The SEC has used a low-profile closed-end fund case to make a point about the powers of fund directors and highlight the value of having independent lawyers advise fund directors.
Funds have the right to sue fund advisers for alleged breaches of fiduciary duty by the advisers, the SEC argued in a recent federal court filing. The Investment Company Act - the key federal law that governs mutual funds - permits funds to sue and also permits shareholders acting on behalf of funds to file so-called derivative actions for alleged injuries that a fund incurs at the hands of an adviser, the SEC argued.
The Investment Company Act, as interpreted by the courts, provides that directors have the power to authorize funds to file suits against advisers, the SEC said.
"In view of the statutory responsibilities of independent directors of investment companies to protect the interests of their shareholders ... it would be anomalous to rule now, for the first time, that they do not have the right to initiate a lawsuit on behalf of their" fund, the SEC said.
The SEC made its arguments in a friend-of-the-court brief filed May 15 with the U.S. Court of Appeals in New York. Courts often permit entities such as government agencies and trade groups that are not parties to a lawsuit but have an interest in its outcome to file such documents.
The appeals court is hearing a dispute in which Ariel Marquit, a fund shareholder, contends that the directors and advisers to three funds in which she invested - the Spain Fund, the New Germany Fund and the Central European Equity Fund - violated their fiduciary duty by permitting the funds to have chronic discounts to the funds' net asset value.
A lower court dismissed Marquit's claims in a decision Dec. 29. Marquit's claims failed because she did not demand that the funds' directors take steps to remedy the alleged breach of fiduciary duty, according to the lower court decision. Making such a demand is a requirement before filing suit, the court ruled.
Marquit filed an appeal of that decision, arguing that she did not need to make such a demand on fund directors because the fund had no right to sue.
Marquit's attorney, Richard Brualdi of New York, did not return a call seeking comment. Representatives of Alliance Capital Management LP of New York, adviser to the Spain Fund, and affiliates of the Deutsche Bank Group of New York, which manage the New Germany Fund and the Central European Fund, declined to comment.
Neither the appeals court nor the parties to the case asked the SEC to intervene in the matter, said Meyer Eisenberg, deputy general counsel for the SEC. The SEC filed the brief to support the right of funds to sue advisers and to assert the authority of fund directors, Eisenberg said. The case also highlights the importance of having lawyers who are independent from a fund adviser serving as counsel to fund directors, he said.
The SEC has proposed rules that would require that fund directors who have lawyers make sure that those lawyers are independent from the fund adviser.
The SEC said in its brief that it is in the midst of proposing new rules to strengthen the independence of fund directors, including the independent counsel rule.
"The independent directors have come to play an increasingly important role in overseeing the operations of investment companies in recent years," the SEC said in its brief.