Adam Voron

Last year, in Oxford University Bank v. Lansuppe Feeder, LLC,[1] the Second Circuit split from the Third[2] and Ninth[3] Circuits in holding that section 47(b) of the Investment Company Act of 1940 (the “ICA”) creates an implied private cause of action to seek rescission. By properly applying maxims of statutory interpretation, the Second Circuit reached the correct ruling.

The ICA regulates investment companies and “address[es] the particular abuses associated with companies comprised of liquid pools of securities[.]”[4] Within the ICA, section 47(b)(1) makes contracts made in violation of the ICA “unenforceable by either party[,]” provided the court does not find that enforcement would be more equitable.[5] Section 47(b)(2) provides that a court “may not deny rescission at the instance of any party” of the contract unless denial of rescission would lead to a more equitable result.[6]

In Oxford, junior noteholders of a special purpose investment vehicle, Soloso, intervened in the liquidation action of the vehicle’s assets, alleging that the proposed liquidation scheme had run afoul of the ICA because notes had been sold to a non-“qualified purchaser.”[7] The notes in question included “provisions meant to ensure that Soloso remain[ed] exempt from ICA’s registration requirement, including, as relevant here, that notes may be sold or transferred only to Qualified Purchasers as defined under the ICA[.]”[8] The junior noteholder intervenors argued that this violation made the notes unenforceable, and they were thus entitled to rescission under 47(b).[9] According to the district court, there was no private cause of action under 47(b), and it denied the junior noteholders’ requested relief.[10]

The Second Circuit disagreed.[11] It argued that the district court had “overlooked clear evidence of Congressional intent to provide a right of action: the text of [section] 47(b) itself,”[12] and that this text “unambiguously evinces Congressional intent to authorize a private action.”[13] The court pointed to the fact that section 47(b)(2) states that “a court may not deny rescission at the instance of any party” and that this “necessarily presupposes that a party may seek rescission in court by filing suit.”[14] The next question was who, in fact, “any party” applied to. The court asserted that “[t]he most natural reading of . . . ‘any party’ refers to parties to a contract whose provisions violate the ICA.”[15] According to the court, restricting the definition of “any party” to the SEC—thus denying availability of a private cause of action—would be nonsensical for three reasons.[16] First, using “any party” to describe the SEC would be ludicrous because it is “a phrase that so unambiguously contemplates that more than one entity may seek rescission.”[17] Second, if “any party” means the SEC in 47(b)(2), that would mean “party” has a different definition in 47(b)(1); it makes more sense that Congress intended the definition of party to be consistent across these sections.[18] Third, in other provisions of the ICA, the SEC is referred to “as ‘the Commission’ or ‘Commission,’ but never simply as a ‘party.’”[19]

The Second Circuit’s decision is notable in light of the Supreme Court’s hostility against implying private rights of action.[20] The Supreme Court was not always so hostile. In fact, “virtually every decision from 1962 to 2000 indicated that private actions could be implied under the [ICA], leading to successful suits covering virtually all the significant sections of the [ICA].”[21] This practice of freely implying private rights of action came to a close with the Supreme Court’s decision in Alexander v. Sandoval.[22] The Court chastised what it called the “ancien regime” under which “‘it [wa]s the duty of the court to be alert to provide such remedies as [we]re necessary to make effective the congressional purpose’ expressed by a statute.”[23] Thus, “the interpretive inquiry begins with the text and structure of the statute, and ends once it has become clear that Congress did not provide a cause of action.”[24]

Unlike the Third and Ninth Circuits, the Second Circuit followed this mandate. As the Second Circuit persuasively argued, courts unwilling to interpret section 47 as providing a private cause of action “effectively read [section] 47(b)(2) out of the ICA, purporting to apply Sandoval while seeming to ignore its central message that a court’s inquiry should focus on Congressional intent as manifested in the text of the statute.”[25] The Third and Ninth Circuits were overzealous. Yes, cases implying private causes of action in ICA provisions other than section 47(b)[26]do not survive the more searching Sandoval test[27]—but cases implying private rights of action under section 47(b) do.[28]

While the availability of a private right of action to seek rescission under 47(b) exposes investment companies to more litigation risk, it is unlikely to change the investment company landscape dramatically given its limited application. The Second Circuit’s analysis helps show why. The intervenors claimed that the sale of notes to non-qualified purchasers violated the ICA.[29] With such an argument, the intervenors theoretically had the right to sue to rescind the contracts whereby the notes were sold to non-qualified purchasers.[30] These contracts, however, were not what the intervenors were attempting to rescind.[31] Rather, they wanted to block the performance of the indenture under which senior noteholders would be paid prior to junior noteholders.[32] But as the court explained, this would require the intervenors to identify a part of the indenture that violated the ICA; the intervenors failed to do so.[33]Therefore, they had failed to state a claim, meaning that despite the finding of a private right of action, the intervenors’ action was, nonetheless, dismissed.[34]

In addition, section 47(b) will have limited application because it needs to be tethered to provisions of the ICA where plaintiffs can demonstrate a violation. For example, the plaintiffs in the Ninth Circuit case had identified two provisions of the ICA[35]—sections 7(a)(4) and 3(b)(2)—that would prove useless regardless of the contracts being challenged. Section 7(a) specifies that unless registered with the SEC, an investment company cannot “engage in any business or interstate commerce.”[36] The defendant was registered with the SEC, so this provision is futile, even if brought via a section 47(b) claim; there would be no way for the plaintiffs to demonstrate that defendant was running afoul of it. Similarly, according to section 3(b)(2), “[w]henever the Commission . . . finds that the circumstances which gave rise to the issuance of an order granting [exemption from the ICA] under this paragraph no longer exist, the Commission shall by order revoke such order.”[37] The provision makes clear that the SEC is the decider—being attached to section 47(b) does not magically transform the language into saying something entirely different. In short, only certain violations of the ICA would permit private plaintiffs to pursue rescission under section 47(b).[38] Contrary to the Ninth Circuit’s reading[39] then, a private cause of action under 47(b) would not suddenly allow private parties to wrestle authority away from the SEC and trample investment companies with a deluge of lawsuits; its potential impact is much more limited. 

