Petition — Ruskay v. Waddell

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JUL 21 1977

tk alin T mecnaes RODAK, R., CLERK

Supreme Court of the United States

Octoser Term, 1976

@@7-119

Sopuiz Ruskay, Lovis Feipman, Trustee etc., WesstER

Factors, Inc., and Irwin L. Fernsere, as Trustee etc.,

Petitioners,

—versus—

Cuauncey L. Wappett, Joz Jack Merriman, CORNELIUS

Roacu, Mitcuet J. Vauicenti, Wappett & Reep, Inc.

(a New York corporation), Wappet, & Rezep, Ino. (a

Massachusetts corporation), and Unirep Funps, Inc.,

Respondents.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

WituuM E. Havpex

Attorney for Petitioners

295 Madison Avenue

New York, N.Y. 10017

(Tel.: 212—532-4800)

Pomerantz Levy Haupexk & BLock

Of Counsel

July 21, 1977

TABLE OF CONTENTS

PAGE

bel hr StS REN EO ieee ar

PREIS RE SEE el WO <a oe CS 2

SR EAR AR, 0 Re ET ee 2

Constitutional and Statutory Provisions Involved ...... 3

I i ceermsenmnenicabenes 3

Statement of the Case ............................ aepliliataniiiiblbinanesene (

Reasons for Granting the Writ .............-.-.-....0:--0-0-0--0<0-0---- y

1. The general release in Horenstein-Ruskay did not

extinguish the sale-of-office claim because Judge

Lasker’s settlement decision gave no considera-

En 9

2. The general release in Horenstein-Ruskay did not

extinguish the sale-of-office claim because the

plaintiffs could not adequately represent the

stockholders with respect to that claim .................. 11

3. The general release in Horenstein-Ruskay did not

extinguish the sale-of-office claim because the set-

tlement notice did not advise the stockholders

that such a claim was to be released ........................ 12

PAGT.

4. The importance of the question presented to the

judicial administration of stockholders’ deriva-

tive and class actions, as well as the conflict of the

decision below with earlier decisions of this Court

and other Circuits urgently call for the grant

OE Te Ce IO ecccitcncrneetesedaitnanittiiniseereinginietitn 14

ConcLusion iiciccheiiaiaiasbiahertebwiaipanteiiltpcibceidiedeilhtadiimaiialainaimaaiinisiintds 16

Appenpix A—Opinion of the Court of Appeals ............ la

Appenpix B—Judgment of the Court of Appeals ........ 22a

APPENDIX C—Decision of the Court of Appeals denying

‘petition for rehearing ............................---- 25a

Appenprx D—Opinion of the District Court .................. 26a

Appenpix E—Notice of Horenstein-Ruskay settlement

TIIINI scichiatcsdedstiatinbndembinliamabenninns .. BOA

Appenpix F—Excerpts from Horenstein-Ruskay plain-

tiffs’ memorandum in support of pro-

posed settlement cenetititliatathinss 39a

Aprenpix G—Opinion of the District Court approving

the Horenstein-Ruskay settlement ........ 42a

iii

TaBLe oF Cases

PAGE

City of Detroit v. Grinnell Corp., 495 F. 2d 448 (2d Cir.

OE <eikcialenttaenticiiniasceniiiinienniaendiinet

Eisen v. Carlisle € Jacquelin, 417 U.S. 156 (1974) -....... 5, 13

Girsh v. Jepson, 521 F. 2d 153 (3rd Cir. 1975) ................ 3, 4,

Gonzales v. Cassidy, 474 F. 2d 67 (5th Cir. 1973) ........ 4,11

Greenfield v. Villager Industries, 483 F. 2d 824 (3d Cir.

1973) .... mS

. .. 0 13

Grumin v. International House of Pancakes, 513 F. 2d

114 (8th Cir.), cert. denied, 423 U.S. 864 (1975) ........ 14

Hansberry v. Lee, 311 U.S. 32 (1942) 2. cc eee eee eee 4,11

Mills v. Electric Auto-Lite Co., 396 U.S. 375 (1970) ....... 14

Milstein v. Werner, 57 F.R.D. 515 (S.D.N.Y. 1972) ........ 14

Norman v. McKee, 431 F. 2d 769 (9th Cir. 1970) ............ 3

Papilsky v. Berndt, 466 F. 2d 251 (2d Cir.), cert. denied,

SF 4,5,

Phillips v. Tobin, 548 F. 2d 408 (2d Cir. 1976) ................ 12

Protective Committee v. Anderson, 390 U.S. 414 (1968) 3, 10

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

cert. dismissed, 409 U.S. 802 (1972) 7,11

Ruskay v. Jensen, 342 F. Supp. 264 (S.D.N.Y. 1972) ... 2

Ruskay v. Waddell, 552 F. 2d 392 (2d Cir. 1977) ............. 2

Smith v. Alleghany Corp., 394 F. 2d 381 (2d Cir.),

cert. denied sub nom. Smith v. Kirby, 393 U.S. 939

(1968) 5, 11, 14

PAGE

Stella v. Kaiser, 218 F. 2d 64 (2d Cir. 1954), aff’d on

rehearing, 221 F. 2d 115 (2d Cir.), cert. denied,

ie SO) | ee er ee 6

AUTHORITY

7A C. Wright and A. Miller, Fed. Prac. & Proced.,

Civil (1972), §1840, p. 440 —_—

STATUTES AND REGULATIONS

Constitution of the United States

Fifth Amendment . 3

Federal Rules of Civil Procedure

Bule 33.1. ..........- 2, 3, et passim

Investment Company Act of 1940

§ 15(a) (4), 15 USC § 80a-15(a) (4)

§ 15(b) (2), 15 USC § 80a-15(b) (2)

§ 44, 15 USC § 80a-43 ....

Judicial Code, 28 U.S.C. § 1254(1)

non nNnn a

In THE

Supreme Court of the United States

Octroser Term, 1976

Sopuiz Ruskay, Lovis Fetpman, Trustee etc., WEBSTER

Factors, Inc., and Inwuy L. Fernsere, as Trustee etc.,

Petitioners,

—versus—

Cuauncey L. Wappett, Jozk Jack Merriman, Cornevius

Roacu, Mircuent J. Vauicenti, Wappett & Reep, Inc.

(a New York corporation), Wappett & Resp, Ine. (1

Massachusetts corporation), and Unirep Funps, [nc.,

' Respondents.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

Petitioners, who were the plaintiffs-appellants below,

pray this Court for a writ of certiorari to review the

judgment of the Second Circuit entered February 17, 1977.

Opinions Below

The opinions of the Second Circuit (la*) and of the

District Court for Southern New York (26a) are reported,

* Numerals followed by the letter “a” (e.g., “la”) refer to pages

of the Appendices of this Petition. Numerals preceded by the let-

ter “A” (e.g., “A15’”) refer to the Appendix in the Court below.

respectively, at 552 F. 2d 392 (1977) and 342 F. Supp.

264 (1972).

Jurisdiction

The judgment of the Second Circuit (22a) was dated

and entered February 17, 1977. A timely petition for re-

hearing was denied May 9, 1977 (25a). The jurisdiction

of this Court is invoked under 28 USC § 1254(1).

The jurisdiction of the District Court rested on § 44 of

the Investment Company Act, 15 USC § 80a-43, and the

principles of pendent jurisdiction.

Question Presented

Can a judicially approved settlement of a stockholders’

derivative action validly authorize a general release of

claims which have not been pleaded in the compiaint, have

never been considered or scrutinized by the Court, and

whose existence and proposed extinguishment have never

been made known to the stockholders?

The Court below, one judge dissenting, sustained the

validity of such a general release. We submit that the

decision is contrary to Rule 23.1 FRCP, to constitutional

due process, and to the decisions of this Court as well as

the Third and Fifth Circuits. The consequences of the

decision for future settlements of derivative actions would

be far-reaching and unfortunate indeed.

Constitutional and Statutory Provisions Involved

The Fifth Amendment of the Constitution provides

that—

“No persc. shall be * * * deprived of life, liberty

or property, without due process of law; * * * .”

Rule 23.1 of the Federal Rules of Civil Procedure pro-

vides that a shareholder’s derivative action—

“shall not be dismissed or compromised without the

approval of the court, and notice of the proposed dis-

missal or compromise shall be given to shareholders

or members in such manner as the court directs.”

Summary of Argument

1. Before approving the settlement of a stockholder’s

derivative action, the district court must evaiuate the

strength of the claims to be discharged and balance them

against the benefits of the settlement. Protective Com-

mittee v. Anderson, 390 U.S. 414, 434, 439-41 (1968); City

of Detroit v. Grinnell Corp., 495 F. 2d 448, 455 (2d Cir.

1974). In so doing, the court acts as guardian of the absent

shareholders, in whose interest the action is brought,

Norman v. McKee, 431 F. 2d 769, 774 (9th Cir. 1970). But

the court cannot evaluate the unknown and unpleaded

claims that are discharged by a general rviease; it is

unable, therefore, to protect the absent parti.s’ interests

in such claims. By sanctioning such a general release, the

decision below contravenes Rule 23.1 FRCP and is in con-

flict with Girsh v. Jepson, 521 F. 2d 153, 159 (3rd Cir.

1975).* It is also in conflict with due process, since it

cannot be due process for u court to issue a blanket adjudi-

cation of claims without knowledge or consideration of

their existence, let alone their nature, amount or probable

merit.

2. The primary responsibility for negotiating a deriva-

tive settlement rests on the plaintiff who, under Rule 23.1,

must “fairly and adequately represent the interests of the

shareholders”. Adequate representation is, moreover, re-

quired by constitutional due process. Hansberry v. Lee,

311 U.S. 32 (1942); Gonzales v. Cassidy, 474 F. 2d 67, 74

(5th Cir. 1973); Papilsky v. Berndt, 466 F. 2d 251, 259-60

(2d Cir.), cert. denied, 409 U.S. 1077 (1972). To be ade-

quate, the representation must insure the forthright, vig-

orous and tenacious prosecution of the claim; Gonzales,

supra, at 75; Papilsky, supra, at 259-60. But a derivative

plaintiff cannot adequately represent the shareholders with

respect to claims he has not pleaded, whether due to ig-

norance of their existence or lack of faith in their merit;

he does not “insure the vigorous prosecution” of such

claims. A general release of unpleaded claims as part of

a derivative settlement is thus incompatible with the con-

stitutional and statutory requirement of adequate repre-

sentation. The decision below, nevertheless, gives effect

to such a general release.

3. A general release is also incompatible with the re-

quirement of an adequate settlement notice to the stock-

* The Girsh ease forbids judicial approval of the release of an

unpleaded claim without development of its probable merit and of

the fairness of the consideration for surrendering the claim.

holders. The notice is prescribed by Rule 23.1 and is

required by constitutional due process, Eisen v. Carlisle

@é Jacquelin, 417 U.S. 156, 173 (1974); Greenfield v. Vil-

lager Industries, 483 F. 2d 824, 831, 833-34 (3d Cir. 1973).

Notice is essential “to ensure that the dismissal of the

derivative suit is in the best interests of the corporation

and the absent stockholders”; it enables the stockholders

“to intervene to protect the corporate claim and to continue

the litigation if that seems advisable”; Papilsky, supra,

466 F. 2d at 258. Hence it is that only “maximum notice”

“can comport with constitutional standards of due process”,

Girsh v. Jepson, supra, 521 F. 2d at 159 and n. 12. But a

notice that unpleaded and unknown claims are to be

extinguished by a general release leaves the stockholders

in the dark and prevents them from protecting their cor- .

poration’s claims precisely because those claims are un-

known ; the notice thus fails to fulfill its purpose. Such was

the notice at bar. Since an inadequate notice is inconsistent

with due process, it deprives the judgment of res judicata

effect, Smith v. Alleghany Corp., 394 F. 2d 381, 391 (2d

Cir.), cert. denied, 393 U.S. 939 (1968), and invalidates a

general release given pursuant to the settlement.

