United States: Investment Services Regulatory Update - May 2017

Last Updated: May 18 2017
Article by John S. Marten and Nathaniel Segal


U.S. District Court Denies Plaintiffs' Motion to Compel Production of Documents Subject to Attorney-Client Privilege in Mutual Fund Excessive Fee Litigation

On April 25, 2017, the U.S. District Court for the Northern District of Illinois issued an order (the Order) denying the plaintiffs' motion to compel Calamos Investment Trust, a Massachusetts business trust (the Trust), and its Independent Trustees to produce certain documents redacted or withheld under the attorney-client privilege in connection with pending litigation against Calamos Advisors LLC and Calamos Financial Services LLC (collectively, Calamos or the Defendants). The plaintiffs, shareholders of the Calamos Growth Fund, a series of the Trust, who have alleged that Calamos breached its fiduciary duty under Section 36(b) of the 1940 Act by charging excessive advisory and distribution fees to the Fund, argued that, although the documents in question may be subject to the attorney-client privilege, a "fiduciary exception" to the privilege should apply to allow the plaintiffs to gain access to the documents. The Trust and the Independent Trustees, who are not parties to the litigation, opposed the motion.

In connection with the Section 36(b) case against Calamos, plaintiffs issued subpoenas requesting production of certain documents from the Trust and the Independent Trustees. In response, the Trust and the Independent Trustees produced a limited number of documents, with certain documents involving legal advice provided to the Independent Trustees redacted or withheld in reliance on the attorney-client privilege. Thereafter, the plaintiffs moved to compel production of the redacted and withheld documents, arguing that a "fiduciary exception" to the privilege should apply.

The attorney-client privilege gives a client the right to maintain the confidentiality of communications, which includes the right to refrain from producing a document in response to a subpoena, "where the document contains a confidential communication between a client and her attorney in which the client seeks legal advice." The purpose of the privilege is to encourage full and frank communications between attorneys and their clients. The fiduciary exception to the attorney-client privilege, which derives from trust law, prohibits trustees who obtain legal advice in connection with their administration of a trust from asserting the privilege with respect to the trust's beneficiaries. The exception is based on the notion that the benefit of legal advice provided to a trustee in connection with the administration of a trust runs to the trust's beneficiaries, to whom the trustee owes a fiduciary duty, and that, accordingly, communications relating to the provision of such legal advice should not be withheld from the beneficiaries.

The Court stated that, to establish the applicability of the fiduciary exception, otherwise known as the "Garner doctrine" after the seminal 1970 case Garner v. Wolfinbarger, 430 F.2d 1093 (5th Cir. 1970), "the party seeking discovery must establish both a fiduciary relation and good cause for overcoming the privilege." Citing Garner, the Court identified several factors that may establish good cause. These factors include: whether the claim is colorable; the apparent need or desirability for the party seeking production to have the information and the ability to obtain the information from other sources; whether the communication relates to past, present or prospective actions; whether the communication relates to legal advice relating to the litigation in connection with which production is being sought; the extent to which the communication is identified versus the extent to which the party seeking production is "blindly fishing"; and the risk of revealing trade secrets or other confidential information.

The Court conceded that several factors weighed in the plaintiffs' favor, including that the plaintiffs were not seeking communications related to the defense of, or discovery in, the present 36(b) litigation, there was no risk of disclosing trade secrets and, pursuant to a confidentiality order in place, the documents would not have been disclosed publicly. However, the Court determined that the plaintiffs failed to demonstrate the necessity of the information and its unavailability from other sources. In this connection, the Court noted its agreement with the Southern District of New York which, in previous cases, held that the necessity of the information and its unavailability from other sources is the "most important factor" in undertaking the Garner analysis and determining whether the attorney-client privilege should be pierced. Consequently, the Court denied the plaintiffs' motion to compel after determining that the plaintiffs had not met their burden to demonstrate good cause to overcome the attorney-client privilege based on the fiduciary exception.

In denying the plaintiffs' motion to compel, the Court distinguished the November 2016 order issued by the U.S. District Court for the Eastern District of Washington in Kenny v. Pacific Investment Management Company LLC, a Section 36(b) case in which, under similar facts, the court granted the plaintiff's motion to compel production of documents subject to the attorney-client privilege by applying the fiduciary exception. The Court found Kenny unpersuasive, noting that the U.S. Court of Appeals for the Ninth Circuit, which hears appeals from the U.S. District Court for the Eastern District of Washington, had not adopted the good cause standard from Garner, and that accordingly the Kenny court did not, and was not required to, apply that standard in determining the applicability of the fiduciary exception.

The Order was issued by the U.S. District Court for the Northern District of Illinois under the caption Chill v. Calamos Advisors LLC, et al., Case No. 17-C-1658. The Order relates to Section 36(b) litigation currently pending in the U.S. District Court for the Southern District of New York under the caption Chill v. Calamos Advisors LLC, et al., Case No. 15- C-1014 (S.D.N.Y. filed Feb. 11, 2015).

BlackRock Settles Charges of Operating ETF Without Required SEC Exemptive Relief

On April 25, 2017, the Securities and Exchange Commission (SEC) announced the settlement of administrative proceedings against BlackRock Fund Advisors (BlackRock) for causing iShares MSCI Russia Capped ETF (the Russia ETF), an exchange-traded fund (ETF) it advised, to operate in violation of Sections 22(d) and (e) of the 1940 Act and Rule 22c-1 thereunder.

