeal, Plaintiffs allege that the district court erred in both
respects. For the reasons set forth below, we agree with the district courtʹs
second reason and therefore AFFIRM the judgment of the district court.
STATEMENT OF THE CASE
A. Background
The Fund is an open‐ended investment company, i.e., a mutual fund,
organized under Maryland law and registered under the 1940 Act, 15 U.S.C. §§
80a‐1 et seq. As a mutual fund, the Fund sells shares of the Fund to investors and
pools this money to invest in, among other things, equity securities of different
companies. The Fundʹs shares are ʺoffered only to persons in the United States
by way of a prospectus.ʺ Appʹx at 11.
Under the 1940 Act, the Fund must file an annual registration
statement with the SEC, comprised of a statement of additional information
(ʺSAIʺ) and a prospectus. See 1983 Guidance, 48 Fed. Reg. at 37,929. As required
by the 1940 Act, the Fundʹs SAI, which was incorporated by reference into its
prospectus, includes fourteen ʺinvestment restrictionsʺ it adopted ʺas a matter of
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fundamental investment policy, which may not be changed without a
stockholder vote of a majority of the outstanding securities as defined in Section
2(a)(42) of the 1940 Act.ʺ Appʹx at 35; see 15 U.S.C. § 80a‐8(b)(1)‐(2).1
One such restriction (the ʺConcentration Policyʺ) included in the
Fundʹs May 2015 SAI, and incorporated by reference into its May 2015
prospectus, states that ʺ[t]he Fund may not . . . [c]oncentrate investments in an
industry, as concentration may be defined under the 1940 Act or the rules and
regulations thereunder . . . or by guidance regarding, interpretations of, or
exemptive orders under, the 1940 Act or the rules or regulations thereunder
published by appropriate regulatory authorities.ʺ Appʹx at 35‐36.
While neither the 1940 Act nor any rule or regulation promulgated
pursuant to the 1940 Act defines ʺconcentration,ʺ the SEC has twice provided
guidance on concentration policies. See Appʹx at 36 (adopting definition of
ʺconcentrationʺ as ʺmay be defined . . . by guidance . . . published by appropriate
regulatory authoritiesʺ). In 1983, the SEC adopted Form N‐1A, the registration
1 In relevant part, the 1940 Act requires that a registration statement include ʺa
recital of the policy of the registrant [with] respect [to] . . . concentrating investments in
a particular industry or group of industries.ʺ 15 U.S.C. § 80a‐8(b)(1). In addition, the
1940 Act requires that a registration statement include ʺa recital of all investment
policies of the registrant . . . , which are changeable only if authorized by shareholder
vote.ʺ Id. § 80a‐8(b)(2).
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form for open‐ended investment companies, and provided guidelines (the
ʺGuidesʺ) for preparing and filing Form N‐1A. See 1983 Guidance, 48 Fed. Reg.
at 37,958. Guide 19 states the SECʹs position that ʺinvestment . . . of more than 25
percent of the value of the registrantʹs assets in any one industry represents
concentration.ʺ Id. at 37,962. A fund that intends to concentrate ʺshould . . .
specify in the prospectus the industry or group of industries in which it will
concentrate.ʺ Id. If the fund does not intend to concentrate, ʺno further
investment may be made in any given industry if, upon making the proposed
investment, 25 percent or more of the value of the registrantʹs assets would be
invested in such industry.ʺ Id. While Guide 19 therefore prohibits a non‐
concentrating fund from making asset purchases that would cause it to exceed
the 25 percent threshold, it also allows for concentration by so‐called ʺpassive
increaseʺ ‐‐ ʺwhen securities of a given industry come to constitute more than 25
percent of the value of the registrantʹs assets by reason of changes in value of either
the concentrated securities or the other securities.ʺ Id. (emphasis added). In that
circumstance, although the fund would otherwise be ʺconcentrat[ing]ʺ as defined
under Guide 19, ʺthe excess need not be sold.ʺ Id.
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In 1998, the SEC adopted amendments to Form N‐1A. See
Registration Form Used by Open‐End Management Investment Companies, 63
Fed. Reg. 13,916 (Mar. 23, 1998) (ʺ1998 Guidanceʺ). The 1998 Guidance
recognized the SECʹs position that ʺa fund investing more than 25% of its assets
in an industry is concentrating in that industryʺ and ʺincorporated this
percentage test into [amended] Form N‐1A.ʺ Id. at 13,927.