4. If the decision below is permitted to stand, the use

of general releases in derivative settlements will become

universal. Corporate wrongdoers will be able to secure

blanket absolution for undisclosed fiduciary breaches by

paying a relative peppercorn for a general release. In the

present case, the settlement of a $2,000,000 claim (46a)

for $650,000 has been held to wipe out a $62 million liability

through the device of a general release (13a). Such a re-

sult may be tolerable in a release executed by a private

party on his own behalf (as in the cases cited by the Court

below at 8a-9a°), but not in derivative or class settle-

ments. A general release in such actions would de-

stroy crucial safeguards of valuable corporate and class

rights, would defeat due process and the purpose of Rule

23.1, and would open the door to countless abuses. The

courts, appointed to act as guardians of the rights of absent

shareholders, would become the vehicles for the destruction

of such rights.

Statement of the Case

Petitioners are stockholders of defendant United Funds,

Inc. (“United”), a registered mutual fund. They brought

these four derivative actions, consolidated by the District

Court, against the directors of United, against Waddell &

Reed, Inc. (“W&R”), United’s investment adviser and prin-

cipal underwriter, and against the principal stockholders

of W&R. In 1969 the W&R stockholders, including three

of the individual defendants, sold the stock of W&R to

a new owner, Continental Investment Corporation. The

price, $80 million, was vastly in excess of W&R’s asset

value of $18 million. Under the Investment Company Act

(the “Act”), 15 USC § 80a-15(a)(4) and 15(b)(2), the sale

automatically terminated United’s advisory and under-

writing agreements with W&R (the “service agreements”).

Since these agreements were the principal source of W&R’s

income, the parties to the sale conditioned their contract

upon the reinstatement of the service agreements by the

* The only case cited below that concerned the effect of a re-

lease pursuant to a derivative or class settlement is Stella v. Kaiser,

218 F. 2d 64 (2d Cir. 1954), aff'd on rehearing, 221 F. 2d 115 (2d

Cir.), cert. denied, 350 U.S. 835 (1955) ; but the claim there held

to be discharged had been alleged in the earlier action and was

specifically involved in the earlier derivative settlement.

stockholders and directors of the Fund. The sellers and

the management of the Fund agreed to procure the rein-

statement of the agreements’ they did procure it, and the

$80 million was paid (A1-A16).

Petitioners charge that the transaction violated the Act

because it constituted a sale of W&R’s fiduciary offices as

adviser and underwriter. Petitioners seek to recover the

$62 million excess of the sales price over the asset value

of the stock under the principles of Rosenfeld v. Black, 445

F. 2d 1337 (2d Cir. 1971), cert. dismissed, 409 U.S. 802

(1972). Since the rationale of Rosenfeld is relevant here,

we summarize it in the margin.*

The District Court granted summary judgment dismiss-

ing this claim (26a) as barred by a judgment and

release issued in connection with the settlement of two

earlier derivative actions brought by stockholders of United

(the “Horenstein-Ruskay actions”). Commenced in 1967

and early 1969 (long before the W&R stock sale), these

actions charged that a subsidiary of W&R, acting as stock

broker for United, had engaged in improper brokerage

practices yielding large illegal profits to W&R and its sub-

sidiary at the expense of United (3a). When the pro-

posed sale of W&R’s stock was announced in 1969, the

Horenstein-Ruskay plaintiffs secured leave to and did file

* Rosenfeld rests on the familiar principle that a fiduciary may

not sell his office for personal gain (445 F. 2d at 1342). An imvest-

ment adviser is a fiduciary under the Act (pp. 1342-43). While he

cannot directly assign his office to another (p. 1344), he cu . bring

about a er of the office by inducing the stockholders of the

fund to appoint his chosen successor (ibid.). It is this use of in-

fluence with the stockholders of the fund for which the adviser,

as a fiduciary, must not accept personal gain (pp. 1342, 1347 n.13).

He does accept such gain if the price he receives exceeds the asset

value of the advisory company.

supplemental complaints alleging that part of the sales

price was an outgrowth and, in effect, a capitalization of

W&R’s illegal brokerage profits and should, therefore, be

impressed with a trust for the Fund (30a; A107, A172).

The Horenstein-Ruskay supplemental complaints did not,

however, charge that the 1969 transaction was a sale of

W&R’s advisory and underwriting offices, nor did they

allege the facts necessary to support such a charge.* In-

deed, the District Court held that Horenstein-Ruskay “con-

sciously avoided” such a claim (32a).

Ultimately, in 1970, the Horenstein-Ruskay actions were

settled with court approval pursuant to FRCP 23.1. In

submitting the proposed settlement, Horenstein-Ruskay

advised the District Court that their supplemental com-

plaints—the only complaints containing any reference to

the W&R stock sale—had “become moot” and were “not

a factor to be considered by the Court” (4la). Neither

the settlement notice to the stockholders of the Fund

(35a) nor Judge Lasker’s decision approving the settle-

ment (42a) suggested that a claim for the sale of the

advisory and underwriting offices was alleged or was to

be included in the settlement. The judgment (A228) and the

general release (5a; A234) issued by United pursuant to

this settlement were the basis on which the District Court

dismissed the present actions (26a). The Court of

* A dictum of the Court below suggests otherwise (10a-lla) ; but

the Horenstein-Ruskay supplemental complaints (lla, n.12; A107,

A172) did not allege that the $80 million sales price for the W&R

stock included a substantial premium in excess of the asset value of

the stock; or that, in return for the premium, the sellers and W&R

agreed to and did arrange for the reinstatement of the service agree-

ments ; or that the stockholders and directors of United did approve

such reinstatement. These are essential elements of a claim under

Rosenfeld; see p. 7 n., above.

Appeals affirmed solely on the basis of the general release,

but did not pass on the issue of res judicata (13a).

Reasons for Granting the Writ

For present purposes we accept, arguendo, the holding

below that the language of the general release (5a; A234)

was sufficiently broad to include the present sale-of-office

claim.* That claim, however, was not alleged in Horenstein-

Ruskay; its existence was not revealed in the settlement

notice to United’s stockholders; Judge Lasker’s settlement

decision did not mention the claim, let alone scrutinize its

possible merit. We submit that the discharge of the claim

by a sweeping general release was invalid.

1. The general release in Horenstein-Ruskay did not

extinguish the sale-of-office claim because Judge

Lasker’s settlement decision gave no considera-

tion to that claim.

When Hore: stein-Ruskay submitted their settlement to

the Court, * ,» advised Judge Lasker, as noted, that their

supplemen.. *omplaints—the only complaints referring to

the W&R stock sale—had “become moot” and were “not

a factor to be considered by the Court” (41a). Judge

Lasker’s settlement decision (42a) did, indeed, not so

much as mention the stock sale, let alone consider a sale-

of-office claim. In summarizing and carefully analyzing the

plaintiffs’ charges, he discussed solely the alleged broker-

age abuses (44a-46a). Since the amount of the brokerage

claim was about $2,009,000, Judge Lasker concluded that

the settlement, ranging from $535,000 to $650,000, was

* For a contrary view of the scope of the release, see the dis-

senting opinion below (13a).

“respectable” (46a). It is hard to conceive that this

decision could validly authorize the unwitting release of

an unknown $62 million sale-of-office claim.

As noted, a court cannot approve a derivative settlement

without scrutinizing the strength of the claims and bal-

ancing them against the benefits of the settlement. Pro-

tective Committee v. Anderson, supra, 390 U.S. at 434,

439-41; City of Detroit v. Grinnell Corp., supra, 495 F. 2d

at 455. If an unpleaded claim is to be released, it must be

subjected to the same scrutiny and evaluation, Girsh v.

Jepson, supra, 521 F. 2d at 159. The Horenstein-Ruskay

settlement decision, far from evaluating the sale-of-office

claim, did not even mention it. To treat this decision as

authorizing the extinction of the claim would give it an

effect incompatible with either due process or Rule 23.1.

The Court below refused to consider the propriety of

the general release because “one who has obtained the

benefit of a settlement [should not be allowed] to object,

in a subsequent proceeding, that the documents he helped

draft were unfair to him” (6a, n.4). This language re-

ferred to Sophie Ruskay, who is one of the plaintiffs in

this case and was a plaintiff in Horenstein-Ruskay. The

Court below overlooked, however, that the three other

petitioner-plaintiffs in the case at bar—Louis Feldman,

Webster Factors, Inc. and Irwin I. Feinberg—had nothing

to do with the Horenstein-Ruskay litigation and certainly

did not “help draft” the general release. The same error

underlies the remark of the Court below about “plaintiff”

having given a general release (10a); the three plain-

tiffs other than Sophie Ruskay did nothing of the sort.

Plaintiffs’ appeal brief below (p. 38 n.) expressly referred

to the difference between Ruskay and the three other

present plaintiffs.*

2. The general release in Horenstein-Ruskay did not

extinguish the sale-of-office claim because the

plaintiffs could not adequately represent the

stockholders with respect to that claim.

As noted, the requirement that a derivative plaintiff be

an adequate representative of the stockholders is rooted

not only in Rule 23.1 but in constitutional due process;

Hansberry v. Lee, supra, 311 U.S. 32; Gonzales v. Cassidy,

supra, 474 F. 2d at 74; Papilsky v. Berndt, supra, 466 F. 2d

at 259-60. Adequate representation must be such “as to

insure the vigorous prosecution of the claim”, Papilsky,

ibid. The Horenstein-Ruskay plaintiffs certainly did not

vigorously prosecute the sale-of-office claim.. They did not

even plead the claim; their settlement brief.expressly dis-

avowed the supplemental complaints (41a), the only

complaints mentioning the W&R stock sale. Since Horen-

stein-Ruskay thus did not adequately represent United’s

stockholders with respect to the sale-of-office claim, they

were powerless to give the claim away by the device of

a general release.

A settlement decree in a derivative suit is res judicata

only “where the notice [to stockholders] and representa-

tion are adequate”; Smith v. Alleghany Corp., 394 F. 2d

* Equally erroneous is the assumption of the Court below that

counsel for Horenstein-Ruskay were familiar with the sale-of-

office theory because they were, at the same time, contesting the

District Court decision ‘ta Rosenfeld v. Black (10a). The firm

of Pomerantz Levy Haudek & Block, who prosecuted Rosenfeld v.

Bluck and who are general counsel for the present plaintiffs, had

nothing to do with the Horenstein-Ruskay litigation (plaintiffs’

appeal brief, p. 16 n. 2; see list of Horenstein-Ruskay counsel,

42).

381, 391 (2d Cir.), cert. denied sub nom. Smith v. Kirby,

393 U.S. 939 (1968); 7A C. Wright and A. Miller, Fed.

Prac. & Proced., Civil (1972), § 1840, p. 440. Since an in-

adequate representative cannot bind his fellow stockholders

by res judicata, Phillips v. Tobin, 548 F. 2d 408, 410 n. 2

(2d Cir. 1976), he cannot escape the constitutional require-

ment of adequate representation by adding a release to

his settlement.

