Opposition Brief — Little v. Lessler

No. au) EILED

IN THE

Supreme Court of the United-States®=__"

October Term, 1988

ARTHUR D. LITTLE, et al,

Petiti

Vv.

RICHARD LESSLER,

Respondent

Brief in Opposition to Petition for a Writ of Certiorari to

the United States Court of Appeals for the First Circuit

MORDECAI ROSENFELD, PC.

233 Broadway

New York, NY 10279

(212) 964-1369

ALAN E. BANDLER

300 Park Avenue

New York, NY 10022

(212) 980-6800

AMEDEO C. MEROLLA

ASQUITH, MEROLLA, ANDERSON, RYAN &

WILEY

155 South Main Street

Providence, RI 02903

(401) 331-9100

BENJAMIN J. STEIN

7251 Pacific View Drive

Los Angeles, CA 90068

(213) 876-4522

Counsel for Respondent

A

i

i

No. 88-1018

IN THE

SUPREME COURT OF THE UNITED STATES

OCTOBER TERM, 1988

ARTHUR D. LITTLE, et al,

Petitioners,

V.

RICHARD LESSLER,

Respondent.

Brief in Opposition to Petition for a Writ of Certiorari to

the United States Court of Appeals for the First Circuit.

I.

Counter-Questions Presented.

1. Whether the issues raised in the Petition are hypotheti-

cal and premature because it has not yet been determined

whether a Section 17(a) (of the Investment Company Act)

violation has in fact occurred, and the Court of Appeals has

remanded the case to the District Court for just such a

determination?

2. Whether the amended complaint states a valid claim

under the Investment Company Act of 1940?

il

Table of Contents.

Page

Counter-Questions Presented ..................4-. i

We A Pi oie oo 5k chen eens ili

Counter-Statement of the Case ................... 1

Ah, “Teub FEE 5c cece k ks ee eh

2. Tine Statutory ViciOtOms..... 2. cc cccccevsass 4

3. FRO PrOCOGUINGS TAIOW «occ ck ccs ciwcsses 4

ARGUMENT:

The Petition for a Writ of Certiorari should be denied 6

k, Fee CGO 36 WE oak 25 Re ee 6

II. Petitioners’ contention that there is a conflict or a

genuine doubt about the right to assert a private

right of action under the Investment Company

Puch 0 DE GT kc ko are Seca eee 7

III. A private right of action has been recognized under

Section 17 of the Investment Company Act; but

in any event the issue is hypothetical and pre-

PPC ee re ry eee ee 8

IV. Claims under Section 17 of the Investment Com-

NE we hr oe 10

CANIN 5s ckvunai na eek eet eee 11

ill

TABLE OF AUTHORITIES.

Page

CASES:

: Bancroft Convertible Fund, Inc. v. Zivco Investment

/ Holdings, Inc., 825 F.2d 731 (3rd Cir. 1987).. 7

Brown v. Bullock, 294 F.2d 415 (2d Cir. 1961)..... 7,8

: Rae W, WA Me OF OP CADIS) oo ccs ccaccceceees 8

Entel v. Allen, 270 F. Supp. 60 (S.D.N.Y. 1967)..... 8

Fogel v. Chestnutt, 668 F.2d 100 (2d Cir. 1981) (Fogel

If), cert. denied 459 U.S. 828 (1982)....... 7 ea

Fogel v. Chestnutt, 533 F.2d 731 (2d Cir. 1975 (Fogel

I), cert. denied 429 U.S. 824 (1976)......... 7,8

Goodall v. Columbia Ventures, Inc., 374 F. Supp. 1324

i a a 8

Greater Iowa Corp. v. McLendon, 378 F.2d 783 (8th

Re chk e wee 7

J. I. Case Co. v. Borak, 377 U.S. 426 (1364) ....... 8

Krome v. Merrill Lynch & Co. Inc., 637 F. Supp. 910

cred kb etcekanekek eek Kes 8

Levitt v. Johnson, 334 F.2d 815 (1st Cir. 1964), cert.

denied 379 U.S. 961 (1965). ............... 7

Moses v. Burgin, 445 F.2d 369 (1st Cir. 1971 ) cert.

denied 404 U.S. 994 (1971). ............... 7

iV.

