On August 28, a federal district court in Tennessee dismissed
two shareholders' claims in a derivative lawsuit against
BlackRock's iShares Trust and iShares, Inc. (together, the
Funds), Blackrock Fund Advisors (BFA), the Funds' investment
adviser, Blackrock Institutional Trust Company, N.A. (BRC), the
Funds' securities lending agent, and the directors of the
Funds. The plaintiffs, two pension funds invested in the Funds,
brought the suit seeking relief under various sections of the
Investment Company Act of 1940 (the 1940 Act), including Section
36(b), in connection with the Funds' securities lending
transactions. Section 36(b) provides a right of action for
excessive fund compensation to the investment adviser or any of its
affiliates. The plaintiffs alleged that BFA and BTC received an
excessive amount of compensation from securities lending revenue
earned on the Funds' securities lending transactions.
Funds that engage in securities lending typically contract with a
lending agent to facilitate lending transactions with borrowers.
The lending agent usually receives compensation by retaining a
portion of the revenue generated from the securities lending
transactions. Under the Funds' securities lending agreement,
BFA and BTC retained approximately 40 percent of the revenue
created from the transactions, with the Funds receiving the
remaining 60 percent. The plaintiffs argued that this compensation
was grossly excessive and that more of the profit should have been
returned to the Funds' shareholders. The original complaint
cited a 2012 Finadium survey showing that a majority of mutual
funds using a non-affiliated lending agent had retained 90 percent
of revenue. The complaint also stated that the securities lending
arrangement among Vanguard Group, Inc. and the Vanguard Funds
allowed those funds to retain 100 percent of securities lending
revenue after costs.
The Court dismissed all of the plaintiffs' claims, holding
that the Section 36(b) claim was precluded by an exception within
the statute. That exception, Section 36(b)(4), provides that
transactions between entities that have obtained an exemptive order
under Section 17 from the SEC are excepted from a Section 36(b)
action. The Court pointed out that predecessors of BFA and BTC had
received an exemptive order from the SEC under Section 17 of the
1940 Act permitting them to conduct the joint securities lending
transactions among them and the Funds, and this exemption therefore
removed the plaintiffs' securities lending claim from the scope
of Section 36(b). The Court gave the plaintiffs until September 17,
2013, to either amend the complaint or ask for a deadline
extension.
A copy of the court's opinion is available here.
A copy of the pension funds' complaint is available here.
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