3. The general release in Horenstein-Ruskay did not

extinguish the sale-of-office claim because the set-

tlement notice did not advise the stockholders

that such a claim was to be released,

The Horenstein-Ruskay settlement notice (35a) de-

scribed the proposed release as discharging defendants

from liability with reference to any “matters or transac-

tions described or referred to in the various pleadings by

the plaintiffs” (38a). The scope of the release was thus

to be determined by the contents of the plaintiffs’ plead-

ings. In describing those pleadings, the notice set forth

the alleged brokerage abuses in considerable detail (35a-

36a); but the supplemental complaints were simply de-

scribed as alleging—

“that the defendants Waddell, Merriman and Roach

arranged to sell a majority of the voting shares of

W&R held by themselves and members of their families

at a price of $80 per share; that such price was largely

attributable to the profits derived by W&R from the

acts, transactions and practices complained of in their

principal complaints ; and that the proposed sale should

be enjoined or the proceeds thereof sequestered for

the benefit of United” (37a).

This was followed by a summary of the defenses to the

supplemental complaints (37a).*

The notice thus did not reveal that the stock sale would

transfer control of W&R; the sale was described as in-

volving only a majority of the voting shares held by the

named individuals and their families (not a majority of

all outstanding voting shares). Nor did the notice reveal

that the total sales price was $80 million; or that it sub-

stantially exceeded the asset value of the stock; or that

the sale would terminate the service agreements; or that

the sellers and W&R were to be paid for arranging the

reinstatement of the service agreements: or that the agree-

ments were, in fact, reinstated.

By no stretch of imagination could a reader of this notice

have guessed that the settlement and release were to in-

clude a $62 million sale-of-office claim, -i.e., a claim that

the defendants, for private gain, had used their fiduciary

influence with the stockholders and directors of United

for the reinstatement of the service agreements. Stock-

holders, reading the notice, had no reason to suspect that

such a claim, unrevealed by the notice and far exceeding

in importance the claims disclosed, was to fall by the

wayside. A settlement notice is designed to inform the

stockholders not to become a trap for the unwary. The

Horenstein-Ruskay notice was inadequate to warn the

stockholders of the effects of the proposed general release.

As noted, an adequate settlement notice is required not

only by Rule 23.1 but by due process, Eisen vy. Carlisle &

Jacquelin, supra, 417 U.S. at 173; Greenfield y. Villager

* Since the scope of the release was to be determined by the con-

tents of the plaintiffs’ pleadings, the recital of the defenses in the

notice is, for present purposes, not relevant.

Industries, supra, 483 F. 2d at 831, 833-34; Grunin v. Inter-

national House of Pancakes, 513 F. 2d 114, 120 (8th Cir.),

cert. denied, 423 U.S. 864 (197&); Milstein v. Werner, 57

F.R.D. 515, 518 (S.D.N.Y. 1972). Just as a settlement de-

cree based on an inadequate notice is not res judicata,

Smith v. Alleghany Corp., supra, 394 F. 2d at 391, it cannot

validly authorize a general release.

It is no answer, as suggested by the Court below (6a, n.4),

that any objection to the grant of a general release should

have been made in the settlement hearing before Judge

Lasker. The stockholders of United could not object, pre-

cisely because the settlement notice did not give them the

necessary information. In any event, the infirmity of the

general release is of constitutional dimensions, because of

the inadequacy of both the representation and the notice.

The ineffectiveness of such a release—just as the ineffec-

tiveness of an unconstitutional settlement decree as res

judicata—can be raised collaterally and does not depend

on the happenstance of stockholders’ objections.

4. The importance of the question presented to the

judicial administration of stockholders’ deriva-

tive and class actions, as well as the conflict of

the decision below with earlier decisions of this

Court and other Circuits urgently call for the

grant of review by this Court.

Stockholders’ derivative and class suits, this Court has

held, “involve corporate therapeutics, and furnish a benefit

to all shareholders by providing an important means of

enforcement” of the securities laws; Mills v. Electric Auto-

Lite Co., 396 U.S. 375, 396 (1970).

The admission of general releases as part of derivative

settlements would pervert the stockholder’s action from

a tool of corporate therapeutics into an engine of cor-

porate inequity. No matter how meritorious and impor-

tant a corporate claim might be, a general release embedded

in a derivative settlement would wipe it out—and would

wipe it out without the “benefit to all shareholders” which

is the great and animating purpose of all stockholders’

suits. Since a general release destroys even unknown

corporate claims (10a, n.10), it operates without judicial

scrutiny; it operates without the vigorous protection of

the corporate claim by an adequate representative; and

it operates without an opportunity for other stockholders

to champion the claim. Such a destruction of corporate

claims through the machinery of a stockholder’s action

mocks the purpose of derivative suits, which are designed

to protect corporate causes of action, not to defeat them.

Corporate insiders and other defendants in derivative

litigations have no justifiable interest in securing a general

release. It is they who have intimate knowledge of their

dealings with the corporation; the court, the stockholders

at large and, in most instances, the derivative plaintiff

lack that knowledge. If the defendants wish absolution

from a claim not specifically asserted in the complaint,

they are best able to supply the pertinent information; the

plaintiff, the absent stockholders and the court will then

be apprized, and the court can properly determine whether

a release of the new claim should fairly be permitted. But

a general release would allow the defendants to sneak

into forgiveness.

A great number, probably a majority of meritorious

derivative actions are disposed of by court-approved settle-

ments. Even now, general releases in derivative settle-

ments are “not uncommon” (6a, n.4), although the

decision below is the first to give them sweeping effect

bevond the scope of res judicata. If that decision were

to stand, it takes no great power of prophecy to foresee

that the use of general releases in derivative settlements

will become universal. Corporate insiders will, in this

fashion, secure broad immunity for misconduct no matter

how grave. This Court, we submit, should set its face

against such erosion of constitutional due process, pro-

cedural fairness and elementary justice.

CONCLUSION

The petition for a writ of certiorari should be granted

and the judgment below should be reversed.

Dated: July 21, 1977

Respectfully submitted,

Wituiram FE. Havpex

Attorney for Petitioners

295 Madison Avenue

New York, N.Y. 10017

(Tel.: 212—532-4800)

Pomerantz Levy Haupex & Buiock

Of Counsel

APPENDICES

iin i i ee

APPENDIX A

Opinion of the Court of Appeals

UNITED STATES COURT OF APPEALS

For tae Seconp Crecorr

No. 213—September Term, 1976.

(Argued November 24,1976 Decided February 17, 1977.)

Docket No. 76-7270

——h

Soppure Rusgay, Louis Fetpman, Trustee, etc., WessTer

Factors, Inc., and Inwrmy L. Fremsexc, as Trustee, etc.,

Plaintiffs-Appellants, .

Vv.

Cuauncey L. Wappetz, Joz Jack Merriman, CorneLivs

Roacu, Mrrcner J. Vaticenti, Wappert & Reep, Inc.

(a New York corporation), Wappetn & Reep Inc. (a

Massachusetts corporation), and Unrrep Funps, Iwnc.,

Defendants-A ppelizes.

Before:

Mawsrretp, Van GraaFeranp and MEeskmL,

Circuit Judges.

—+-o-+-

Plaintiffs brought an action in the United States Dis-

trict Court for the Southern District of New York alleging

a sale of fiduciary office arising out of a transfer of the

stock of the investment adviser to a mutual fund. The

district court, Metzner, J., granted defendants’ motion for

summary judgment on grounds of release and res judicata,

and plaintiffs appealed.

Affirmed.

—o

AsranaM L. Pomerantz, New York, New York

(Pomerantz Levy Haudek & Block, Wil-

liam E. Haudek, New York, New York, of

counsel), for Plaintiffs-A ppellants.

Ausert D. Jornpan, New York, New York (Cole

& Deitz, Martin S. Berglas, Robert M. Ker-

rigan, New York, New York, of counsel),

for Defendants-Appellees Merriman, Roach,

Valicenti and Waddell é Reed, Inc.

Marvin Scuwazrtz, New York, New York (Sul-

livan & Cromwell, Susan J. McCone, New

York, New York, of counsel), for Defen-

dant-Appellee Chauncey L. Waddell.

Keitey Deve & Warren, New York, New

York (On the Brief), for Defendant-Ap-

pellee United Funds, Inc.

Mesxuu, Circuit Judge:

This case arises out of the sale of the stock of an in-

vestment advisory company, a class of transaction that

has spawned more than its share of unusually complex

litigation. The instant appeal, the latest chapter in a

series of class and stockholder actions concerning a large

mutual fund, is no exception.

The mutual fund in question is United Funds, Inc.

(“United”). Prior to 1969, the investment advisor of

United was Waddell & Reed, Inc. (“W&R”). In that year,

W&R sold 97 percent of its outstanding shares to Con-

tinental Investment Corporation (“CIC”). CIC then

merged W&R into one of its wholly-owned subsidiaries,

CWR Corporation, whose name was changed to Waddell

& Reed (“New W&R”).

The investment advisory contract was terminated by

operation of law when the sale was made. 15 U.S.C. §80a-

15(a)(4). The sale was thus made conditional upon the

reinstatement, by United’s shareholders, of the contract

with New W&R. In June, 1969, this approval was duly

given.

Prior to this reorganization, two shareholder actions

(the “Horenstein-Ruskay actions”) were begun in federal

court, one brought by Mrs. Ruskay, who is the plaintiff

in the instant action as well.' In substance, these actions

alleged that W&R had illegally diverted the brokerage

business of United to a wholly-owned subsidiary of W&R,

Kansas City Securities Corporation (“KCSC”). They also

alleged that United’s account had been “churned” and that

Wé&R had appropriated “give-ups”? which properly be-

longed to United. The return of all these profits, allegedly

amounting to several million dollars, was demanded. While

this action was pending, the sale to CIC was announced.

With that development, the theory of the action was

changed by amending the complaint to allege that the

price paid by CIC for W&R stock represented, in part, the

profits realized from the breaches of fiduciary obligations

set forth in the original complaints. The actions now sought

1 In addition to the two actions involved in the instant appeal, Mrs.

Ruskay has brought a derivative suit concerning United in New York

Supreme Court, Buskay v. Reed, Index No. 8283/64.

2 “Churning” occurs when an account is actively traded solely to gen-

erate commissions. The “give-ups” in this case arose when W&R ordered

that the broker-dealers executing trades for United “give up” part of

their commissions to other broker-dealers, who had not actually executed

the trades in question, but had performed useful services for W&R and

United. For an excellent discussion by Judge Friendly of the problems

posed by give ups, see Arthur Lipper Corp. v. SEC, slip op. 901, 904-07

(24 Cir. Dee. 10, 1976).

recovery from W&R on a theory of constructive trust. In

December, 19€9, both of these actions were settled for

$650,000. .A release was executed in October, 1970.

The law governing the sale of an investment advisor’s

stock at that time was expressed in Rosenfeld v. Black, 319

F.Supp. 891 (S.D.N.Y. 1970). In that case, it was held that

the sale of such stock for whatever the market would pay,

absent any specific wrongdoing by the advisor, was entirely

proper, and did not render the selling stockholder account-

able to the fund. See also SEC v. Insurance Securities, 254

F.2d 642 (9th Cir.), cert. denied, 358 U.S. 823 (1958).

The following year, the decision of the district court was

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

(Friendly, J.), cert. dismissed under Rule 60, 409 U.S. 802

(1972). Shortly thereafter, Mrs. Ruskay brought a second

derivative action. This time, the complaint alleged, in

keeping with Rosenfeld, that the excess of the price

paid for W&R over its net asset value, approximately

$62,000,000, represented a sale of W&R’s fiduciary position.

The defendants moved for summary judgment on the

grounds that the settlement of the prior actions barred

these suits on grounds of res judicata and release. The

district court, Metzner, J., granted the motion, 342 F.Supp.

264 (S.D.N.Y. 1972), and this appeal followed. We affirm.

As part of the settlement of the 1969 actions approved

by Judge Lasker pursuant to the requirements of Rule

23.1, a release was executed in favor of W&R and the

individual defendants. In relevant part, it read:

3 Rule 23.1, which governs derivative actions, provides:

The action shall not te dismissed or compromised without the

approval of the court, and notice of the proposed dismissal or com-

promise shall be given to shareholders or members in such manner

as the court directs.