Page

Rosenfeld v. Black, 445 F.2d 1337 (2d Cir. 1971)... 7

_Taussig v. Wellington Fund, Inc., 313 F.2d 472 (3rd 7

Cir. 1963), cert. denied 374 U.S. 806 (1963) 7

Transamerica Mortgage Advisors, Inc. v. Lewis, 444

NE FG Vaid ve yh wu epee sas 7

STATUTES:

15 U.S.C. Section 80a-17(a)............ 6, 8, 9, 10, 11

REGULATIONS:

Rule 14a-9(b) (Securities Exchange Act), 17 CER.

ON RRND soon vv wade ssdevcndeue 9

IN THE

SUPREME COURT OF THE UNITED STATES

OCTOBER TERM, 1988

s

ARTHUR D. LITTLE, et al,

Petitioners,

v.

RICHARD LESSLER,

Respondent.

Brief in Opposition to Petition for a Writ of Certiorari to

the United States Court of Appeals for the First Circuit.

Counter-Statement of the Case.

1. The Background Facts.

This case involves unique facts but tried and true legal

principles.

It involves a 1986 “going private” by Narragansett Capi-

tal Corporation (the “Corporation”), a company that was

registered pursuant to the Investment Company Act as a

closed-end non-management investment company. The

inside directors of the Corporation—defendants Little,

Manchester, Barber, Vandenberg, Nelson and McNulty—

also owned a separate company, Narragansett Manage-

2

ment Company (the “Management Company”) which had

acted over the years as the Corporation’s investment

adviser. The Corporation was in the business of buying

large equity positions in a variety of small (often not pub-

licly held) companies and then selling those positions,

hopefully for a profit.

The Complaint alleges that as a result of the “going

private” transaction, the Management Company (i.e., the

Corporation’s inside directors), ended up with a 20% inier-

est in the assets that were sold to the third party, defendent

Monarch Capital Corporation (““Monarch”).* Since Mon-

arch’s announced plan was to sell all of those purchased

assets, the Management Company’s 20% interest would be

reduced to cash in a very few years. As explained below, it

was the fact that the Management Company (i.e., the inside

directors) would, at no cost to themselves, retain a 20%

interest in the Corporation’s assets that prompted this law-

suit. Of course, defendents do not admit that they obtained

a 20% interest in the Corporation’s assets at no cost.

Rather, they claim that their 20% interest is really only fair

payment for rendering investment advice to Monarch. The

Complaint alleges that the so-called investment advisory

contract is “a sham” to mask the truth.

The same Corporate insiders sought to obtain the same

20% interest in the Corporation’s assets two years earlier,

in 1984. They submitted an application to the Securities

and Exchange Commission on April 12, 1984, and sought

an exemption under Section 17 of the Investment Company

Act. When that exemption was not granted defendants

withdrew their application; a few months later they pro-

posed the 1986 “going private,” which is the transaction

*That 20% interest is in addition to the more usual management

fee of 2%-3% of the assets that the Management Company also

receives.

3

here in issue. The complaint alleges that the defendants,

when they withdrew their application from the S.E.C.,

sought to by-pass Section 17 of the Investment Company

Act by the unique and oblique technique of obtaining the

very same 20% interest in the Corporation, albeit by calling

it “investment advisory” fees.

The proxy statement, dated September 19, 1986, advised

the Corporation’s shareholders that the Corporation and all

of its assets were being sold to a third party, defendant

Monarch, and that each shareholder of the Corporation

would receive consideration of $56 per share. The proxy

statement disclosed that Monarch planned to liquidate all

of the Narragansett assets it purchased, over the next few

years, and would retain the Management Company to do

the job. For its efforts, the Management Company would be

paid between 2% and 3% of the assets it was managing (the

so-called Management Fee) plus 20% of all the profits

realized on the liquidation (the so-called 20% Contingent

Fee). That 20% interest would, concededly, yield to the

Management Company, in a very few years, a very tidy

sum indeed; the proxy statement itself projects that the

assets, bought for $122 million, would be sold for $245

million.* These fees were described in the proxy statement

as “investment advisory fees.”

The thrust of the complaint (brought in the United States

District Court for the District of Rhode Island) is that

Monarch’s agreement to pay the Management Company

20% of the profits (on the sale of the assets that Monarch

had bought from the Corporation) was unlawful, and that

that 20% belonged to all of the Corporation’s shareholders.

