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Laborers' Local 265 Pension Fund v. iShares Trust

United States Court of Appeals, Sixth Circuit

September 30, 2014

LABORERS' LOCAL 265 PENSION FUND; PLUMBERS and PIPEFITTERS LOCAL NO. 572 PENSION FUND, Plaintiffs-Appellants,
v.
iSHARES TRUST et al., Defendants-Appellees

Argued July 30, 2014 

Appeal from the United States District Court for the Middle District of Tennessee at Nashville. No. 3:13-cv-00046--Aleta Arthur Trauger, District Judge.

ARGUED: C. Mark Pickrell, THE PICKRELL LAW GROUP, P.C., Nashville, Tennessee, for Appellants.

Seth M. Schwartz, SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP, New York, New York, for Appellees.

ON BRIEF: C. Mark Pickrell, William G. Brown, THE PICKRELL LAW GROUP, P.C., Nashville, Tennessee, James G. Stranch, III, J. Gerard Stranch IV, Michael G. Stewart, Michael J. Wall, BRANSTETTER, STRANCH & JENNINGS, PLLC, Nashville, Tennessee, Jenny L. Dixon, ROBBINS ARROYO LLP, San Diego, California, for Appellants.

Seth M. Schwartz, Jeremy A. Berman, SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP, New York, New York, John R. Jacobson, Milton S. McGee, III, RILEY WARNOCK & JACOBSON, PLC, Nashville, Tennessee, Bruce H. Schneider, STROOCK & STROOCK & LAVAN LLP, New York, New York, for Appellees.

Before: BOGGS, CLAY, and GILMAN, Circuit Judges.

OPINION

Page 400

RONALD LEE GILMAN, Circuit Judge.

An affiliate of the investment advisor for iShares mutual fund functions as a middleman between iShares and those who seek to borrow iShares's securities holdings, charging a fee of 35% for all net revenue received by iShares from such lending activity. The plaintiff shareholders challenge this fee as excessive under the Investment Company Act of 1940 (ICA), 15 U.S.C. § 80a-1 et seq.

Page 401

Their complaint was dismissed by the district court for failure to state a claim. For the reasons set forth below, we AFFIRM the judgment of the district court.

I. BACKGROUND

A. Factual background

Securities lending promotes market efficiency and liquidity by making securities readily available to a variety of borrowers, including short-sellers. The Second Circuit has described the practice as follows:

Securities lending is an important and significant business that describes the market practice whereby securities are temporarily transferred by one party (the lender) to another (the borrower). The borrower is obliged to return the securities to the lender, either on demand, or at the end of any agreed term. For the period of the loan the lender is secured by acceptable assets delivered by the borrower to the lender as collateral. Typically, the collateral--which, in the United States, often takes the form of cash--is valued at 102% [to] 105% of the market value of the loaned securities. The borrower of securities may be motivated by any number of factors, including the desire to cover a short position, to sell the borrowed securities in hopes of buying them back at a lower price before returning them to the lender, or to gain tax advantages associated with the temporary transfer of ownership of the securities.

United States v. Zangari, 677 F.3d 86, 88 (2d Cir. 2012) (internal citations, footnotes, and quotation marks omitted).

The plaintiffs in this case are two pension funds that are shareholders in exchange-traded funds issued by iShares, Inc. and iShares Trust (collectively iShares). iShares, as part of its mutual-fund operations, lends its securities holdings to various borrowers. This lending activity generates substantial revenue for iShares because borrowers must post cash collateral and pay interest on their loans. BlackRock, Inc., which is not named as a defendant, is the corporate parent of iShares. Defendant BlackRock Institutional Trust Company, N.A. (BTC), a wholly owned subsidiary of BlackRock, serves as iShares's lending agent. BTC functions as a middleman between iShares and those who seek to borrow iShares's securities holdings. In exchange for its services as lending agent, BTC receives 35% of all securities-lending net revenue. The parties refer to this percentage as the " lending fee."

Defendant BlackRock Fund Advisors (BFA) is a wholly owned subsidiary of BTC. BFA is the investment adviser for iShares and manages the funds' portfolios pursuant to an investment-advisory agreement. Under this agreement, BFA receives a separate fee that is not at issue in this case.

The plaintiffs allege, among other things, that BFA and BTC violated Section 36(a) and Section 36(b) of the ICA, 15 U.S.C. § 80a-35(a), (b), by charging an excessive lending fee. According to the plaintiffs, the fee charged by BTC bears no relationship to the actual services rendered.

B. Procedural background

The plaintiffs filed suit in federal district court against BFA, BTC, individual iShares directors, and several nominal defendants in January 2013. In response, the defendants moved under Rule 12(b)(6) of the Federal Rules of Civil Procedure to dismiss the complaint for failure to state a claim. The district court granted the defendants' motion and dismissed the complaint in August 2013. Although the district

Page 402

court granted the plaintiffs leave to amend their complaint, the plaintiffs instead filed this appeal following the entry of a final judgment.

The plaintiffs do not object to the practice of securities lending in general, but they do object to the 35% lending fee that BTC charges. They specifically allege that:

66. BFA, acting as investment adviser to iShares and the Funds, has retained BTC, its parent company, to manage the lending of securities owned ...

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