Tapping the Reservoir: Mutual Fund Litigation under Section 36(a) of the Investment Company Act of 1940

Abstract:     
In the wake of the 2003 mutual fund scandal, numerous lawsuits have been filed against mutual fund officers, directors and investment advisers. Many of these lawsuits allege violations of section 36(a) of the Investment Company Act of 1940. Section 36(a) provides a federal cause of action for a breach of fiduciary duty involving personal misconduct in respect of any investment company. The interpretation of this phrase, however, remains unsettled. After examining relevant legislative history and case law, the Article argues that the federal courts should fashion federal law as to what fiduciary duties are owed under section 36(a), drawing on analogous state law as appropriate. This approach would allow federal courts to tailor fiduciary duty standards for the unique investment company structure as opposed to simply applying state fiduciary duty standards developed for traditional corporations.

The Article also argues that the involving personal misconduct standard of section 36(a) should be interpreted to include more than just self-dealing and personal impropriety, as some courts have suggested. Specifically, along the lines of the business judgment rule, the standard should encompass any decision that was not made on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company. This interpretation strikes the appropriate balance between attracting competent individuals to serve as fund directors and holding fund directors accountable. This interpretation would also extend business-judgment-rule-type protection to investment advisers, a result warranted by the risk-taking nature of portfolio management.

Number of Pages in PDF File: 56

Keywords: Investment company act, mutual fund directors, section 36, section 36(a), mutual fund litigation

JEL Classification: K22, K23

Accepted Paper Series