JACK GREEN, Individually v. Fund Asset Management, L.p.

PRECEDENTIAL
Filed April 18, 2002
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
No. 01-2736
JACK GREEN, Individually and as Trustee;
LAWRENCE P. BELDEN, Trustee;
STANLEY SIMON, Trustee
v.
FUND ASSET MANAGEMENT, L.P.;
MERRILL LYNCH ASSET MANAGEMENT, L.P.;
MERRILL LYNCH & CO., INC.;
MERRILL LYNCH, PIERCE, FENNER & SMITH, INC.;
PRINCETON SERVICES, INC.; ARTHUR ZEIKEL;
TERRY K. GLENN; MUNIENHANCED FUND, INC.;
MUNIVEST FUND II, INC.; MUNIYIELD FUND, INC.;
MUNIYIELD INSURED FUND, INC.;
MUNIYIELD INSURED FUND II, INC.;
MUNIYIELD QUALITY FUND, INC.;
MUNIYIELD QUALITY FUND II, INC.
Jack Green,
Lawrence P. Belden,
Stanley Simon,
Appellants
On Appeal from the United States District Court
for the District of New Jersey
D.C. Civil Action No. 97-cv-03502
(Honorable Dickinson R. Debevoise)
Argued March 4, 2002
Before: SCIRICA and ROSENN, Circuit Judges,
and WARD, District Judge*
(Filed: April 18, 2002)
LAURENCE M. JOHNSON, ESQUIRE
(ARGUED)
Davis, Malm & D’Agostine
One Boston Place
Boston, MA 02108
ROBERT E. SULLIVAN, ESQUIRE
Sullivan, Weinstein & McQuay
2 Park Plaza
Boston, MA 02116
BRUCE I. GOLDSTEIN, ESQUIRE
ALBERTO G. SANTOS, ESQUIRE

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Saiber, Schlesinger, Satz and
Goldstein
One Gateway Center
Newark, NJ 07102
Attorneys for Appellants
MARK HOLLAND, ESQUIRE
(ARGUED)
JAMES N. BENEDICT, ESQUIRE
SEAN M. MURPHY, ESQUIRE
MARY K. DULKA, ESQUIRE
C. NEIL GRAY, ESQUIRE
Clifford Chance Rogers & Wells LLP
200 Park Avenue
New York, NY 10166
_________________________________________________________________
* The Honorable Robert J. Ward, United States District Judge for the
Southern District of New York, sitting by designation. 2
PAUL A. ROWE, ESQUIRE
ALAN S. NAAR, ESQUIRE
Greenbaum, Rowe, Smith, Ravin,
Davis & Himmel LLP
P.O. Box 5600
Woodbridge, NJ 07095
Attorneys for Appellees,
Fund Asset Management, L.P.,
Merrill Lynch Asset Management,
L.P., Merrill Lynch & Co., Inc.,
Merrill Lynch, Pierce, Fenner &
Smith, Inc., Princeton Services,
Inc., Arthur Zeikel, and Terry K.
Glenn
ROBERT J. DEL TUFO, ESQUIRE
(ARGUED)
FRANK E. DERBY, ESQUIRE
Skadden, Arps, Slate, Meagher &
Flom LLP
One Newark Center, 18th Floor
Newark, NJ 07102
Attorneys for Appellees,
MuniEnhanced Fund, Inc.,
MuniVest Fund II, Inc., MuniYield
Fund, Inc., MuniYield Insured
Fund, Inc., MuniYield Insured
Fund II, Inc., MuniYield Quality
Fund, Inc., MuniYield Quality
Fund II, Inc.
OPINION OF THE COURT
WARD, District Judge.
This is an appeal from the district court’s grant of
summary judgment for defendants on claims that

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investment advisors to municipal bond funds breached
their fiduciary duties under S 36(b) of the Investment
Company Act of 1940 ("ICA") and state law. Because we
conclude that plaintiffs have failed to allege any conduct
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constituting a breach of fiduciary duty by the investment
advisors, we affirm the judgment of the district court.
I. Background1
Plaintiffs, shareholders in seven closed-end, publicly-
traded municipal investment funds (the "Funds"), brought
suit against the Funds and their investment advisors, Fund
Asset Management, L.P. ("FAM") and Merrill Lynch Asset
Management, L.P. ("MLAM"), claiming that defendants had
violated their fiduciary duties under the ICA and state law.
The Funds at issue invest in long-term, tax-exempt
municipal bonds. In order to increase the overall yield to
shareholders, the Funds’ advisors seek to maximize the
number of high-yield, long-term bonds in the Funds’
portfolios through the use of leverage. The advisors raise
capital to buy additional long-term bonds by selling shares
of preferred stock. Investors who buy preferred stock
receive tax-exempt monthly dividends based on short-term
interest rates, typically two and one-half to four percent.
Because the long-term investments purchased by the
Funds with the proceeds from the sale of preferred shares
normally pay higher rates of return than the Funds are
obligated to pay to preferred shareholders, the yield to
common shareholders is increased. All of the tasks
associated with the sale of preferred stock as well as the
overall management of the Funds are handled by FAM and
MLAM. For their services, FAM and MLAM receive an
advisory fee of one-half of one percent of the Funds’ average
weekly net assets.
Plaintiffs here do not allege that the advisors’
compensation was excessive; rather, they allege that
because the bonds purchased with the proceeds from the
sale of preferred shares are included in the corpus of assets
upon which the advisory fee is based, FAM and MLAM have
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1. Because the factual background and procedural history of this case
have been set forth in great detail in three previous opinions, see Green
v. Fund Asset Mgmt., 19 F. Supp. 2d 227 (D.N.J. 1998) ("Green I"); 245
F.3d 214 (3d Cir. 2001) ("Green II"); 147 F. Supp. 2d 318 (D.N.J. 2001)
("Green III"), only those facts necessary to the disposition of the instant
appeal are set forth here.
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a strong financial incentive to keep the Funds fully
leveraged. This incentive, they maintain, creates an actual
conflict of interest between the Funds and their advisors