B. Procedural History
Plaintiffs filed this complaint on May 21, 2018, alleging that the
Fund breached a contract with its shareholders based on its Concentration
Policy. Plaintiffs allege that the Fundʹs prospectus and SAI constituted an offer
by the Fund to manage its investments according to the policies set forth therein,
including the Concentration Policy. Plaintiffs further allege that class members
ʺaccepted that offer when they purchased and continued to hold their sharesʺ in
the Fund, thereby creating an enforceable contract. Appʹx at 17.
According to Plaintiffs, the Fundʹs Concentration Policy ʺprohibits
investment of more than 25% of the value of total assets of the Fund in any single
industry at any given time.ʺ Appʹx at 12. Plaintiffs allege that the Fund violated
the Concentration Policy at least three times in 2015: (1) on March 31, 2015, when
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27.3% of the Fundʹs net assets became concentrated in the healthcare industry,
with the Fund holding 26% of its net assets in Valeant Pharmaceuticals
International, Inc., a healthcare company; (2) on June 30, 2015, when 30% of the
Fundʹs net assets were concentrated in the healthcare industry, with the Fund
holding 28.7% of its net assets in Valeant; and (3) on September 30, 2015, when
26% of the Fundʹs net assets became invested in the healthcare industry. The
complaint alleges that this concentration caused Plaintiffs and putative class
members to suffer losses in the value of their shares when there was a sharp
decline in the value of the Fundʹs healthcare industry investments and the Fund
failed to take corrective action. The Fund moved to dismiss for failure to state a
claim, arguing that its adoption and publication of the Concentration Policy did
not form a contract with Plaintiffs. The Fund also argued that, assuming a
contract was formed, the Complaint failed to allege a breach because SEC
guidance to the 1940 Act, which is incorporated in the policyʹs definition of
concentration, allows for concentration that results from passive changes in
value.
The district court granted the Fundʹs motion to dismiss. The district
court concluded that Plaintiffs failed to allege a contract based on the
8
Concentration Policy because it found there was no offer, intent to be bound, or
meeting of the minds. In the alternative, the district court held that, even
assuming the existence of an enforceable contract, Plaintiffs failed to sufficiently
allege a breach. The district court held that the 1998 Guidance continues to allow
for concentration by passive increase, and therefore concluded that the complaint
failed to allege a breach of the Fundʹs Concentration Policy. Judgment was
entered accordingly on October 18, 2018. This appeal followed.
STANDARD OF REVIEW
We review a district courtʹs grant of a motion to dismiss under
Rule 12(b)(6) de novo. Bldg. Indus. Elec. Contractors Assʹn v. City of New York, 678
F.3d 184, 187 (2d Cir. 2012). ʺTo survive a motion to dismiss, a complaint must
contain sufficient factual matter, accepted as true, to state a claim to relief that is
plausible on its face.ʺ Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (internal quotation
marks omitted). ʺ[W]e accept as true all factual allegations and draw from them
all reasonable inferences; but we are not required to credit conclusory allegations
or legal conclusions couched as factual . . . allegations.ʺ Nielsen v. Rabin, 746 F.3d
58, 62 (2d Cir. 2014) (internal quotation marks omitted). ʺAccordingly,
ʹthreadbare recitals of the elements of a cause of action, supported by mere
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conclusory statements, do not suffice.ʹʺ Id. (quoting Iqbal, 556 U.S. at 678)
(brackets omitted).
DISCUSSION
We assume, without deciding, that Plaintiffs plausibly alleged the
existence of a contract that included the Concentration Policy as an enforceable
term that could not be changed without a shareholder vote. We reach only the
district courtʹs alternative holding and conclude that, even assuming the
existence of a binding contract, Plaintiffs failed to plausibly allege a breach.
I. Applicable Law
ʺTo state a claim for breach of contract under New York law, the
complaint must allege: (i) the formation of a contract between the parties; (ii)
performance by the plaintiff; (iii) failure of defendant to perform; and (iv)
damages.ʺ Orlander v. Staples, Inc., 802 F.3d 289, 294 (2d Cir. 2015) (internal
quotation marks omitted).2 At issue here is only whether the Fund failed to
perform under the contract ‐‐ i.e., whether the Fund breached the Concentration
Policy.