*The entire difference would not be profit; there is a formula that

includes expenses, and a return on investment for Monarch.

The Statutory Violations.

The Complaint alleges that the 1986 “going private”

transaction violated both the Investment Company Act

(Sections 17(a), 36, 47(b) and 48(a)) and the Securities

Exchange Act of 1934 (Sections 10(b) and 14(a)). We note

particularly the inter-connection between Sections 17 and

36(b) of the Investment Company Act; Section 36(b), by its

terms, excludes transactions covered by Section 17. Since

Section 36(b) is directed at excessive investment advisory

fees, and since defendants themselves described their 20%

interest as an “ investment advisory fee,” the Complaint

pleaded that the challenged transaction violated (in the

alternative) both Sections 17(a) and 36(b). The Court of

Appeals upheld only the Section 17(a) claim so that, techni-

cally, that is the only section now before the Court.

3. The Proceedings Below.

Defendants, prior to answer and discovery, moved to

dismiss the complaint pursuant to Rules 12(6)(6) and 9(b)

of the Federal Rules of Civil Procedure, and the District

Judge (Pettine, J.) referred the motions to a magistrate. The

magistrate issued a Report and Recommendation on Sep-

tember 29, 1987 (the “Report”*) recommending that

defendants’ motions for dismissal be granted. Without a

hearing, the District Court adopted the Report and dis-

missed the complaint.

The essence of the Report is that the sale of the Corpora-

tion’s assets to Monarch was separate from, and not related

to, the investment advisory contract between Monarch and

the Management Company. Hence the Report held that

ae *The Report and the Circuit Court’s opinion are annexed to the

etition.

5

there were no violations of federal law involved in connec-

tion with the sale of the Corporation’s assets to Monarch.

In particular, the Report found no violation of Section

17(a) of the Investment Company Act because of the find-

ing that the two contracts signed by Monarch (its purchase

of the Corporation’s assets and the contrast for investment

advisory services) were separate and distinct. Although the

Report specifically found that no violation of Section 17(a)

had been pleaded, it also found (inconsistently) no violation

of Section 36(b) (of the Investment Company Act) on the

ground that Section 36(b) specifically excludes transactions

subject to Section 17. The Report also dismissed the claims

asserted under the Securities Exchange Act on the general,

ground that Rule 9(b), which requires that allegations of

fraud must be pleaded with particularity, had not been

complied with.

The District Court approved the Report as submitted

without argument, and an appeal to the First Circuit Court

of Appeals followed.

—_

The First Circuit (per Judges Bownes, Breyer and Caf-

frey) unanimously reversed on the basic Investment Com-

pany Act allegation but affirmed the dismissal on all Secu-

rities Exchange Act allegations. In particular, the Court

held that, based on the unique and very special facts of the

case, a violation of Section 17(a) of the Investment Com-

pany Act had been pleaded. The Court noted that the

defendants had (i) applied to the S.E.C. for approval, (ii)

then withdraw their application for a 20% interest in the

Corporation from S.E.C. consideration and, (iii) then them-

selves proposed a variation of that same theme by seeking

the same 20% interest, albeit through the oblique device of

the so-called investment advisory contract. The Court also

noted the Report’s inconsistency of dismissing the Section

6

17 claim and then also dismissing the Secticn 36(b) claim

on the ground that Section 36(b) specifically excludes

transactions covered by Section 17. In choosing between

which of those two mutually exclusive sections to sustain,

the First Circuit chose Section 17(a). As a result of the

proceedings below, only the Section 17(a) claim is, techni-

cally, before this Court.

With this brief summary of events as background, we

respectfully submit that the Petition for a Writ of Certiorari

should be denied.

ARGUMENT.

The petition for a writ of certiorari should be denied.

I. The case is unique.

This is a most atypical case, involving an alleged attempt

by defendants to circumvent Section 17(a) of the Invest-

ment Company Act by entering into a “sham” transaction

involving a so-called investment advisory contract pursuant

to which they would receive 20% of the profits as the

Corporation’s assets are liquidated (in addition to a pay-

ment of 2%—3% of the value of the assets being managed).

We have found no precedent for such obliqueness. Having

first sought and then withdrawn their application before the

S.E.C. (for an exemption to allow them to obtain a 20%

interest in the Corporation), defendants should be the last

persons to argue that only the S.E.C. can hear this alleged

violation of Section 17.