This provision gives the other shareholders precisely the protection

that the dissent would grant by allowing this case to proceed. The

district judge, before approving a settlement, must carefully consider

Unrrep Funps, Inc., a Delaware corporation having

its principal office and place of business at 20 West

9th Street, Kansas City, Missouri, for good and suffi-

cient consideration, the receipt and adequacy of which

is hereby acknowledged, does hereby release and for-

ever discharge Waddell & Reed, Inc., a New York

corporation having its principal office and place of

business at 20 West 9th Street, Kansas City, Missouri,

and Kansas City Securities Corporation, a Missouri

corporation having its principal office and place of

business at 20 West 9th Street, Kansas City, Missouri,

their respective directors, officers, agents and em.

ployees and all individual defendants in the above

entitled actions, including Chauncey L. Waddell,

Cornelius Roach, Joe Jack Merriman and Robert W.

Wagner and their respective heirs, executors, admin-

istrators and assigns of and from any and all claims,

demands or causes of action arising at any time from

the beginning of the world to the date of these presents

the undersigned, its successors or assigns, had, now

has or may hereafter have against the aforementioned

released parties, or any one or more of them, for or

by reason of any of the matters or transactions recited

or described in the complaints, supplemental com-

plaints and/or other pleadings filed by the plaintiffs

in the above entitled actions saving and reserving,

however, the obligations of the defendants as set forth

in the Stipulation of Settlement in these actions.

(emphasis added)

Appellants vigorously urge that, despite the clear lan-

guage of this release, it is operative only as to the specific

the interests of the absent shareholders. Upon this record, it is abun-

dantly clear that Judge Lasker carried out this obligation fully, and

concluded that a general release was appropriate under the circumstances

claims they were pressing at the time of settlement. This

contention is devoid of merit.‘

In executing this release and paying out a substantial

amount of money, the appellees sought more than relief

from the particular allegations involving KCSC which

were the focus of the lawsuit. The affairs of W&R and

CIC had already given rise to a flood of litigation in the

Southern District and the state courts of Delaware and

New York. It was certainly reasonable and businesslike

to seek finally to settle any allegations of wrongdoing

arising out of the sale of W&R, in order that there would

no longer be a cloud over the transaction. As the district

court found, this was the precise intent of the settling

parties. 342 F.Supp. at 271. This is the clear import of

the language “any and all claims demands or causes of

action .. . for or by reason of any of the matters or trans-

actions recited or described in the complaints, supplemental

complaints, and/or other pleadings ....” Appellants have

not advanced any reason for a narrow construction of this

broad language.°

4 We are not referred to any case, nor bas our research disclosed one, -

in which a general release like this has teen given such a construction.

Contrary to the suggestion of the dissent, it is not uncommon for

genera! releases to be granted in settlements of derivative suits. See,

¢.g., Rosenfeld v. Black, 336 F.Supp. 84, 87 (S.D.N.Y. 1972). More-

over, the decision relied upon by the dissent, Heddendorf v. Goldfine,

167 F.Supp. 915, 928 (D.Mass. 1958), specifically endorses the grant of

a general release under circumstances strikingly similar to those in this

case,

In any event, the propriety of the grant of a general release is not

before us. The time to make that objection was in the settlement hear-

ings conducted by Judge Lasker. We are unwilling to allow one who

has obtained the benefit of a settlement to object, in a subsequent pro-

ceeding, that the documents he helped draft were unfair to him.

5 Although the dissent suggests otherwise, in this case the release was

referred to throughout as a “general” release. Judgment and Order of

Lasker, J., 67 Civ. 4175, 69 Civ. 276, June 25, 1970. Judge Lasker went

on to explain that the settlement was in full satisfaction of any claim

er a eee te

Advised by highly competent counsel, the plaintiffs made

an informed decision to grant repose to the defendants in

return for a substantial sum.* In hindsight, the bargain

appears to have been a bad one for the plaintiffs. Had they

known then what they know now, it is likely that more

money would have been demanded before a compromise was

reached. However, the understandable desire of the plain-

tiffs for a larger recovery in no way limits the scope of the

release they gave in an arms-length transaction. As Judge

Pollack has recently stated, in determining the scope of a

release similar to this one:

Plaintiffs’ claims herein, arising as they do out of a

controversy pre-dating the execution of the release,

might have been adjudicated at the time of its execu-

tion. Instead, plaintiff made an intelligent and knowl-

edgeable choice to forego litigation in favor of compro-

which might arise in the future out of the “matters and transactions”

. recited in the pleadings. An identical broad reading of the release is

given in the Notice of Settlement Hearing, which stated:

The Stipulation of Settlement to be submitted for approval to

the Court was arrived at to accomplish results deemed by both

plaintiffs and defendants to be in the best interests of United and,

from the viewpoint of the defendants, to avoid further expense,

inconvenience and the distraction of burdensome and protracted

litigation, as well as to put at rest all contentions or controversies

asserted or which might have been asserted on the basis of the

matters and transactions described or referred to in the various

pleadings of the plaintiffs.

Id. at 3 (emphasis added). At no time during the settlement negotiations

did plaintiffs’ counsel attempt to narrow this broad language or preserve

any future claim.

6 In light of the recovery now sought, we realize that $650,000 might

seem an insignificant sum. However, Judge Lasker stated that it was

the largest settlement, up to that time, ever received by a mutual fund

in a derivative suit. In any event, the risk that a party may forfeit

a huge judgment by premature settlement is simply one of the hazards

of litigation, just as is the possibility that cne may pay a great deal

to settle a claim which turns out to be entirely unfounded.

mise. His execution of a valid release bars his claims

herein.

Mittendorf v. J. R. Williston & Beane, 372 F.Supp. 821, 836

(S.D.N.Y. 1974).

In construing the scope of this release, we are to give

effect to the intent of the parties. Zenith Radio Corp. v.

Hazeltine Research, 401 U.S. 321, 342-48 (1971). Any fair

reading of that intent, as demonstrated by the language of

the release itself and the circumstances surrounding its exe-

cution, supports the conclusion that the plain meaning of

the release bars the instant action.

There can be no question that the sale of W&R to CIC

was one of the transactions recited in the pleadings, and

that the current claim arises out of it. See First Nat. Bank

of Cincinnati v. Pepper, slip op. 529, 546 (2d Cir. Nov. 16,

1976) (Friendly, J.) ; Panichella v. Pa. R. R., 268 F.2d 72,

74-75 (3d Cir. 1959), cert. denied, 361 U.S. B32 (1960). It

would have been a simple matter to except the claim now

asserted from the blanket language of release.’ Cf. United

States v. Allegheny-Ludlum Industries, 517 F.2d 826, 852

(Sth Cir.), cert. denied, 44 U.S.L.W. 3593 (April 20, 1976).

The absence of any such reservation leads us to the conclu-

sion that none was intended. The case is similar to Dura

Elec. Lamp Co. v. Westinghouse Elec. Corp., 249 F.2d 5 (3d

Cir. 1957), which concerned the scope of a similar release.

In that case, Judge Goodrich stated:

It is to be noted that the language of the release

is as general as language can be. There is-nothing by

which it may be interpreted as a covenant not to sue.

There is nothing which even hints at a reservation of

rights. There is nothing in the facts here which looks

7 In this connection, we note that plaintiff, represented by the same

counsel, has executed a release in this action excepting certain claims.

to a reexamination of the release based upon fraud or

mutual mistake or anything of the sort. The trans-

action was one conducted between lawyers so we do

not have an instance where a court may strive to

extricate an uninformed layman from the consequences

of a hasty settlement.

There is an affidavit by the president of the plaintiff

company which figures in the district court proceed-

ings. This affidavit does not claim that the company

was lured into making this settlement. It simply says

that it was not the intention of the president to re-

lease all claims against other conspirators. We think

this affidavit does not change the application of the

rule. When a man uses words which have a given legal

effect he is bound by that effect in the absence of

fraud or mistake none of which there is hére.

Id. at 7 (citations omitted). See Stella v. Kaiser, 218 ¥'.2d

64 (2d Cir. 1954) (Clark, Ch.J.), aff'd on reh., 221 F.2d 115

(2a Cir.), cert. denied, 350 U.S. 835 (1955) ; 4 Williston on

Contracts §§ 601, 603 (3d ed. 1961); cf. Gordon v. Vincent

Youmans, 358 F.2d 261, 263 (2d Cir. 1965). Nor is it a

valid ground for objection that plaintiffs were ignorant of

the theory of recovery now advanced, inasmuch as all the

litigants appear to have been aware of it.* The memoran-

dum of W&R in support of the settlement explicitly dis-

cussed the possibility of recovery on this theory and found

it wanting. This memorandum was available to all par-

ties, as well as Judge Lasker, who explicitly approved the

8 The dissent suggests that Judge Tyler would not have allowed the

plaintiffs to press a Rosenfeld claim. We can see no reason to grant

relief as a result of such speculation.

10a

settlement as fair.* Moreover, at the same time, plaintiffs’

counsel was engaged in vigorously contesting the decision

of the district court in Rosenfeld v. Black, supra, in which

he ultimately succeeded. See R. Jennings & H. Marsh, Se-

curities Regulation, 1559 (3d ed. 1972). He could have

urged the same legal point in this action, or made mention

of the possibility of such a future claim during the settle-

ment proceedings. To now allow plaintiff to prosecute this

action after giving what is, on its face, a general release

would allow the defendants to be “sandbagged,” a result

we are not willing to countenance.”

Finally, it is not at all clear that this claim was not

actually pleaded in the complaints in the Horenstein-

Ruskay actions.“ Fed.R.Civ.P. 8 abandoned the require-

ment that a cause of action be pleaded; instead, the com-

plaint is to set forth “a short and plain statement” show-

ing that the plaintiff is entitled to relief. Every element

of a claim under Rosenfeld v. Black is set forth in the

9 This memorandum also discussed the desire of W&R and the individual

defendants to lay to rest any legal question involving the sale to CIC.

10 Even were plaintiffs’ counsel unaware of the possibilities of recovery

on a Rosenfeld theory, a general release would still be binding as to

this cause of action. First Nat. Bank of Cincinnati v. Pepper, slip op.

529, 546 (2d Cir. Nov. 16, 1976). A change in controlling law, even

one grounded in the Constitution, is not a basis for reopening a judg-

ment. Chicot County Drainage District ¥. Barter State Bank, 308 US.

371 (1940).

The dissent suggests that a general releare exceeded the authority of

the party granting it. Whatever is the law as to a release of wholly

unrelated claims in a derivative action, it is clear that related claims,

as here, may be released under the supervision of the district court.

11 We do not intend to rest our decision on this ground, as the dissent

apparently assumes. Our holding is that the clear language of the

release bars the instant claim. The wide scope of the pleadings is

merely one of the surrounding circumstances of the earlier action sup-

porting that conclusion.

lla

Horenstein-Ruskay complaints."* The fact that plaintiffs’

counsel decided not to press these claims is merely a tac-

12 Thus, the supplemental complaint in Horenstein v. Waddell ¢ Reed

stated:

65. The sale to Continental of the approximately 51% of WRI's

voting stock owned or controlled by Defendants Waddell and Mer-

riman would be sufficient to transfer absolute control of WRI to

Continental, thereby putting WRI and its wholly-owned sutsidiary

Defendant KCSC within the ownership and control of Continental.

66. Continental was formed in May 1968 and is located prin-

cipally in Boston, Massachusetts, and its primary business is in-

suring mortgage lenders against loss on their residential mortgage

loans.

