Appeal from the United States District Court for the Northern District of Illinois, Eastern Division. No. 97 C 5255--Ronald A. Guzman, Judge.
Before Flaum, Chief Judge, and Bauer and Ripple,
The opinion of the court was delivered by: Flaum, Chief Judge.
The plaintiffs in this case are common shareholders of six closed-end, tax-exempt municipal bond funds. They allege that Nuveen, the funds' investment adviser, breached its fiduciary duty under §36(b) of the Investment Company Act of 1940 ("ICA" or "the Act") by receiving compensation based on a percentage of the daily net assets of the funds. Such an arrangement, plaintiffs contend, creates an inherent conflict of interest in violation of the Act. The district court granted summary judgment in favor of the defendant, finding that the plaintiffs failed to produce evidence establishing a breach of fiduciary duty under §36(b). For the reasons stated herein, we affirm the decision of the district court.
The six funds at issue are closed-end, *fn1 tax-exempt, leveraged *fn2 companies that invest in tax-free municipal bonds. The stated primary objective of the funds is to provide shareholders current income exempt from regular federal income tax. The stated secondary objective is to enhance portfolio value relative to the municipal bond market "through investments in tax-exempt Municipal Obligations that, in the opinion of the adviser, are underrated or undervalued or that represent municipal market sectors that are undervalued."
Each of the funds uses leverage to increase the amount of current income generated. That is, each of the funds issues preferred stock, used as a leveraging tool, as well as common stock. *fn3 The sale of common stock provides the majority of the capital with which the funds purchase long-term municipal bonds. The proceeds from the sale of preferred stock, sold at a dividend rate that is based upon short-term tax-exempt interest rates, are invested into additional longterm municipal bonds that pay rates of return that exceed the preferred-share dividend amount. The difference between the dividend paid to the preferred shareholders and these long-term interest rates amounts to additional income to common shareholders. So long as the long-term rates exceed the short-term dividend rates, which they do under normal market conditions, common shareholders receive greater current income than they would if the identical fund were not leveraged. *fn4 It is undisputed in this case that the long-term always exceeded the short-term rates. The Nuveen funds were leveraged for the entire time period in question.
Being a common shareholder of a leveraged investment company is not without risks. The dividends and values of preferred shares are set; the holders of preferred shares always have a prior claim on the funds' assets. Therefore, a decrease in the value of those assets is borne only by the holders of common shares. Generally, the more highly leveraged the fund, the greater the risk of loss resulting from decreased portfolio value. Each of the six funds' prospectuses informed its common shareholders that leverage creates increased volatility in the value of their shares. *fn5
Under the ICA, each investment company must have a board of directors, at least 40% of which is disinterested from the fund and its advisers. A majority of the directors of each of the funds at issue in this case is unaffiliated with Nuveen. The directors maintained ultimate control over the extent of the funds' leverage and the decisions as to whether to deleverage at a given time; they did, however, rely upon Nuveen for recommendations on leverage decisions. Nuveen operates and manages the funds in question. Its compensation is based on a percentage of the daily net assets of the funds, including the value of assets attributable to outstanding preferred shares. *fn6 Thus, assuming the number of outstanding common shares remains fixed, the more highly leveraged the fund, the higher Nuveen's compensation. The six funds issued preferred shares equaling approximately 35% of the funds' total assets to create leverage. Because an adviser's services and costs increase, to some extent, as its fund's assets increase, almost all investment companies and 100% of the 202 current closedend, leveraged municipal bond funds, base adviser compensation on net or total assets.
We review the district court's grant of summary judgment de novo, construing all of the facts and reasonable inferences that can be drawn from those facts in favor of the nonmoving party. See Central States, Southeast & Southwest Areas Pension Fund v. Fulkerson, 238 F.3d 891, 894 (7th Cir. 2001). A grant of summary judgment is appropriate if the pleadings, affidavits, and other supporting materials leave no genuine issue of material fact, and the moving party is entitled to judgment as a matter of law. Fed. R. Civ. P. 56(c).
The logic of the plaintiffs' underlying contention is easy to understand, but their conclusion is ultimately false. With the current compensation structure, the more highly leveraged a closed-end fund, the more compensation its advisers receive. A fund's interests may not always be best served by being highly leveraged. *fn7 Therefore, the plaintiffs conclude, assuming that the funds' advisers are the decision makers--an assumption that has proven incorrect in this case, as will be discussed below--the advisers have a personal monetary incentive to act in a manner that may not be best for the common shareholders of the funds, creating an impermissible conflict of interest.
This incentive alone, the plaintiffs argue, violates the ICA §36(b). Under this provision, an investment company's adviser owes the shareholders a fiduciary duty "with respect to the receipt of compensation for services." 15 U.S.C. §80a-35(b). Two primary issues arise with regard to this contention: first, does the alleged conflict of interest alone violate §36(b) of the Act, and second, does such a conflict exist in this case. The district court answered both questions in the negative.
Congress enacted the ICA in 1940 to provide a comprehensive federal program to address mismanagement and abuse of investment companies that had become prevalent in the depression era. William P. Rogers and James N. Benedict, Money Market Fund Management Fees: How Much is Too Much?, 57 NYU L. Rev. 1059 (Dec. 1982). Because Congress recognized the potential for a fund's adviser to self-deal under a compensation scheme based on a percentage of fund assets, it mandated that forty percent of a fund's board of directors be unaffiliated with the fund's adviser. Id.; 15 U.S.C. §80a-10(a). These independent directors were directly accountable to shareholders and were, among other duties, responsible for determining adviser compensation and approving, by majority, all agreements with advisers. 15 U.S.C. §80a-15(c). In 1970, recognizing that the potential for abuse called for greater and more easily enforced protection for investors, Congress ...