Section 22(d) of the 1940 Act, among other things, prohibits a dealer from selling a redeemable security that is being offered currently to the public by or through an underwriter, except at a current public offering price described in the prospectus. Rule 22c-1 generally requires that a dealer selling, redeeming, or repurchasing a redeemable security only do so at a price based on the security's net asset value ( NAV). As the SEC's order explains, because secondary market trading in shares of ETFs takes place at current market prices, and not at the current offering price described in the prospectus or based on the security's NAV, ETFs have obtained exemptions from Section 22(d) of the 1940 Act and Rule 22c-1 in order to operate lawfully. Section 22(e) of the 1940 Act also prohibits a registered op en-end fund from suspending the right of redemption, or postponing the date of payment or satisfaction upon redemption for more than seven days after the tender of such security for redemption. As also explained in the SEC's order, ETFs that invest in foreign securities and effect redemptions in kind are sometimes unable to meet this requirement because the ETFs track foreign indexes with local market delivery cycles that re quire a delivery process in excess of seven days. Thus, ETFs and their sponsors also seek exemptive relief from Section 22(e) in order to operate without violating the 1940 Act.

The SEC order states that BlackRock believed that the Russia ETF, the sole series of iShares MSCI Russia Capped ETF, Inc. (the iShares Russia Registrant), was already covered by previously issued exemptive relief which had been granted to iShares Inc. and iShares Trust. Each of iShares Inc. and iShares Trust, the order explains, is an open-end management investment company consisting of numerous ETFs, each of which is organized as a series of iShares Inc. or iShares Trust, respectively. The order notes that in January 2007, the SEC granted exempt ive relief to iShares Inc. and iShares Trust allowing them "to offer additional series, based on securities indices (the 'Future Funds'), without the need for additional exemptive relief from the Commission" (the iShares Future Fund Relief). The SEC order states that because the iShares Future Fund Relief only covered iShares Inc. and iShares Trust and their series, the separately organized iShares Russia Registrant and its series, the Russia ETF, were not covered by the iShares Future Fund Relief. Consequently, the SEC alleged that from December 2010, when the Russia ETF began selling its shares, until January 2015, when the Russia ETF was merged into a newly created series of iShares Inc., and in the absence of exemptive relief, BlackRock (1) caused shares of the Russia ETF to be purchased and sold at prices other than the NAV in the secondary market; (2) caused shares of the Russia ETF to be sold in the secondary market at negotiated prices, rather than a current public offering price described in the prospectus; and (3) caused the Russia ETF to violate Section 22(e) of the 1940 Act when it postponed the date of payment or satisfaction for more than seven days after its shares were tendered for redemption.

Pursuant to the terms of the order, BlackRock agreed to pay a civil money penalty of $1.5 million and agreed to cease and desist from any violations (and future violations) of the laws violated by the foregoing conduct.

The SEC order is available at: https://www.sec.gov/litigation/admin/2017/ic-32613.pdf.


Financial CHOICE Act of 2017 Would Impose Heightened Pleading Standards and Raise the Burden of Proof for Plaintiffs in Section 36(b) Excessive Fee Litigation

On April 19, 2017, the Chairman of the Financial Services Committee of the U.S. House of Representatives, Jeb Hensarling (R-TX), released an updated version of the Financial CHOICE Act (H .R. 10), the financial regulatory reform legislation that aims to repeal and replace various provisions of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. The latest version of the Financial CHOICE Act, dubbed "CHOICE 2.0," modifies, in several respects, the original bill (or "CHOICE 1.0") that w as introduced in the last Congress and cleared the House Financial Services Committee, but did not advance to the full House of Representatives for a vote. The latest iteration of the bill has also been approved by the House Financial Services Committee, which recently passed CHOICE 2.0 in a 34-26 vote on May 4, 2017. Notably , CHOICE 2.0 includes amendments to Section 36(b) of the 1940 Act, which were not included in CHOICE 1.0, that would impose heightened pleading standards and raise the burden of proof for plaintiffs in excessive fee litigation. Section 36(b) imposes a fiduciary duty on investment advisers with respect to the compensation they receive for providing advisory services to funds and provides fund shareholders with an express private right of action to en force this duty against advisers and their affiliates that receive compensation from funds. In such cases, the burden of proof rests on the plaintiffs to show, by a preponderance of the evidence, that the advisory fee is excessive, i.e., that the fee is "so disproportionate that it does not bear a reasonable relationship to the service the defendant rendered and could not have been negotiated at arm's-length."

CHOICE 2.0 would require that a complaint brought under Section 36(b) "state with particularity all facts establishing a breach of fiduciary duty, and, if an allegation of any such facts is based on information and belief, the complaint shall state with particularity all facts on which that belief i s formed." In addition to the heightened pleading standards proposed under CHOICE 2.0, the bill would raise the burden of proof for plaintiffs from a "preponderance of the evidence" standard to a "clear and convincing evidence" standard. That is, under CHOICE 2.0, a fund shareholder would "have the burden of proving a breach of fiduciary duty by clear and convincing evidence."

The current draft of the bill is available at: https://www.congress.gov/115/bills/hr10/BILLS-115hr10ih.pdf.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Topics
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions