(Article from Securities Law Alert, August/September 2019)
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On August 5, 2019, the Second Circuit held that Section 47(b) of the Investment Company Act (“ICA”) “creates an implied private right of action for a party to a contract that violates the ICA to seek rescission of that violative contract.” Oxford University Bank v. Lansuppe Feeder, 933 F.3d 99 (2d Cir. 2019) (Leval, C. J.). The Second Circuit expressly disagreed with the Third Circuit’s decision in Santomenno ex rel. John Hancock Trust v. John Hancock Life Ins. Co., 677 F.3d 178 (3d Cir. 2012), which held that there is no private right of action under Section 47(b) of the ICA.
Background
Section 47(b) of the ICA provides in relevant part as follows:
Validity of Contracts
(1) A contract that is made, or whose performance involves, a violation of this subchapter . . . is unenforceable by either party . . .
(2) To the extent that a contract described in paragraph (1) has been performed, a court may not deny rescission at the instance of any party unless the court finds that under the circumstances the denial of rescission would produce a more equitable result than its grant and would not be inconsistent with the purposes of this subchapter.
15 U.S.C. § 80a-46(b).
In Bellikoff v. Eaton Vance Corp., 481 F.3d 110 (2d Cir. 2007), the Second Circuit held that certain other provisions of the ICA do not create a private right of action. The district court in Lansuppe Feeder v. Wells Fargo Bank, 2016 WL 5477741 (S.D.N.Y. 2016), relied on the three “Bellikoff factors” to find that there is also no private right of action under Section 47(b). First, the court found “the ICA explicitly provides for enforcement of all ICA provisions by the SEC.” Second, the court noted that “[t]he explicit creation of a private right of action in Section 35(b) of the ICA . . . suggests that Congress’s omission of an explicit right of action from Section 47(b) was intentional.” Third, the court found that “there is no implication [in Section 47(b)] of an intent to confer rights on . . . a protected particular class of persons.”
Second Circuit Finds Section 47(b)(2) Reflects a Clear Congressional Intent to Provide a Private Right of Rescission
The Second Circuit determined that the district court “erred in its application of the third Bellikoff factor, and in so doing, overlooked clear evidence of Congressional intent to provide a right of action: the text of § 47(b) itself.” Oxford University Bank, 933 F.3d 99. The Second Circuit explained that “[a]lthough Congress did not expressly state [in Section 47(b)(2)] that a party to an illegal contract may sue to rescind it, the clause that begins ‘a court may not deny rescission at the instance of either party’ necessarily presupposes that a party may seek rescission in court by filing suit.” The court concluded that “[t]he language Congress used is thus effectively equivalent to providing an express cause of action.”
The Second Circuit found that “§ 47(b)(2) also identifies a ‘class of persons’ who benefit from the availability of the right of action.” The court reasoned that “[t]he most natural reading of the clause providing for rescission, which appears in a section entitled ‘Validity of Contracts’ and provides a remedy that benefits a party to an illegal contract, is that ‘any party’ refers to parties to a contract whose provisions violate the ICA.” The court deemed “unpersuasive” the argument that the term “any party” refers to a governmental actor, such as the SEC. The court reasoned, inter alia, that “Section 47(b)(2) cannot be read in isolation from § 47(b)(1), which provides that contracts that violate the ICA are unenforceable by parties to the contract.” The court explained that Section 47(b)(2) “provides the parallel remedy—rescission rather than non-enforcement—for violative contracts that have already been performed.”
The Second Circuit found it significant that the Supreme Court reached the same conclusion with respect to a similar provision in the Investment Advisors Act (“IAA”), companion legislation to the ICA. In Transamerica Mortgage Advisors v. Lewis, 444 U.S. 11 (1979), the Court held that “in providing that contracts violating the IAA were void, Congress intended to include a right to seek rescission as well.” Oxford University Bank, 933 F.3d 99 (discussing Transamerica Mortgage Advisors, 444 U.S. 11).
The Second Circuit recognized that “the Third Circuit and several lower courts have reached the opposite result” with respect to the availability of a private right of action under Section 47(b). The court explained that it “respectfully disagree[d]” with the Third Circuit’s decision in Santomenno, 677 F.3d 178, because the Third Circuit “relied on interpretive canons that are intended to help resolve ambiguity” rather than “focusing on the text of the statute.” The Second Circuit noted that “the Third Circuit failed to mention the strongest textual indication of Congressional intent to provide a private right of action: the clear language of § 47(b)(2) that ‘a court may not deny rescission at the instance of any party.’” The Second Circuit similarly disagreed with district court decisions holding that Section 47(b)’s “‘language is not sufficient to find an implied private right of action’ because ‘it contains a remedy but not a substantive right.’” Id. (quoting Smith v. Oppenheimer Funds Distrib., 824 F. Supp. 2d 511 (S.D.N.Y. 2011)).[1] The court found “[t]hese district court decisions effectively read § 47(b)(2) out of the ICA.”
[1] See also Smith v. Franklin/Templeton Distribs., 2010 WL 2348644 (N.D. Cal. 2010) (“By its terms, § 47(b) provides a remedy . . . rather than a distinct cause of action or basis for liability.”); Stegall v. Ladner, 394 F. Supp. 2d 358 (D. Mass. 2005) (“ICA § 47(b) provides a remedy rather than a distinct cause of action or basis of liability”).