67. With an eye toward their own personal profit and aggrandi:e-

ment, and in total disregard of their fiduciary and legal obligations

to United and United's shareholders, the Defendants Waddell and

Merriman have agreed to and are preparing to sell their controlling

stock to Continental, and the Defendants United, KCSC, and Roach

have acted and continue to act in concert with Waddell and Mer-

riman to facilitate such sale and to facilitate Continental's tender

offer for the remaining outstanding shares of WRI.

Similar charges were made in the amended complaint in that action, as

follows:

46. The transactions herein alleged were caused by WRI, the in-

dividual defendants and the other directors of United pursuant to

a plan among them to benefit WRI and its officers, directors and

stockholders, at the expense of United and its shareholders.

47. The acts of WRI and the individual Defendants, and the

diversion to themselves of opportunities belonging to United, herein-

before alleged, were and are unlaw"ul and in violation of the Invest-

ment Advisors Act, the Investm .: Companies Act, the Securities

Exchanges [sic] Act, the common law, and the Investment Advisory

Agreements between WRI and United.

48. The acts herein alleged have been and are a gross atuse of

trust, enacted in bad faith, and carried out with gross negligence

and disregard by the defendants of the fiduciary duties which are

imposed upon them by the law.

49. Lo ane oe Gnaieline of WRI,

did, at all times herein mentioned, and now do, dominate and con-

trol the directors and officers of United and the policies and the

conduct of the affairs of United.

50. The officers and directors of United have teen at all tines

herein mentioned, and still are, subservient to the directions and

l2a

tical decision of the sort that $s made in any litigation. Of

course, if this new cause of action was actually pleaded,

all parties agree that the release bars this new lawsuit.

In an era of ever-increasing caseloads, the settlement of

complex lawsuits is a welcome development. Without it,

judicial administration would prove an impossible task.

Thus, strong policy considerations require that what all

parties thought to be a closed matter remain so. One who

gives a general release has had his opportunity to press

his claim; before waiving his rights, he should carefully

consider the possibility of a development such as the one

that gave birth to this lawsuit. That risk was implicit in

the settlement, and we see no reason to relieve the appel-

lant from the consequences of his choice. Once the deci-

sion to settle is made, a party must abide by it.

wishes of WRI, and its directors, officers and stockholders, without

regard to the best interests of United.

51. The payment of excessive brokerage commissions to KCSC

and other brokers, and the diversion of portions thereof as herein-

before alleged, and the other results of tle aforesaid practices, have

amounted to and continue to amount to a waste and spoliation of

United's assets.

52. The foregoing acts have caused substantial harm and injury

to United.

53. The individual defendants hare been guiltzeef other acts of

mismanazement, malfeasance and non-feasance in their capacities

as officers and/or directors of United and/or WRI, which acts con-

stitute gross negligence, waste of corporate assets and opportunities,

and fraudulent disrezard of the duties and responsibilities owed by

them to United.

54. Such acts of mismanagement, malfeasance, and non-feasance

are also attributable to defendants WRI and KCSC.

Were the shoe on the other foot, we hare no doubt that counsel would

vigorously contend that these pleadings are sufficient under Rule § to

support a Rosenfeld cause of action. Haring made these sweeping

charges of treach of fiduciary duty in verified pleadings. plaintiff will

not now te beard to say that she did not really intend tke broad alle-

gations of the complaint.

’

‘

In view of our disposition of this case on the ground of

release, it is unnecessary to reach appellees’ other conten-

tion that the claim is barred by res judicata. Stella v.

Kaiser, supra, 221 F.2d at 116 (L. Hand, J.). The judg-

ment of the district court is affirmed.

MaAnsFIELD, Circuit Judge (Dissenting) :

I must dissent for the reason that in my view the record

is clear that in settling and releasing the earlier Horenstein-

Ruskay stockholders’ derivative claims based on alleged

improper brokerage activities the parties to those actions

did not settle or release claims that were first asserted years

later to the effect that defendants sold their investment

advisory office in violation of principles outlined in Rosen-

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

The two claims are entirely separate and distinct from

each other. Indeed the facts giving rise to the sale-of-office

claim did not occur until some two years after the broker-

age accounting action had been instituted. The sale-of-office

claim could not, therefore, have been asserted in the settled

action without court permission, see F.R.C.P. 15(d), which

was never sought or obtained for such a claim. Nor did

the parties to the earlier suits, in settling the brokerage

claims, indicate that sale-of-office claims were contemplated,

much less settled, probably for the reason that the princi-

ples of Rosenfeld v. Black were yet to be finally established.

Indeed, in seeking court approval of the settlement and

release of claims for an accounting for illegal brokerage

profits estimated at a few million dollars, they did not

advise the court, United’s stockholders, or anyone else, that

they were also settling a sale-of-office claim amounting to

some $62,000,000. Had they done so, it is clear that, in view

of the possibility that the defendants’ sale of advisory office

would violate basic principles being advanced in Rosenfeld,

l4a

neither the district court nor United’s stockholders would

have authorized settlement of a claim that might be worth

$62,000,000 for a mere $535,000 to $650,000. Indeed, in ap-

proving the settlement, Judge Lasker noted that when con-

sidered against the plaintiffs’ claim of $2,064,000 damages

the proposed settlement figure appeared to be a “respect-

able” one.

In short, the court, parties and United stockholders,

thought they were settling brokerage claims, not a sale-

of-office claim, which was never mentioned. In my view

the expansive interpretation (to me a misinterpretation)

given by the majority to the earlier settlement and court

approval not only ignores the limited powers and purpose

of the parties but it strips United and its stockholders of

a valuable claim and confers an unjustifiable windfall upon

the defendants.

The original Horenstein-Ruskay actions, commenced in

1967 on behalf of the investment fund United against

W & R, which was investment advisor to United, and

W & R’s directors, claimed that the defendants channeled

United’s portfolio securities transactions to a W & R sub-

sidiary, Kansas City Securities Corporation (KCSC), as

the stockbroker for United and that in the handling of

these United transactions on a brokerage basis the de-

fendants engaged in various improper practices (e.g.,

“churning,” self-dealing, improper diversion of customer-

directed “give-ups,” etc.) which yielded illegal profits to

W & R and to its subsidiary, KCSC. The Horenstein plain-

tiffs sought injunctive relief, impressment of a trust, and

an accounting for the profits thus alleged to have been

illegally diverted by the defendants.

Following the 1969 agreement by the defendants to

sell control of W & R, which had a net asset value of

$18,000,000 or $18 per share, to Continental Investment

15a

Corporation (CIC) for $80,000,000, the Horenstein plain-

tiffs, fearing that the individual defendants would thereby

escape with the alleged ill-gotten gains realized as a re-

sult of their brokerage activities in the handling of the

United account, sought leave in May, 1969, to amend their

complaint by adding two new causes of action. One of the

proposed new counts (the Second) claimed that the sale

would deprive KCSC of its seat on the Pacific Stock Ex-

change, as a result of which United would incur a sub-

stantial loss, since under the investment advisory contract

certain portions of KCSC’s fees were remitted to United.

The other proposed new count (the Third) alleged that

at least part of the premium paid for the W & R shares

above the net asset value of $18 per share was attributable

to the illegal profits realized by W & R as a result of its

improper brokerage practices in the management of the

United investment fund. In short, the Horenstein plain-

tiffs claimed that, since the prem um represented a cap-

italization of the illegal brokerage profits, the sale should

be enjoined or the pr» 2zeds be impounded in trust for

United pending the outcome of the derivative suits. At

no time did the Horenstein plaintiffs claim that the de-

fendants had violated their fiduciary duty by selling their

investment advisory position; their claims were directed

solely against brokerage abuses and they sought relief lim-

ited to preventing the defendants from retaining the profits

(realized directly or through capitalization and sale) at-

tributable to those abuses.

The distinct and discrete nature of the Horenstein claims

was recognized by Judge Harold R. Tyler, who granted

the plaintiffs’ motion for leave to add the claim requesting

a tracing of the allegedly ill-gotten profits, which he viewed

as “substantially a request for an alternative basis for

relief on the claims already stated in the complaint.”

ifa

Horenstein v. Waddell ¢ Reed, Inc., 13 Fed. R. Serv. 2d

330, 333 (S.D.N.Y. 1969). The only difference the addition

of this request would make, he stated, “will be on legal

argument and, perhaps, an additional motion for a pre-

liminary injunction against the tender offer and sale.” Jd.

As to that part of Horenstein’s proposed supplementa-

tion that alleged direct losses to United from the sale,

however, Judge Tyler denied the motion. The proposed

count, he stated, had nothing to do with the churning,

self-dealing, diversion of give-ups and other brokerage

activities alleged in the original complaint; it arose merely

out of the sale of W & R stock and the investment advisory

contract between W & R and United. He held, therefore,

that the court lacked the power to entertain the suit under

the doctrine of pendent jurisdiction and that, even if the

court did have the power, “I find that the interests of

judicial economy and fairness to litigants would not be

served by adding this claim to either the Horenstein action

or the consolidated actions.” Id. at 336. Thus Judge Tyler

was unwilling to allow the Horenstein plaintiffs to add a

claim that was not based on the alleged brokerage

improprieties.

On June 4, 1969, Horenstein amended his complaint to

request the tracing of profits, and plaintiff Ruskay followed

suit in early July. On July 2, however, the tender offer

was consummated. No trust was imposed on the proceeds.

In December 1969 both suits were settled.

In the latter part of 1971, following our decision in

Rosenfeld v. Black, 445 F.2d 1337 (2d Cir. 1971), cert. dis-

missed, 409 U.S. 802 (1972), Ruskay and three stockholders

who had not been involved in the Horenstein-Ruskay

actions brought the present suits, alleging that the sale of

the W & R stock constituted a sale of fiduciary office in

violation of the principles established in Rosenfeld v.

Black, supra. Their claim is based not merely on the

l7a

defendants’ transfer of ownership of W & R to CIC ata

premium but on the parties’ agreement that the sale at

such a premium would not become effective unless the

selling defendants succeeded in obtaining for the purchaser

the reinstatement of the United investment fund’s advisory

agreements, which would require the approval of United’s

directors. The defendants were alleged to have violated

their fiduciary duty by accepting the premium in exchange

for successfully influencing the selection of W & R’s

successor. Plaintiffs here appeal from the district court’s

order granting partial summary judgment and dismissing

this claim on the grounds of res judicata.

Discussion

A stockholder-plaintiff in a derivative suit represents

his company and its stockholders in a limited capacity only.

He generally may settle only those disputes which are or

could have been asserted by him with respect to the trans-

actions alleged in his complaint on the company’s behalf.

He may not use his claims or lawsuit as the basis for re-

leasing the defendants generally or as a means of releasing

claims which could not have been advanced by him.’

The essential question before us, therefore, is whether

the sale-of-office claim was or could have been asserted in

the Horenstein-Ruskay suit. The record answers this

question in the negative. The claim was never asserted

1 If claims beyond the bounds of the complaint are to be settled, the

ordinary course of action is to seek amendment of the complaint to

include those claims as part of the settlement. See, e.g., Masterson v.

Pergament, 203 F.2d 315 (6th Cir.), cert. denied, 346 U.S. 832 (1953) ;

Cherner v. Transitron Electronic Corp., 221 F. Supp. 48, 50 (D. Mass.

1963); Heddendorf v. Goldfine, 167 F. Supp. 915, 921, 928 (D. Mass.

1958). Such a procedure is appropriate only where the new claims have

been adequately and explicitly considered by the parties and the court.

Winkelman v. General Motors Corp., 48 F. Supp. 490, 495-96, modified,

48 F. Supp. 500 (S.D.N.Y. 1942).

18a

in the settled lawsuit. Nor could it have been asserted,

since the facts giving rise to it did not occur until long

after that suit was begun, and Judge Tyler’s ruling makes

it clear that permission would not have been granted to

add it.