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that amounts to a per se breach of fiduciary duty under
S 36(b). Secondly, plaintiffs allege that the advisors’ failure
to disclose this conflict of interest adequately in the Funds’
prospectuses is a separate actionable breach of fiduciary
duty.
Defendants moved for summary judgment on plaintiffs’
S 36(b) claims,2 contending that a potential conflict of
interest in the calculation of fees does not amount to an
actionable breach of fiduciary duty under S 36(b) of the ICA
and that the method of calculating advisory fees was fully
disclosed in the Funds’ prospectuses. The district court
granted defendants’ motion for summary judgment on June
5, 2001, holding that (1) plaintiffs’ claims against the
Funds’ officers were not cognizable under S 36(b) because
the officers were not the recipients of the advisory fees;3 (2)
the disclosure of the fee arrangement in the Funds’
prospectuses was "nose-face plain;" and (3) the conflict of
interest inherent in the fee structure did not constitute a
per se breach of fiduciary duty by the Funds’ advisors. See
Green III, 147 F. Supp. 2d 318 (D.N.J. 2001). Because the
court determined that, even if true, plaintiffs’ allegations
did not establish a violation of S 36(b), the court entered
summary judgment for defendants. This appeal followed.
II. Discussion
We review the district court’s decision de novo . Schnall v.
Amboy Nat’l. Bank, 279 F.3d 205, 208 (3d Cir. 2002). Our
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2. Plaintiffs’ original complaint asserted claims under SS 8(e), 34(b), and
36(a) as well as S 36(b) of the ICA and state law. On February 23, 1998,
the SS 8(e), 34(b), and 36(a) claims were dismissed. Plaintiffs then filed
an amended complaint, and defendants moved for judgment on the
pleadings on the grounds that the state law claims were pre-empted by
federal law. The district court granted defendants’ motion, but the
decision was reversed by this Court in Green II , 245 F.3d 214 (3d Cir.
2001), and the state law claims reinstated. Defendants subsequently
filed the motion for summary judgment that is the subject of this appeal.
3. Plaintiffs have not appealed from the portion of the judgment
dismissing the claims against the Funds’ officers.
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initial task is to determine whether the district court erred
in ruling that a fee arrangement in which a fund’s
investment advisors have an incentive to maximize leverage
in order to increase their advisory fees is not a per se
breach of an investment advisor’s fiduciary duties under
S 36(b) of the ICA. We conclude that the legislative history
and the text of S 36(b) make clear that potential conflicts of
interest in mutual fund fee arrangements are not per se
violations of investment advisors’ fiduciary duties: an actual
breach must be alleged and proven.
Section 36(b) of the ICA provides that investment
company advisors owe shareholders in investment

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companies a fiduciary duty with respect to determining and
receiving their advisory fees. 15 U.S.C. S 80a-35(b) (1997).
The legislative history of the section indicates that Congress
recognized the conflicts of interest inherent in mutual fund
fee arrangements -- indeed, this was the impetus for
enacting S 36(b). The Senate Report accompanying S 36(b)
noted that "[s]ince a typical fund is organized by its
investment adviser which provides it with almost all
management services and because its shares are bought by
investors who rely on that service, a mutual fund cannot,
as a practical matter, sever its relationship with the
adviser." S. REP. NO. 91-184 (1969), reprinted in 1970
U.S.S.C.A.N. 4897, 4901. The report also stated that"in
view of the potential conflicts of interest involved in the
setting of these fees, there should be effective means for the
courts to act where mutual fund shareholders or the SEC
believe there has been a breach of fiduciary duty." Id. at
4898 (emphasis added). Section 36(b), Congress believed,
"provides an effective method whereby the courts can
determine whether there has been a breach of this duty by
the adviser." Id. (emphasis added.)
The text of S 36(b) lends further support to the district
court’s conclusion that S 36(b) was intended to provide a
very specific, narrow federal remedy that is more limited
than the common law doctrines on which plaintiffs
primarily rely. See Green III, 147 F. Supp. 2d at 329 (citing
Verkouteren v. Blackrock Fin. Mgmt., Inc., 37 F. Supp. 2d
256, 261 (S.D.N.Y. 1999); see also S. REP. NO. 91-184
(1969), reprinted in 1970 U.S.S.C.A.N. 4897, 4898 & 4903
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("[T]he unique structure of mutual funds has made it
difficult for the courts to apply traditional fiduciary duty
standards in considering questions concerning
management fees," and S 36(b) was designed"to provide a
means by which the Federal courts can effectively enforce
the federally-created fiduciary duty with respect to
management compensation.") (emphasis added).
The fact that the fiduciary duty imposed by S 36(b) is
significantly more circumscribed than common law
fiduciary duty doctrines is demonstrated by S 36(b)’s
limitations on recovery: under S 36(b), a shareholder may
only sue the recipient of the fees; recovery is limited to
actual damages resulting from the breach; and damages are
not recoverable for any period prior to one year before the
action was instituted, in this case before June 21, 1995. 15
U.S.C. S 80a-35(b)(3). Further, the plaintiff has the burden
of proving a breach of fiduciary duty, id. at S 80a-35(b)(1),
in contrast with the common law rule that requires a
fiduciary to justify its conduct. See, e.g., Gartenberg v.
Merrill Lynch Asset Mgmt., Inc., 528 F. Supp. 1038, 1044
n.6 (S.D.N.Y. 1981), aff ’d, 694 F.2d 923 (2d Cir. 1982) ( "At
common law it was incumbent on the fiduciary to justify
his transaction with his cestui. Under this statute[S 36(b)]
the burden is reversed.").

