Second Circuit Affirms Dismissal in Class Action Targeting 'Passive' Concentration of Investments
A three-judge panel of the Second Circuit held that Sequoia's investment policy allowed for "passive" changes in value that propelled the fund's position in the health care industry to exceed the threshold following its initial investment.
September 09, 2019 at 04:47 PM
4 minute read
Judge Denny Chin of the U.S. Court of Appeals for the Second Circuit. Photo: David Handschuh/NYLJ
A federal appeals court in Manhattan upheld the dismissal Monday of a proposed class-action lawsuit accusing Sequoia Fund Inc. of breaching a contractual provision, which supposedly barred the Maryland-based mutual fund from concentrating more than 25% of its assets in any one industry.
A three-judge panel of the U.S. Court of Appeals for the Second Circuit held that Sequoia's investment policy allowed for "passive" changes in value that propelled the fund's position in the health care industry to exceed the threshold following its initial investment.
The ruling nixed an appeal by two Sequoia shareholders, who argued that the fund had violated its concentration policy on three separate occasions in 2015, when its stake in Valeant Pharmaceuticals International Inc. increased to more than 25% of its net assets.
According to the complaint, filed in 2018, the fund's concentration policy was meant to limit Sequoia's risk of loss, and the alleged violation caused the firm to hemorrhage more than $600 million when Valeant's stock price dropped.
U.S. District Judge George B. Daniels of the Southern District of New York, however, dismissed the lawsuit last year, ruling that there was no binding agreement to enforce. Even if one did exist, he said, U.S. Securities and Exchange Commission rules permitted the passive increases at issue in the case.
On appeal, plaintiffs attorneys from Robinson Brog Leinwand Greene Genovese & Gluck argued that 1998 guidance from the SEC had rescinded the agency's previous rules to no longer permit concentration by passive increase. But Second Circuit Judge Denny Chin on Monday rejected that assertion in a 16-page opinion that upheld the lower court's ruling in regard to the alleged breach. The panel did not reach the question of whether there was in fact an enforceable contract.
Chin said that while the newer guidance did not directly address the issue of passive increases, it did apparently endorse the earlier rule, and nothing in the text suggested a change in approach.
"If the SEC had indeed adopted such a change, non‐concentrating funds would be required to constantly monitor for sudden increases and decreases in asset values, and adjust their investments in each industry to avoid exceeding the 25% threshold," he said. "It seems doubtful that the SEC would adopt such a major change without calling attention to it and without explanation."
Chin was joined in the opinion by Judges Pierre N. Leval and Rosemary S. Pooler.
Robert Skinner, a partner with Ropes & Gray who represented Sequoia, said Monday that his team was "gratified by the Second Circuit's decision, including its recognition of industry concentration standards long followed by the mutual fund industry."
An attorney for the plaintiffs, Thomas Edwards and Michael Fortune, was not immediately available to comment on the ruling.
Sequoia was represented by Skinner, Amy D. Roy and Lee S. Gayer of Ropes & Gray.
According to the opinion, the plaintiffs were represented by Raymond Farrow and Mark A. Griffin of Keller Rohrback in Seattle and Felicia S. Ennis and Alan M. Pollack of Robinson Brog in New York. The firm's website, however, no longer listed Ennis and Pollack as working for the firm.
The case was captioned Edwards v. Sequoia Fund.
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