At any rate, our research (and petitioners’; see Petition

p.13) has uncovered no case with a factual situation even

remotely similar to this one. Such a one-time transaction

does not merit this Court’s review.

7

Il. Petitioners’ contention that there is a conflict or a genuine

doubt about the right to assert a private right of action under

the Investment Company Act is not-correct.

Petitioners’ underlying theme is that the law is still unset-

tled as to whether there exists any private rights of action

(except for claims under amended Section 36(b)) under the

Investment Company Act of 1940. In fact, however, private

rights of action have long been sustained in a broad variety

of Investment Company Act cases. See, particularly, Judge

Friendly’s oft-quoted decision Fogel v. Chestnutt, 668 F.2d

100 (2d Cir. 1981) (Fogel ID, cert. denied 459 U.S. 828

(1982); Judge Friendly carefully distinguished, for Invest-

ment Company Act cases, this Court’s decision in Trans-

america Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11

(1979), on which petitioners so heavily rely. Accord: Brown

v. Bullock, 294 F.2d 415 (2d Cir. 1961); Rosenfeld v. Black,

445 F. 2d 1337 (2d Cir. 1971); Taussig v. Wellington Fund,

Inc., 313 F.2d 472 (rd Cir. 1983), cert. denied 374 U.S.

806 (1963); Levitt v. Johnson, 334 F.2d 815 (1st Cir. 1964)

cert. denied 379 U.S. 961 (1965); Moses v. Burgin, 445 F.2d

369 (1st Cir. 1971) cert. denied 404 U.S. 994 (1971);

Greater Iowa Corp. v. McLendon, 378 F.2d 783 (8th Cir.

1967); Fogel v. Chestnutt, 533 F.2d 731 (2d Cir. 1975)

(Fogel I), cert. denied, 429 U.S. 824 (1976); Bancroft Con-

vertible Fund, Inc. v. Zico Investment Holdings, Inc., 825

F.2d 731 (3rd Cir. 1987). Bancroft, it should be noted,

relied upon this court’s decision in Merrill Lynch, Pierce,

Fenner & Smith, Inc. v. Curran, 456 U.S. 353 (1982).

We underscore that Judge Friendly’s decision in Fogel II

specifically dealt with this Court’s decision in Transamerica

and its relationship to a private right of action under the

Investment Company Act. When petitioners in Fogel II

sought a review of that decision, this Court denied cer-

tiorari, at 459 U.S. 828 (1982). Fogel II raised the issue of a

8

private right of action under the Investment Company Act

squarely. By contrast, this case raises it in a most indirect

way. If so fundamental change in the law is to be made—if

a private right to bring an action under the Investment

Company Act is henceforth to be denied—it should be done

in a case where the issue is more neatly presented than it is

in this unique factual context. As the authorities above

demonstrate, from 1940 until now, the law has been clear:

There is a private right of action under the Investment

Company Act.

Ill. A private right of action has been recognized under Section

17 of the Investment Company Act; but in any event the

issue is hypothetical and premature.

As petitioners concede (at p.13), many cases have upheld

a private right of action, specifically, under Section 17 of

the Investment Company Act. Krome v. Merrill Lynch & Co.

Inc., 637 F. Supp. 910 (S.D.N.Y. 1986); Goodall v. Colum-

bia Ventures, Inc., 374 F. Supp. 1324 (S.D.N.Y. 1974); Entel

v. Allen, 270 F. Supp. 60 (S.D.N.Y. 1967). These cases are

in accordance with the broad holdings that have upheld

private rights of action under the Investment Company Act,

Brown v. Bullock, 294 F.2d 415 (2d Cir. 1981). See, J. L

Case Co. v. Borak, 377 U.S. 426 (1964) and Fogel v. Chest-

nutt, 668 F.2d 100 (2d Cir. 1981) (Fogel II), cert. denied

459 U.S. 828. See, too, Cort v. Ash, 423 U.S. 66 (1975)

(plaintiff being a member of the class protected by the Act,

as set forth in Brown v. Bullock, supra). Indeed, the petition

concedes that the Circuit Courts have not divided on the

question of whether a private right of action may be

brought under Section 17 (Petition, p.13).