The majority seek to remedy this glaring deficiency by

taking the position that since the sale of W & R stock was

described in the supplemental Horenstein-Ruskay com-

plaint and the sale-of-fiduciary office claim arises out of

that sale, the present plaintiffs are precluded from assert-

ing the sale-of-office claim. The majority’s analysis,

however, proves too much. The claim Horenstein unsuc-

cessfully attempted to add in the original actions—that

the sale would deprive a W & R subsidiary of its exchange

seat and would thereby injure United—also arose out of

the sale. Thus, under the majority’s analysis, that claim

would similarly be barred, even though it clearly did not

form and could not have formed any part of the subject

matter of the Horenstein-Ruskay actions. The sale-of-

office claim asserted here stands in the same position as

the loss-of-exchange-seat claim which Judge Tyler refused

to add to the Horenstein-Ruskay complaint. Both claims

are completely unrelated to the breaches of fiduciary duty

alleged in the original complaint. Both are related to the

Horenstein-Ruskay action only to the extent that the sale

was mentioned in the amended complaint in that action

as the basis for tracing the illegal brokerage profits and

the claims for loss-of-exchange seat and for sale-of-

fiduciary-office also arose out of that sale. Neither could

have been alleged at the time the lawsuit was filed. Both

involved little additional factual proof but many additional

legal problems.

Thus it is readily apparent that Judge Tyler would have

denied a motion to add a Rosenfeld claim to the original

19a

complaint and, under such circumstances, we have held

that it must be assumed that he would have refused to

add the claim. Burns Bros. v. Central Railroad of New

Jersey, 202 F.2d 910 (2d Cir. 1953). In essence, what the

majority has done is to hold that the representatives in

the original actions settled disputes as to which they had

no authority to act as representatives. In this I cannot

concur.

Nor does the majority’s reliance on the release executed

between United and the Horenstein-Ruskay defendants,

rather than on other elements of the settlement, change

this analysis. The release was effective only to the extent

that the Horenstein plaintiffs acted within the limits of

their representation, as part of the settiement of their

suits. A company cannot, as a general matter, bar deriva-

tive actions on its behalf by release.

Even if the Horenstein plaintiffs might have been per-

mi‘ted to assert a Rosenfeld-type claim, the language of

the settlement documents should not be construed to bar

such a claim. The release was not, as the majority con-

tends, a general release—indeed, such a release would not

ordinarily have been approved.’ It released the defendants

2 As iis court stated in Heddendorf v. Goldfine, 167 F. Supp. 915, 928

(D. Mass. 1958), when it explicitly considered and approved a general

release under the circumstances of the case:

“While, in general, this Court has some doubt whether it is desirable

for a tribunal to release defendants from liability not only for

specific items of disclosed wrongdoing but also for any undisclosed

wrongdoing during a defined period, the Court has no scruples in

approving in this case such a general release. Here we have had

the benefit of the most intensive investigation by one of the

country’s foremost specialists in this type of litigation. We have

had an abundance of depositions. There has been a thorough can-

vas [sic] by a committee of Congress. This Court itself has con-

ducted a number of bearings and has even gone so far as to open

up a suggested line of evidence. On the special facts of this case,

a general release is appropriate. But the special facts may not be

“20a

only from “all claims, demands or causes of action arising

... for or by reason of any of the matters or transactions

recited or described in the complaints, supplemental com-

plaints and/or other pleadings.” Although Judge Lasker

referred to the release as a “general” one in his order,

it is clear from the context that he meant only that it

released the defendants generally from any claims arising

out of the churning and self-dealing transactions forming

the basis of the claims. The transactions which were the

focus of the Horenstein-Ruskay actions were churning and

self-dealing transactions allegedly undertaken by W & R

prior to the institution of the lawsuits in 1967. The sale

of W & R stock was relevant to the suits only because

plaintiffs demanded that the proceeds of those churning

and self-dealing transactions be traced through to the sell-

ing stockholders. No allegation was made that the defen-

dants had breached their fiduciary duties by selling their

advisory positions on condition that they would influence

United to validate the purchaser (CIC) as adviser. Judge

Tyler, in granting in part Horenstein’s motion to supple-

ment his complaint, viewed the tracing request simply as

a remedy designed to recover the illegal brokerage profits.

Although defendants’ attorneys, in a passing reference,

derided the possibility of a Rosenfeld claim in their briefs,

Judge Lasker made no mention of any such claim, much

less of its merit, in his order approving the settlement,

even though he painstakingly and exhaustively discussed

the chances of plaintiffs’ success on all of the grounds al-

leged in their original complaints. The reason is clear:

the district court did not intend to authorize settlement of

“uae paralleled in other litigation. And so this case may not serve as a

broad precedent.”

Where, as here, there is no indication that the district court which

approved the settlement even considered the possibility of a general

release, it is wholly inappropriate for this court to infer one.

2la

such a claim. Nor did the stockholders, who were given

absolutely no notice of it in the settlement notice sent to

them as mandated by F.R.C.P. 23.1.

While I agree with the majority that “the settlement of

complex lawsuits is a welcome development,” it should not

be expanded beyond the parties’ intent, particularly in

representative or derivative suits where the effect is to

injure innocent stockholders. Because a representative

shareholder acts within a limited grant of authority when

settling a dispute on behalf of all stockholders and because

of the dangers inherent in representative settlements, I

would construe such settlement agreements narrowly, lim-

iting their effect to the dispute clearly before the court at

the time of settlement. We have stretched the effect of

representative and derivative actions far enough by allow-

ing nonparties to be precluded merely by receipt of a notice

of settlement. It is asking too much to require, as the

majority apparently would here, that each stockholder

consult a lawyer as to possible subtleties of language and

law not set forth on the plain face of the notice and its

related documents.

For these reasons I would reverse the order of the

district court.

Judgment of the Court of Appeals

UNITED STATES COURT OF APPEALS

For toe Secoyp Ciacuit

At a stated Term of the United States Court of Appeals

for the Second Circuit, held at the United States Court-

house in the City of New York, on the seventeenth day

of February, one thousand nine hundred and seventy-seven.

Present:

Hon. Watter R. Mansrretp

Hon. ExtswortH A. GRAAFEILAND

. Hon. THomas J. MESKILL

Circuit Judges

——~—>—

Sopuie Ruskay,

Plaintiff-Appellant,

—vVvV =

Jutrus Jensen III, Joz Jack Merrmman, Cuauncey L.

WappeLL, Monte J. Watiace, Cornetius Roacn, Nem

W. Watiace, Mircne, J. Varicenti, John Doe 1 to

John Doe 100, Richard Roe 1 to Richard Roe 1000

(fictitious names, the true names being unknown to

plaintiffs, the parties intended being those other than

any defendant above named, who in 1969 sold stock of

Waddell & Reed, Inc., to Continental Investment Corp.)

Waddell & Reed, Inc., (a Mass. Corp.) previously

known as CWR Corp., Continental Investment Corp.,

and United Funds, Inc.,

Defendants-Appellees.

———

eae

Wesster Factors, Inxc.,

Plaintiff-Appellant,

— a

Cuauncey L. Wappett, Ricnarsp H. Wappe.it, THEODORE

H. Wappett, Mitcuett J. Varicenti, Rospert Persons,

James W. Kemper, Jr., Jack D. Merriman, CoRNELIUS

Roacu, Geratp A. Gitvert, Joz Jack MERRIMAN, EpGar

SHoox, Cameron K. Rezep, Dutton Brooxrizxp, Jay B.

DmuincHam, CLarence D. Feit, Jackson W. Goss, W.

Harpy Henpron, Juuivs Jensen II], Jonn A. Kron,

Tomas C. MacLavcuun, Wittiam A. Reasoner, CaRL

B. Scuurz, Morte J. Watitace, Nem W. Wa ttacez,

Joun B. Wornatt, Wappett, & Reep, Inc., (a N. Y.

Corp.) Wappett & Rezp, Inc., (Mass. Corp.), Cownt-

WENTAL InvestMENT Corp., Unrrep F'unps, Inc.,

Defendants-Appellees.

Irwin L. Fernserc, as Trustee for Heren K. Fernsenc,

and Inwrmy L. Fenvserc, and Heren K. Fernserc, as

Joint Tenants,

Plaintiffs-A ppellants,

—_—V.ew

Juuius Jensen III, Joz Jack MERRIMAN, Cuauncey L.

Wappett, Monte J. Watiace, Cornetivs Roacg, etc.,

Defendants-Appellees.

—= >

Lovis FeLpmay,

Plaintiff Appellant,

—

Joe Jack Meremay, et al.,

Defendants-Appellees.

JupitH Bernstern, et al.,

Plaintiff - Appellant,

—VvV.—

Dutton BrooxrFie.p, et al.,

Defendants-Appellees.

———

Apppeal from the United States District Court for the

Southern District of New York.

This cause came on to be heard on the transcript of

record from the United States District Court for the

Southern District of New York, and was argued by counsel.

On Consiperation Wuenreor, it ig now hereby ordered,

adjudged, and decreed that the judgment of said District

Court be and it hereby is affirmed in accordance with the

opinion of this court with costs to be taxed against the

appellants.

A. Dante, Fvsaro,

Clerk

By Vincent A. Caar.in,

Chief Deputy Clerk

SRS Cee A ae

25a

APPENDIX C

Decision of the Court of Appeals

Denying Petition for Rehearing

UNITED STATES COURT OF APPEALS

Seconp Cracuit

At a stated term of the United States Court of Appeals,

in and for the Second Circuit, held at the United States

Court House, in the City of New York, on the ninth day of

May, one thousand nine hundred and seventy-seven.

Docket No. 76-7270

Sorpure Rusxay, Lovis Fetpmay, Trustee, etc.,

Plaintiff s-Appellants,

—_vV—

Cuauncey L. Wane, etc.,

Defendants-A ppellees.

—_—<>—

A petition for rehearing containing a suggestion that the

action be reheard en banc having been filed herein by coun-

sel for the plaintiffs-appellants, and no active judge or

judge who was a member of the panel having requested

that a vote be taken on said suggestion,

Upon ConsiperaTion THEREOF, it is

Orperep that said petition be and it hereby is Dentep.

Invinc R. KavurMay,

Chief Judge.

264 APPENDIX D

Nos, 71 Civ. 3168, 71 Civ. 4424, 71 Civ.

$865 and 71 Civ. 4352.

United States District Court,

8S. D. New York.

March 25, 1972.

Action by shareholders of a mutual

fund against corporate investment advis-

or, directors and officers of advisor and

corporation, which had acquired over 90

percent of outstanding shares of advisor

and merged advisor into its subsidiary,

to recover profits made by investment

advisor’s shareholders when they sold

their stock. The defendants. moved for

;

is upon dif-

ferent claim or demand, prior judgment

27a

RUSKAY v. JENSEN 265

Cite as 2 F.Supp. 264 (1972)

operates as estoppel only as to those is-

sues actually litigated and determined in

prior suit.

2. Judgment 701

For res judicata purposes, inasmuch

as real party in interest as plaintiffs in

both suits was mutual fund and its

shareholders, plaintiffs were the same,

even though the named plaintiffs might

differ.

3 Judgment $°570(5)

Judgment approving settlement and

dismissing complaint as to all claims

which were or might have been asserted

in them with respect to matters and

transactions alleged was a “judgment on

the merits” and would be given full res

judicata effect in subsequent suit be-

tween same parties on same causes o”

action as those compromised in settle-

ment.

See publication Words and Phrases

for other judicial constructions and

definitions.