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In addition, the independent directors of the Funds
testified that they were fully aware that fees were to be paid
on assets acquired through leverage and that they reviewed
and approved the advisory fee agreements each year.
(Swensrud Tr. at 117; West Tr. at 101-02.) The district
court took this into account, as Congress directed;
according to S 36(b), approval of the management fee by the
directors "shall be given such consideration by the court as
is deemed appropriate under all the circumstances." 15
U.S.C. S 80a-35(b)(2); see Green III at 332.
Our interpretation of both the text and legislative history
of S 36(b) mandates that plaintiffs allege and prove an
actual breach of fiduciary duty in order to prevail on their
claims. Because plaintiffs have not pointed to any instance
during the period for which they can recover damages 4
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4. Plaintiffs claim the advisors made an incorrect leveraging decision
during the period extending from fourth quarter 1993 to first quarter
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when the advisors improperly failed to de-leverage the
Funds in order to maximize their fees and because
plaintiffs have not alleged any actual damages they or the
Funds suffered as a result of any improper decision by the
Funds’ investment advisors, they do not have a cognizable
claim under S 36(b). Accord Krantz v. Prudential Invs. Fund
Mgmt. LLC, 77 F. Supp. 2d 559, 563-65 (D.N.J. 1999)
(holding that where plaintiff did not allege any injury
resulting from the approval of investment advisory
agreements by fund directors who were allegedly
"interested" in the fund’s advisor, plaintiff ’s "conclusion
that a fiduciary breach [under S 36(b)] necessarily flows
from the invalid [a]greements must therefore fail.").
Likewise, we conclude that the district court was correct
in ruling that defendants adequately disclosed the method
by which advisory fees would be calculated. First, the fact
that advisory fees would be calculated based on the total
assets of the Funds, including assets acquired through the
use of leverage, was fully disclosed in the Funds’
prospectuses: the definition of "average weekly net assets"
makes perfectly plain that all assets of the fund, including
those bonds purchased with the proceeds of preferred stock
sales, are taken into account in calculating the advisory fee.
Each prospectus states that the advisors will receive a
monthly advisory fee of one-half of one percent of the fund’s
"average weekly net assets." MuniEnhanced Fund
Prospectus at 20.5 "Average weekly net assets" is defined as
"the average weekly value of the total assets of the Fund,
minus the sum of accrued liabilities of the Fund and
accumulated dividends on the shares of preferred stock."
Id. (emphasis added). Indeed, lead plaintiff Jack Green
testified at his deposition that he became aware of the
conflict of interest that led him to bring the instant lawsuit
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1995; however, plaintiffs concede that they cannot recover damages for
this period. The statute prohibits recovery of damages for any period
prior to one year before the action was instituted. Since this action was
filed on June 21, 1996, plaintiffs cannot recover damages for any breach
occurring before June 21, 1995. Moreover, plaintiffs did not invest in the
Funds until May 1995.
5. The prospectuses for the six other funds contain identical disclosures.
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by reading the prospectuses. (Green Tr. at 58-59.) If Mr.
Green was able to correctly ascertain the method by which
the fees would be calculated from public filings, the logical
conclusion is that the method was adequately disclosed.
Therefore, because the information needed to determine the
method of calculating advisory fees was clearly available to
and understood by shareholders, the district court properly
dismissed plaintiffs’ claim that defendants failed adequately
to disclose the basis of their fees.
III. Conclusion
Because we find that plaintiffs have failed to present
sufficient evidence to create a genuine issue of material fact
regarding whether the Funds’ investment advisors breached
their fiduciary duties under S 36(b) of the ICA, we affirm the
judgment of the district court.
A True Copy:
Teste:
Clerk of the United States Court of Appeals
for the Third Circuit
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