2 Both parties agree that either New York or Maryland law applies and there is no
conflict between the two. We therefore apply New York law. See Fin. One Pub. Co. v.
Lehman Bros. Special Fin., 414 F.3d 325, 331 (2d Cir. 2005) (holding that choice‐of‐law
analysis is not required where there is no actual conflict).
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Because we must determine the meaning of the Concentration
Policy, including the SEC guidance incorporated therein, the threshold question
is whether the terms of the Concentration Policy are ambiguous. See Krumme v.
WestPoint Stevens Inc., 238 F.3d 133, 138 (2d Cir. 2000). A contract is
unambiguous ʺwhere the contract language has a definite and precise meaning,
unattended by danger of misconception in the purport of the contract itself, and
concerning which there is no reasonable basis for a difference of opinion.ʺ Law
Debenture Tr. Co. of N.Y. v. Maverick Tube Corp., 595 F.3d 458, 467 (2d Cir. 2010)
(internal quotation marks and brackets omitted). Conversely, a contract is
ambiguous if the language ʺis capable of more than one meaning when viewed
objectively by a reasonably intelligent person who has examined the context of
the entire integrated agreement.ʺ Krumme, 238 F.3d at 139 (internal quotation
marks omitted).
Under New York law, ʺwhen the terms of a written contract are clear
and unambiguous, the intent of the parties must be found therein,ʺ and ʺ[t]he
words and phrases used in an agreement must be given their plain meaning so
as to define the rights of the parties.ʺ Mazzola v. Cty. of Suffolk, 533 N.Y.S.2d 297,
297 (2d Depʹt 1988) (internal quotation marks omitted). Where ʺthe partiesʹ
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intent is unambiguously conveyed by the plain meaning of the agreements, . . .
interpretation is a matter of law.ʺ Crane Co. v. Coltec Indus., Inc., 171 F.3d 733, 737
(2d. Cir. 1999) (internal quotation marks omitted). ʺAt the motion to dismiss
stage, a district court may dismiss a breach of contract claim only if the terms of
the contract are unambiguous.ʺ Orchard Hill Master Fund Ltd. v. SBA Commcʹns
Corp., 830 F.3d 152, 156 (2d Cir. 2016).
II. Application
We turn to the question of whether Plaintiffs have plausibly alleged
that the Fund concentrated its investments in the healthcare industry in violation
of the Concentration Policy. Plaintiffs concede that under the 1983 Guidance a
requirement not to concentrate would not give rise to an obligation to divest if
the concentration (exceeding 25%) resulted from changes in market values rather
than from transactions by the Fund. They argue, however, that the 1998
Guidance rescinded the 1983 Guidance and that the 1998 Guidance does not
permit concentration by passive increase. We disagree.
Plaintiffs contend that because the 1998 Guidance rescinded the 1983
Guidance, the Concentration Policy did not incorporate by reference the 1983
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Guidanceʹs definition of concentration.3 Relying on a footnote from the 1998
Guidance, Plaintiffs argue that ʺthe SEC unambiguously states that all prior
Guides, [Generic Comment Letters] and Guide Releases were not being
republished, were rescinded, and should not be applied henceforth.ʺ Appellantsʹ
Br. at 35‐36 (citing 1998 Guidance, 63 Fed. Reg. at 13,940 n.214).4 At the very
least, Plaintiffs argue that the Concentration Policy is ambiguous and its meaning
should not be resolved at the motion to dismiss stage.
The 1998 Guidance, however, is not ambiguous ‐‐ it did not rescind
Guide 19 of the 1983 Guidance. After explaining that ʺ[t]he Commission
proposed to continue to require a fund to disclose . . . any policy to concentrate,ʺ
the 1998 Guidance cites Guide 19 in noting that the SEC had ʺtaken the position
. . . that a fund investing more than 25% of its assets in an industry is
concentrating in that industry.ʺ 1998 Guidance, 63 Fed. Reg. at 13,927 n.99. The
3 Assuming the Concentration Policy was a contractual obligation, because the
term that the parties unambiguously incorporated into the contract is a provision of a
statute (the term ʺconcentrateʺ as stated in the 1940 Act), the meaning of the Fundʹs
obligation not to ʺconcentrateʺ is not determined in the manner in which courts
ordinarily determine the meaning of an ambiguous contractual provision. The meaning
of term as used in the 1940 Act is its meaning in the contract.