4. Judgment €-570(3)

Settlement decree dismissing com-

plaint as to all claims which were or

might have been asserted as to matters

and transactions alleged eliminated need

to have issues actually litigated and,

since it was unaccompanied by findings

of fact or conclusions of law, it general-

ly could not bind parties as to any issues

which might arise in subsequent lawsuit

on different cause of action.

5. Judgment €585(2)

For res judicata purposes, two caus-

es of action are the same if they allege

violation of but one right by single legal

wrong.

6. Judgment 585 (2)

Where claims for relief in two law-

suits depend on same operative facts and

pertain to same disputed transactions,

they constitute the same cause of action

for res judicata purposes.

7. Judgment -585(2)

Where successive actions involved

claim for same premium paid on sale of

same stock in same corporation pursuant

342 F Supp. —17¥2

to same contract between same parties

as part of same tender offer and the one

right asserted in both acticns was that

of mutual fund to profits made upon

sale of its investment advisor and prin-

cipal underwriter, and the single legal

wrong was breach by defendants of

their fiduciary duty to refrain from

making personal profits upon sale of as-

sets properly belonging to fund, second

action was barred by res judicata. In-

vestment Company Act of 1940, § 1 et

seq., 15 U.S.C.A. § 80a-1 et seq.

8. Action ¢°53(1)

Plaintiff cannot split up his ciaim

and cannot divide grounds {si recovery.

9. Compromise and Settlement ¢16(1)

Where mutual fund shareholders

framed complaint in first action to avoid

effect of prior decision that premium

received upon sale of shares of invest-

ment advisor does not constitute sale

of fiduciary offices, shareholders were

barred, after settling that case, from

maintaining action against same defend-

ants on basis of later decisions that

stockholders of investment advisor must

account to mutual fund for any profits

received upon sale of their shares. In-

vestment Company Act of 1940, § 1 et

seq., 15 U.S.C.A. § 80a-1 et seq.

10. Judgment €589(1)

When plaintiff has two alternate

remedies available to him upon same

cause of action, he may not reserve one

and sue upon the other and judgment on

one will be bar to later suit upon the

other.

11. Judgment ¢587

Fact that decision on one theory of

recovery will have no bearing on deter-

mination of another does not mean that

each theory states a distinct cause of ac-

tion for res judicata purposes.

12. Judgment 632

Where plaintiff, mutual fund share-

holders chose the forum in prior action,

had complete discovery on all issues, vol-

untarily surrendered mutual fund's

claims in exchange for settlement pay-

ment and were fully aware of role

“-

played by certain persons, who were not

parties and whose participation in cha!-

lenged transactions was not independent

of that of defendants, judgment in that

case was a bar to shareholders’ subse-

quent action against such persons and

doctrine of mutuality of estoppel did not

preciude defensive use of res judicata.

Investment Company Act of 1940, § 1 et

seq., 15 U.S.C.A. § 80a-1 et seq.

13. Release ©-27

Where plaintiff mutual fund share-

holders executed release discharging lia-

bility of defendant investment advisor’s

officers and directors, such release also

discharged advisor’s officers and direc-

tors who were not parties to the action

and they were not subject to suit in lat-

er action for the same relief. Invest-

ment Company Act of 1940, § 1 et seq.,

15 U.S.C.A. § 80a-1 et, seq.

14. Release 4-38

Effect of release is governed by in-

tention of parties.

15. Release ¢=27, 38

Where shareholders in investment

advisor were motivated to settle action

against them by shareholders of mutual

fund by the imminent sale of their stock

in advisor, so that it was inconceivable

that parties could have intended to re-

move liability from sellers of advisor’s

stock only to cast it upon buyers, release

signed by shareholders of investment

fund released all parties to the transac-

tion, precluding subsequent action

against corporation which acquired

shares of advisor. Investment Company

Act of 1940, § 1 et seq., 15 U.S.C.A. §

80a-1 et seq.

—- <>

Pomerantz, Levy, Haudek & Block,

New York City, for plaintiffs; William

E. Haudek, New York City, of counsel.

Valicenti, Leighton, Reid & Pine, New

York City, for defendants; Albert D.

Jordan and Elliot Paskoff, New York

City, of counsel.

METZNER, District Judge:

The defendants move pursuant to Rule

56(b), Fed.R.Civ.P., for summary judg-

ment on the ground that all of the

claims asserted in these four consolidat-

ed stockhoiders’ derivative suits are

barred by a judgment of this court en-

tered on June 25, 1970 in an earlier

stockholders’ derivative suit.

The named plaintiffs in each of the

four present actions are shareholders of

United Funds, Inc. [United], and were

shareholders during the time of the

transactions complained of. They sue

on behalf of United and all United

shareholders.

United is a mutual fund registered

under the Investment Company Act of

1940, 15 U.S.C. § 80a-1 et seq. [the

Act], as an open-end management in-

vestment company. As of June 1969, it

had assets in excess of $2 billion and

more than 500,000 shareholders holding

more than 275 million shares of stock.

Defendant Waddell & Reed, Inc. [W &

R) was the investment adviser for Unit-

ed in 1969 and for many years prior

thereto. During this same period of

time W & R also acted as the principal

underwriter for United's shares. De-

fendants Roach, Waddell, Merriman and

Valicenti were directors and officers of

W & R during this time.

Defendant Continental Investment

Corporation (CIC) is a Massachusetts

corporation. CWR Corporation, also «

Massachusetts corporation, is a wholly-

owned subsidiary of CIC. CIC acquired

over 97% of the outstanding shares of

W & R, merged W & R into its subsidi-

ary, CWR, and changed the latter’s

name to Waddell & Reed, Inc. [(W &

R/Mass.}. Defendants Jensen, M. J.

Wallace and N. W. Wallace are directors

and officers of CIC.

All four complaints, with some excep-

tions to be mentioned later, are basically

the same and seek, in essence, to recover

profits made by W & R shareholders

when they sold their stock to CIC.

CIC’s acquisition of W & R had its or-

igins in a contract executed in early

2 ry ee

—_ ee

RUSKAY v. JENSEN 267

Cite as M2 F Supp. 264 (1972)

ene:

1969 between CIC and the holders of

61.69% of W & R's voting stock, includ-

ing defendants Waddell, Merriman and

Roach. Pursuant to that contract, CIC

agreed to purchase this block of stock at

a price of $80 per share and to make a

tender offer for the remaining outstand-

ing shares of W & R at the same price.

At the time the contract was executed,

W & R stock had a par value of $1 per

share and a net asset value of approxi-

mately $18 per share.

The parties to the contract understood

that under the Act the advisory and un-

derwriting agreements between United

and W & R would automatically termi-

nate upon acquisition of W & R by CIC.

Therefore, CIC’s obligations were ex-

pressly conditioned upon reinstatement

by United’s shareholders of the advisory

agreement and reinstatement by Unit-

ed's directors of the underwriting agree-

ment.

On April 18, 1969, United's manage-

ment called a shareholders’ meeting for

June 3, 1969, and sent to all fund share-

holders a proxy statement describing the

arrangement with CIC, seeking approval

for reinstatement of the advisory agree-

ment upon consummation of the deal,

and soliciting votes for re-election of the

15 incumbent directors of United. On

June 3rd, the shareholders approved re-

instatement of the advisory agreement

and re-elected the 15 incumbent direc-

tors.

The complaints charge that the excess

of purchase price over net asset value of

the W & R shares constitutes payment

for W & R's fiduciary positions as in-

vestment adviser and principal under-

writer for United. It is claimed that

this sale of fiduciary offices is illegal

and that the excess, amounting to $62

per share, should have been paid to

United rather than to the stockholders

of W & R.

It is further alleged that the April

18th proxy statement was materially

false and misleading in that it failed to

reveal that United and its shareholders

were entitled to the profits to be made

upon the sale of W & R shares and by

representing that CIC contemplated no

changes in the board of directors of

Unitea or in the management of W & R

upon consummation of the acquisition.

The complaints charge that because of

these defects in the proxy statement the

reinstatement of the advisory and un-

derwriting agreements was void and the

defendants must account to United for

all fees received under the reinstated

ag”eements.

One of the plaintiffs makes an addi-

tional claim based on alleged misrepre-

sentations in proxy material sent to

United's shareholders on Apri! 30, 1971.

This proxy material sought approval of

an amendment to the advisory contract

to increase advisory fees paid by United

to the investment adviser. The com-

plaint charges that the stockholders’ sub-

sequent approval of the amendment was

void because it was based on misrepre-

sentations in the proxy material.

The defendants claim that a judgment

of this court entered on June 25, 1970 in

two earlier stockholders’ derivative suits

is res judicata on all the issues raised by

the present plaintiffs.

The first of these two actions, Horen-

stein v. Waddell & Reed, Inc., 67 Civ.

4175, was commenced on October 26,

1967, and the second, Ruskay v. Merri-

man, 69 Civ. 276, on January 23, 1969.

The initial complaints in both suits were

largely identical and charged that W &

R had breached its fiduciary duty to

United by channeling portfolio transac-

tions through a wholly-owned subsidiary

which acted as broker for United with-

out reducing the management fee

charged United. Allegations were also

made that transactions for United were

used by W & R to gain reciprocal trade

and give-up agreements for W & R with

other brokers.

In May 1969 plaintiffs in the

Horenstein/Ruskay actions, having

learned of CIC’s acquisition offer,

moved and were granted leave to file

supplemental complaints alleging that

the W & R shareholders were going to

30a

268 342 FEDERAL SUPPLEMENT

receive an excessive price for their

shares. It was alleged that the price

was largely a result of the ability of the

investment adviser of United to earn

substantial illegal profits in its manage-

ment of the fund, as alleged in the prin-

cipal complaint. It was claimed that

these illegal profits resulted from a

breach of fiduciary duty, and therefore

the premium paid for them was right-

fully the property of United.

In answer to the supplemental com-

plaints, defendants denied these allega-

tions, and stated that the shareholders

approved the transaction after “full and

fair disclosure” in the proxy statement

by voting for the reinstatement of the

advisory agreement.

On December 24, 1969, the parties in

the Horenstein/Ruskay actions entered

into a stipulation of settlement whereby

the defendants agreed to pay United a

total of $650,000 in exchange for dismis-

sal of the complaints with prejudice.

On June 25, 1970, after a hearing pur-

suant to notice to stockholders, Judge

Lasker entered judgment approving the

settlement and dismissed the complaints

on the merits and with prejudice as to

“any and all claim or claims, or causes

of action, or parts thereof which are or

might have been asserted with respect to

the matters and transactions alleged in

the said complaints. . . .” On Octo-

ber 10, 1970, United executed a release

discharging all defendants named in the

Horenstein/Ruskay actions from any

and all claims United had or might have

against them “for or by reason of any of

the matters or transactions recited or

described in the complaints, supplemen-

tal complaints and/or pleadings filed by

the plaintiffs in the above entitled ac-

tions. -

{1} Any discussion of the issues

presented by this motion must begin

with the classic statement of the rules of

res judicata and collateral estoppel set

forth in Cromwell v. County of Sac, 94

U.S. 351, 24 L.Ed. 195 (1876). Accord-

ing to that case, the judgment in a prior

suit, if rendered on the merits, is res ju-

dicata in a subsequent action between

the same parties on the same claim or

cause of action and operates as an abso-

lute bar not only as to every ground of

recovery or defense actually presented in

the prior action, but also as to every

ground which might have been present-

ed. However, where the second action is

upon a different claim or demand, the

prior judgment operates as an estoppel

only as to those issues actually litigated

and determined in the prior suit. See

also Lawlor v. National Screen Service

Corp., 349 U.S. 322, 326, 75 S.Ct. 865, 99

L.Ed, 1122 (1955) ; Commissioner of In-

ternal Revenue v. Sunnen, 333 U.S. 591,

597, 68 S.Ct. 715, 92 L.Ed. 898 (1948);

Baltimore Steamship Co. v. Phillipe, 274

U.S. 316, 319, 47 S.Ct. 600, 71 L.Ed.