If the Supreme Court were to adjudicate this issue, it should follow the cogent analysis of the Second Circuit. In the meantime, it will be interesting to see how other circuit courts resolve the issue.



[1] Oxford Univ. Bank v. Lansuppe Feeder, LLC, 933 F.3d 99 (2d Cir. 2019).
[2] Santomenno ex rel. John Hancock Trust v. John Hancock Life Ins. Co. (U.S.A.), 677 F.3d 178 (3d Cir. 2012).
[3] UFCW Local 1500 Pension Fund v. Mayer, 895 F.3d 695 (9th Cir. 2018).
[4] Mercer Bullard, Regulating Hedge Fund Managers: The Investment Company Act as a Regulatory Screen, 13 Stan. J. L. Bus. & Fin. 286, 289 (2008).
[5] 15 U.S.C. § 80a-46(b)(1).
[6] 15 U.S.C. § 80a-46(b)(2).
[7] See 15 U.S.C. § 80a-3(c)(7) (explaining that an issuer is not subject to the ICA if its “outstanding securities . . . are owned exclusively by persons, who at the time of acquisition of such securities, are qualified purchasers”).
[8] See Oxford, 933 F.3d at 102.
[9] Id. at 101.
[10] Id. See also Lansuppe Feeder, LLC v. Wells Fargo Bank, No. 15-CV-7034-LTS, 2016 WL 5477741, at *4. (S.D.N.Y. Sept. 29, 2016). The district court also concluded that even if section 47(b) did provide a private right of action, rescission should still be denied. See id. at *5.
[11] 933 F.3d at 101.
[12] Id. at 105.
[13] Id.
[14] Id. (emphasis in original).
[15] Id. (emphasis in original).
[16] Id. at 105–06.
[17] Id.
[18] Id. at 106.
[19] Id. (citing to 15 U.S.C. § 80a-32, 15 U.S.C. § 80a-42, and 15 U.S.C. § 80a-45).
[20] See, e.g., Jesner v. Arab Bank, PLC 138 S. Ct. 1386, 1402 (2018) (“[T]his Court has ‘recently and repeatedly said that a decision to create a private right of action is one better left to legislative judgment in the great majority of cases.’” (quoting Sosa v. Alvarez-Machain, 542 U.S. 692, 727 (2004))).
[21] H. Norman Knickle, The Investment Company Act of 1940: SEC Enforcement and Private Actions, 23 Ann. Rev. Banking & Fin. L. 777, 813 (2004). That being said, courts occasionally did express a modicum of doubt. See, e.g., Fogel v. Chestnutt, 668 F.2d 100, 112 (2d Cir. 1981) (Friendly, J.) (“While we recognize that the question of the existence of a private cause of action under the ICA has become more debatable than we or the defendants thought in 1975, we thus perceive no justification for departing from the law of the case.”).
[22] 532 U.S. 275 (2001).
[23] Id. at 287 (quoting Cort v. Ash, 422 U.S. 66, 78 (1975)) (emphasis in original).
[24] Id. at 286 n.7 (citation omitted).
[25] Oxford, 933 F.3d at 109 (citing Sandoval, 532 U.S. at 286 (“Statutory intent . . . is determinative.”)).
[26] See, e.g., Lessler v. Little, 857 F.2d 866, 871 (1st Cir. 1988) (implying private right of action under section 17(a)(2)); Bancroft Convertible Fund v. Zinco Inv. Holdings, Inc., 825 F.2d 731, 736 (3d Cir. 1987) (implying private right of action under section 12(d)(1)(A)).
[27] Olmsted v. Pruco Life Ins. Co. of N.J., 283 F.3d 429, 434 (2d Cir. 2002) (“[A]n overwhelming majority of courts interpreting the ICA have recognized implied private rights of action to enforce many of its sections. When those cases were decided, however, courts had more latitude to weight statutory policy and other considerations than they do [post-Sandoval].”) (footnote omitted).
[28] See, e.g., Lessler v. Little, 857 F.2d 866, 874 (1st Cir. 1988); Mathers Fund, Inc. v. Colwell Co., 564 F.2d 780, 783 (7th Cir. 1977); Galfand v. Chestnutt Corp., 545 F.2d 807, 814 (2d Cir. 1976).
[29] Oxford, 933 F.3d at 109.
[30] Id.
[31] Id.
[32] Id.
[33] Id.
[34] Id. at 109–10.
[35] See UFCW Local 1500 Pension Fund v. Mayer, 895 F.3d 695, 699 (9th Cir. 2018).
[36] 15 U.S.C. § 80a-7(a)(4) (providing in full that “[n]o investment company organized or otherwise created under the laws of the United States or of a State, and having a board of directors unless registered under section 80a-8 of this title, shall directly or indirectly—engage in any business or interstate commerce”).
[37] 15 U.S.C. § 80a-3(b)(2).
[38] See Knickle, supra note 21, at 847–48 n.461, for hypotheticals of when rescission might be available.
[39] See UFCW Local 1500 Pension Fund, 895 F.3d at 700–01 (9th Cir. 2018).