4 The Guide Releases were the guidelines initially adopted by the SEC in 1972 to
assist funds in preparing and filing registration statements. 1998 Guidance, 63 Fed. Reg.
at 13,940 n.209. The Guide Releases are different from the Guides provided by the SEC
in 1983.
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1998 Guidance then states that the SEC ʺcontinues to believe that 25% is an
appropriate benchmark to gauge the level of investment concentration that could
expose investors to additional riskʺ and that ʺ[t]he Proposed Amendments
incorporated this percentage test into Form N‐1A.ʺ Id. (emphasis added). ʺ[T]his
percentage test,ʺ as Plaintiffs admit in their brief, refers back to the sentence that
cites Guide 19, and Guide 19ʹs percentage test makes clear that, for purposes of
concentration, valuation is at the time of purchase. See 1983 Guidance, 48 Fed.
Reg. at 37,962.
While not expressly speaking to the issue of passive increases, the
section of the 1998 Guidance addressing concentration cites to and effectively
incorporates Guide 19, which allows for such increases. It repeatedly indicates
continuity with the SECʹs previous policy regarding concentration. See 1998
Guidance, 63 Fed. Reg. at 13,927 (ʺThe Commission proposed to continue to
require a fund to disclose . . . any policy to concentrate . . . .ʺ) (emphasis added);
see also id. (explaining, after noting the previous position taken by the
Commission, that the ʺProposed Amendments incorporated this percentage testʺ)
(emphasis added); see also id. (ʺthe Commission continues to believeʺ) (emphasis
added). Nothing in the 1998 Guidance suggests a change in SEC policy
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regarding concentration such as rescinding the prior exception for passive
increases.5 We assume that the agency would not adopt such a major change sub
silentio, in a guidance document that cites and repeatedly indicates continuity
with prior guidance on the issue in question. If the SEC had indeed adopted
such a change, non‐concentrating funds would be required to constantly monitor
for sudden increases and decreases in asset values, and adjust their investments
in each industry to avoid exceeding the 25% threshold. 6 It seems doubtful that
the SEC would adopt such a major change without calling attention to it and
without explanation.
Accordingly, the Concentration Policy defines concentration by
reference to Guide 19 of the 1983 Guidance, and so a fund is concentrating in an
5 Plaintiffs rely in significant part on a footnote in the 1998 Guidance, which states
that the Guides ʺhave not been republishedʺ and ʺwill [not] apply to registration
statements prepared on the amended Form.ʺ See 1998 Guidance, 63 Fed. Reg. at 13,940
n.214. Although the 1998 Guidance may have generally rescinded prior guidance to
write on a clean slate, it incorporated by reference and thus retained Guide 19ʹs
definition of concentration, and nothing in the text of the 1998 Guidance suggests a
change from that definition. Cf. Blackrock Multi‐Sector Income Tr., SEC No‐Action Letter,
2013 WL 3477065, at *4 (July 8, 2013) (ʺAlthough the Guides have since been rescinded,
Guide 19 may be generally instructive with respect to industry concentration.ʺ).
6 Plaintiffs suggest that such monitoring and compliance could be accomplished
by means of sophisticated software rather than labor‐intensive manual monitoring.
Even assuming this were true, the adoption of such software would itself represent a
significant undertaking, and would perhaps also require major changes in investment
practices and strategy.
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industry when, at the time of purchase, investing in an industry would lead the
fund to have more than 25% of its net assets in that industry. See 1983 Guidance,
48 Fed. Reg. at 37,962.
Here, Plaintiffs alleged only that the Fund ʺviolated the
Concentration Policy by allowing its investment in healthcare industry stocks . . .
to exceed 25% of the value of its net assets and failing to take any action to bring
the Fund within its policy limitations.ʺ Appʹx at 17‐18. Because the 1998
Guidance ‐‐ and by extension the Concentration Policy ‐‐ allows for such passive
increases, Plaintiffs have failed to allege a violation of the Concentration Policy.
CONCLUSION
For the reasons set forth above, the judgment of the district court is
AFFIRMED.
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