Petitioners suggest that the statutory scheme of Section

17(a), in the context of the Investment Company Act,

requires the S.E.C.’s expertise. But at bar it is these very

9

defendants themselves who withdrew their application

from S.E.C. consideration. Had they not done so, the S.E.C.

would have acted on their application, and those affected

persons who were dissatisfied with the result could have

pursued an appeal through the judicial system. It is thus

petitioners who have sought to frustrate the statutory

scheme, not respondent.

One further point on the S.E.C.: The Petition appears to

suggest (at p. 9) that because a proxy statement went out,

that that somehow implies S.E.C. approval of the transac-

tion. But, of course, the issue of a Section 17(a) (Investment

Company Act) violation was never discussed with or by the

S.E.C. Furthermore, Rule 14a-9(b) pursuant to the Securi-

ties Exchange Act (17 C.F.R. Section 240.14a-9(b)) specif-

ically provides that the fact that a proxy statement has been

filed with, or examined by, the S.E.C. “shall not be deemed

a finding by the Commission that such material is accurate

or complete or not false or misleading or that the Commis-

sion has passed upon the merits of or approved any state-

ment contained therein or any matter to be acted upon by

security holders”.

In any event, the issue is hypothetical and premature

because there has been no determination that Section 17(a)

has, in fact, been violated; and the relevant facts are in

dispute. The First Circuit remanded the case for discovery

on that issue, and there is yet to be a trial on whether the

facts establish such a statutory violation. The Court held

that the defendants will not be liable unless plaintiff can

prove that the two contracts with Monarch (the contract

pursuant to which Monarch purchased the Corporation’s

assets and the contract by which Monarch retained the

Management Company as the investment adviser) were

related. Even if plaintiff establishes that, the Court held that

he would still also have to prove that the so-called invest-

10

ment advisory fee was so excessive that it amounted to

giving the Management Company an equity position in the

Corporation. In short, a Section 17 violation has not yet

been established.

We suggest that defendants (the Petitioners) would be the

first to assert that no violation of Section 17 will ever be

established. Hence consideration of whether or not plaintiff

can maintain a Section 17 action, were it some day proven,

is both hypothetical and premature. There is nothing for

this Court to review at this time. For instance, had the

District Court sustained the complaint (the way the First

Circuit did), that order, not being final, would not have

been appealable. For the same reasons, this Court should

not entertain this appeal.

IV. Claims under Section 17 of the Investment Company Act are

rare.

As the Petition concedes, there have been only a handful

of cases arising under Section 17 since the Investment

Company Act was passed in 1940 (Petition p.13). -

Whether or not there is a private right of action under

Section 17 is of specific concern to very few people. Surely

dramatic new law—denying a private right of action under

the Investment Company Act—should not be announced in

SO narrow an area of legal interest.

Cases under Section 17 are rare because, typically, inter-

ested parties apply to the S.E.C. for an exemption (which is

either granted or not). It is very uncommon to do what

defendants have done here—themselves try to circumvent

Section 17 by devising an indirect method of self-dealing.

Such a once-in-a-lifetime circumstance does not require

this Court to act.

1]

CONCLUSION.

The petition for certiorari should be denied because the

case is a unique one without broad application; there is no

conflict because a private right of action under the Invest-

ment Company Act in general and under Sections 17 in

particular is old, established law; in any event, the issue of

whether there is a private right to sue under Section 17 is

premature and hypothetical, because no such violation has

been (or may ever be) established; and if this Court wishes

to change old, established precedents, this would be among

the least appropriate cases to do so. Compare, Fogel v.

Chestnutt, 668 F.2d 100 (2d Cir. 1981), in which certiorari

has denied at 459 U.S. 828 (1982).

12

We therefore respectfully submit that the Petition should

be denied.

Respectfully submitted,

MORDECAI ROSENFELD, P.C.

233 Broadway

New York, NY 10279

(212) 964-1369

AMEDEO C. MEROLLA

ASQUITH, MEROLLA, ANDERSON, RYAN

& WILEY

155 South Main Street

Providence, RI 02903

(401) 331-9100

ALAN E. BANDLER

300 Park Avenue

New York, NY 10022

(212) 980-6800

BENJAMIN J. STEIN

7251 Pacific View Drive

Los Angeles, CA 90068

Counsel for Respondent