Agreement to Give Investment Adviser Control Over Managed Account Does Not Create a Group

I previously blogged about a SNDY judge’s dismissal of a complaint alleging that the managed accounts of an investment adviser that sought to influence control of DeVry Education Group, resulting in the adviser’s loss of the RIA exemption in Rule 16a-1(a)(1)(v), were members of a 13(d) group with the adviser, making each managed account a ten percent owner subject to Section 16. Last week, another judge in the SDNY reached the same result on substantially similar facts involving an investment adviser that acquired, for various controlled funds and managed accounts, more than 10% of Sears’ outstanding common stock. See Rubenstein v. Berkowitz.

The plaintiff in Berkowitz made two arguments. First, an agreement that gives an investment adviser investment power over a client’s account relates to the acquisition of securities, and therefore makes the adviser and the client a group regarding any issuer whose securities the adviser purchases in the managed account. The court rejected the argument, noting that Rule 13d-5(b) provides that a group is formed when two or more persons agree to act together regarding the securities “of an issuer.” An investment management agreement that merely gives the adviser discretionary investment authority, and does not identify a specific issuer in which the client’s account will be invested, doesn’t relate to the securities “of an issuer” and therefor doesn’t give rise to a group.

Second, the plaintiff argued, the adviser’s filing of a Schedule 13D disclosing beneficial ownership of more than 10% of Sears’ stock, including securities held in managed accounts, put the owners of the managed accounts on notice that they were part of a control group. By failing to take action to withdraw from the group, the managed accounts impliedly agreed to participate in the control effort and therefore became members of a group. The court rejected this argument, too, holding that “silent acquiescence” is not an “agreement.”

The issues are on appeal to the Second Circuit.