On August 5, 2019, the U.S. Court of Appeals for the Second Circuit created a split with other courts regarding whether there is a private right of action for rescission under Section 47(b) of the Investment Company Act of 1940. The plaintiffs in the litigation, which was initiated in the U.S. District Court for the Southern District of New York, were investors in junior notes issued by a special-purpose vehicle organized as a trust that relied on the exemption from the definition of “investment company” provided by Section 3(c)(7) of the 1940 Act, under which an issuer all of whose securities are owned by “qualified purchasers” is not an investment company. The plaintiffs alleged that certain investors in the junior notes were not qualified purchasers, and therefore that the trust was in violation of the 1940 Act’s registration requirements. Accordingly, the plaintiffs alleged that noteholders should be entitled to rescission of their investments in the notes under Section 47(b) of the 1940 Act, which provides that a contract made in violation of the 1940 Act, or whose performance involves a violation of the 1940 Act, is generally unenforceable by either party and permits the rescission of such a contract to the extent the contract has been performed. The district court concluded that no private right of action exists to assert rescission claims under Section 47(b), and it granted summary judgment to the defendants.

On appeal, the Second Circuit disagreed with the district court and ruled that, based on the text of the statute and its legislative history, Section 47(b) of the 1940 Act creates an implied private right of action to sue for rescission of a contract allegedly made in violation of the 1940 Act. In rendering its decision, the Second Circuit applied the U.S. Supreme Court’s reasoning from its decision on private rights of action in Alexander v. Sandoval (2001), focusing on the text and structure of Section 47(b), which was added to the 1940 Act by a 1980 amendment. The Second Circuit found that Congress’s implied intent was unambiguous even though there was no express right to sue under Section 47(b). The Second Circuit noted that the language of Section 47(b), which provides that “a court may not deny rescission at the instance of any party unless such court finds that under the circumstances the denial of rescission would produce a more equitable result than its grant and would not be inconsistent with the purposes of [the 1940 Act],” “necessarily presupposes that a party may seek rescission in court by filing suit” and “is thus effectively equivalent to providing an express cause of action.”

In recent years, most courts have interpreted the 1940 Act as providing only a single private right of action under Section 36(b), expressly granted to investment company shareholders to recover excessive advisory fees from investment advisers and their affiliates. The Second Circuit acknowledged that it was creating a circuit split with its decision, noting that “the Third Circuit and several lower courts have reached the opposite result.” In particular, the court noted the Third Circuit’s decision in Santomenno ex rel. John Hancock Trust v. John Hancock Life Insurance Co. (2012), in which that court found that plaintiffs lacked a private right of action to seek rescission under Section 47(b). The Second Circuit stated that it did not find the reasoning in Santomenno persuasive.

The opinion was issued under the caption Oxford University Bank v. Lansuppe Feeder Inc., No. 16-4061 (2d Cir. Aug. 5, 2019).