1069 (1927).

These rules raise five basic questions:

(1) Were the parties in the prior ac-

tion the same as in the present one?

(2) Did the prior action go to judg-

ment?

(3) If so, was that judgment on the

merits?

(4) Were the claims or causes of ac-

tion in the prior suit the same as in the

present one?

(5) If not, what issues were actually

litigated and determined in the prior

suit?

{2] The first three of these ques-

tions are easily disposed of in the

present litigation. Both the Horen-

stein/Ruskay actions and the instant

suits were brought derivatively on be-

half of United and its shareholders,

and therefore the plaintiffs in all ac-

tions are the same. The real party in

interest in these suits is the fund and

its shareholders, even though the named

plaintiffs might be different in each

case. Of the defendants, W & R Merri-

man, Roach and Waddell are parties in

all the actions. The effect of

Horenstein/Ruskay on those who were

not named in that suit wil] be discussed

later.

~~ ee Oe ee ee

ee en ee

ME Pitty mate Et ee

3la

RUSEAY v. JENSEN 269

Cite as 342 F.Supp. 264 (1972)

(3,4) As to the second question, on

June 25, 1970 a judgment was entered in

the Horenstein/Ruskay actions approv-

ing the settlement and dismissing the

complaints as to all claims which were

or might have been asserted in them

with respect to the matters and transac-

tions alleged. Such a settlement decree

is a judgment on the merits and is given

full res judicata effect in a subsequent

suit between the same parties on the

same causes of action as those compro-

mised in the settlement. Smith v. Alle-

ghany Corp., 394 F.2d 381, 391 (2d Cir.),

cert. denied, 393 U.S. 939, 89 S.Ct.

300, 21 L.Ed.2d 276 (1968); Stella v.

Kaiser, 218 F.2d 64, 65 (2d Cir. 1954).

cert. denied, 350 U.S. 835, 76 S.Ct. 71,

100 L.Ed. 745 (1955). However, the col-

lateral estoppel effect of a settlement

decree is greatly limited. Since a set-

tlement such as the one in Horen-

stein/Ruskay eliminates the need to

have issues actually litigated and is

unaccompanied by findings of fact or

conclusions of law, it generally cannot

bind the parties as to any issues which

might arise in a subsequent lawsuit on a

different cause of action. Lawlor v. Na-

tional Screen Service Corp., supra.

This brings us to the heart of the

present controversy: whether the causes

of action in Horenstein/Ruskay are the

same as those here. A determination of

this issue requires analysis of the vari-

ous claims asserted in the present and

prior suits.

In the Horenstein/Ruskay actions two

basic claims were raised:

1. A claim, asserted in the principal

complaints, to recover illegal profits

made by W & R as manager of United;

2. A claim, asserted in the supple-

mentary complaints, to recover the pre-

mium to be paid W & R shareholders by

CIC as payment for past and future ille-

gal profits obtainable as manager of

United.

Yin the present litigation, three dis-

tinct claims can be culled from the com-

plaints:

1. Acclaim for the excess of purchase

price over net asset value of the W & R

shares, based on a charge that this ex-

cess constitutes payment for W & R’s fi-

duciary offices as investment adviser

and principal underwriter for United;

2. A claim for profits made under

the reinstated advisory and underwrit-

ing agreements, based both on misrepre-

sentations in the proxy statement of

April 18, 1969, and on the illegality of

the sale of fiduciary offices ;

3. A claim for profits made under

the advisory agreement as amended in

1971, based on misrepresentations in the

proxy material of April 30, 1971.

The major dispute between the parties

here is whether the first claim in the

present suits is identical to the claim as-

serted in the supplemental complaints in

the Horenstein/Ruskay actions. The

court concludes that it is, and it is

therefore barred by res judicata. / A

[5,6] Two causes of action are the

same if they allege “the violation of but

one right by a single legal wrong.” Bal-

timore Steamship Co. v. Phillips, supra

274 U.S. at 321, 47 S.Ct. at 602. Where

the claims for relief in two lawsuits de-

pend on the same operative facts and

pertain to the same disputed transac-

tions, they constitute the same cause of

action. Saylor v. Lindsley, 391 F.2d

965, 969 n. 6 (2d Cir. 1968); Engel-

hardt v. Bell & Howell Co., 327 F.2d 30,

33 (8th Cir. 1964); Williamson v. Col-

umbia Gas & Electric Corp., 186 F.2d

464, 470 (3rd Cir. 1950), cert. denied,

341 U.S. 921, 71 S.Ct. 743, 95 L.Ed. 1355

(1951). '

{7} Such is the case here. Both

Horenstein/Ruskay and the present case

involve a claim for the same premium

paid in the same sale of the same stock

in the same corporation pursuant to the

same contract between the same parties

as part of the same tender offer. The

one right asserted in both actions is the

right of United to the profits made upon

sale of its investment adviser and prin-

cipal underwriter. The single legal

32a

270 312 FEDERAL SUPPLEMENT

wrong is the breach by defendants of

their fiduciary duty to refrain from

making personal profits upon a sale of

assets properly belonging to United.

The fact that the settling plaintiffs

alleged a formula for computing dam-

ages different from that urged here is

not a distinguishing factor between the

two sets of cases. In the former the

premium paid for the stock was alleged

to be a capitalization of the illegal prof-

its which could be made from the man-

agement contracts. In the instant cases

the premium is alleged to have been paid

for reinstatement of the contracts under

which W & R was making iis illegal prof-

its. However denominated, it is the

same asset which is in dispute in both

actions. The management contracts

were inseparable from the profits which

could be made from them.

{8} If the plaintiffs here were to be

successful in their claims, United would

be recovering the same premium twice.

Obviously such a result is inconceivable.

A plaintiff “cannot even split up his

claim . . .; and, @ fortiori, he can

not divide the grounds for recovery.”

United States v. California & Oregon

Land Co., 192 U.S. 355, 358, 24 S.Ct.

266, 267, 48 L.Ed. 476 (1904).

The instant case presents a situation

similar to the one in Chicot County

Drainage District v. Baxter State Bank,

308 U.S. 371, 60 S.Ct. 317, 84 L.Ed. 329

(1940). In that case, plaintiff sought to

avoid the res judicata effect of a prior

judgment by arguing that the statute

pursuant to which the court had acted

was subsequently declared unconstitu-

tional in an unrelated case. The Su-

preme Court rejected this argument,

stating that since plaintiff had an op-

portunity in the prior proceeding to liti-

gate the constitutionality of the statute

and failed to do so, it was bound by the

prior determination.

{9,10} When the supplemental com-

plaints in the Horenstein/Ruskay ac-

tions were filed, the leading authority

on the accountability of an investment

adviser for profits made on the sale of

its shares was Securities and Exchange

Commission v. Insurance Securities,

Inc., 254 F.2d 642 (9th Cir.), cert. de.

nied, 358 U.S. 823, 79 S.Ct. 38, 3 L.Ed.

2d 64 (1958). This case held that a

management contract is not an asset of

the fund, and that a premium received

upon the sale of shares in the invest-

ment adviser does not constitute a sale

of fiduciary offices. Rather than con-

ducting a frontal assault upon the /n-

surance Securities rule, the Hor-

enstein/Ruskay plaintiffs sought to

skirt the issue. They scrupulous),

avoided using “fiduciary offices” lan-

guage in their supplemental complaints,

instead terming the premium a payment

for illegal profits. The memoranda sub-

mitted in support of the proposed settle-

ment show that one reason for settling

was plaintiffs’ recognition that the /n-

surance Securities case made recovery

on the supplemental complaints doubtful.

Then in 1971 the Second Circuit decided

Rosenfeld v. Black, 445 F.2d 1337 (2d

Cir. 1971), appeal pending, which reject-

ed the /nsurance Securities rule and held

that stockholders of an investment ad-

viser must account to the fund for any

profits received upon sale of their

shares. In the wake of this decision,

the present plaintiffs initiated their

lawsuits. However, as in the Chicot

case, supra, it is clear that plaintiffs in

Horenstein/Ruskay had an opportunity

to attack Jnsurance Securities and chose

not to do so. Now that Jnsurance Secu-

rities has been successfully challenged,

plaintiffs cannot reap the benefits of a

claim which was consciously avoided be-

fore. When a plaintiff has two alter-

nate remedies available to him upon the

same cause of action, he may not reserve

one and sue upon the other. A judg-

ment on one will be a bar to a later suit

upon the other. United States v. Cali-

fornia & Oregon Land Co., supra:

Burns Bros. v. Central R.R. of New Jer-

sey, 202 F.2d 910, 913 (2d Cir. 1953).

Plaintiffs urge that proof of the claim

here would require evidence different

from that needed to prove the first ac-

tions. The “same evidence” test may be

8 atten

33a

RUSKAY v. JENSEN 271

Cite as M2 F.Supp. 264 (1972)

useful as a positive test for determining

the identity of claims, but it is not valid

‘as a negative test. Engelhardt v. Bell &

Howell Co., supra 327 F.2d at 34.

[11] It will often be true that a de-

cision on one theory of recovery will

have no bearing on the determination of

another. This does not mean that each

theory states a distinct cause of action.

For example, in Baltimore Steamship

Co. v. Phillips, supra, the Court held

that a claim of negligence based on the

use of defective machinery was identical

to a claim of negligence in regard to the

same injury against the same defendant

based on negligent operation of that ma-

chinery. Nonetheless, it cannot be dis-

puted that a determination that the ma-

chinery was not defective would not

have precluded a finding that it was op-

erated negligently.

Plaintiffs further contend that, in

any event, the judgment in Horen-

stein/Ruskay cannot bar their claim

insofar as it is asserted against

those defendants who were not parties

to the earlier suits. They rely on the

doctrine of mutuality of estoppel. How-

ever, the mutuality requirement has

been greatly diluted in the Second Cir-

cuit by Zdanok v. Glidden Co., 327 F.2d

944 (2d Cir.), cert. denied, 377 U.S. 934,

84 S.Ct. 1338, 12 L.Ed.2d 298 (1964).

The court there held that in a proper

case mutuality should not be used to

preclude defensive use of res judicata

against a person who was a party to the

earlier litigation. This approach has re-

cently been approved by the United

States Supreme Court. Blonder-Tongue

Laboratories, Inc. v. University of Illi-

nois Foundation, 402 U.S. 313, 91 S.Ct.

1434, 28 L.Ed.2d 788 (1971).

{12] The present case is a proper

one for dispensing with the mutuality

requirement. The plaintiffs in Horen-

stein/Ruskay chose the forum in which

they litigated, had complete discov-

ery on all issues, and voluntarily sur-

rendered United's claims in exchange for

the $650,000 settlement payment. Fur-

thermore, they were fully aware of the

role played by the present defendants

who were not parties to the earlier pro-

ceeding. The participation of these de-

fendants in the challenged transactions

was not independent of that of the other

defendants, and in fact in the present

complaint they are named merely as

“co-conspirators with the Horen-

stein/Ruskay defendants.

{13) In any event, regardless of

questions of mutuality, the court holds

that the release executed by the plain-

tiffs in Horenstein/Ruskay has dis-

charged all present defendants, including

those who were not parties to that ac-

tion. W & R, its officers and directors

are within the express terms of the re-

lease.

(14,15) The other defendants, CIC

_and persons associated with it, may also

take advantage of the release. The ef-

fect of a release is governed by the in-

tentions of the parties. Zenith Radio

Corp. v. Hazeltine Research, Inc., 401

U.S. 321, 342-348, 91 S.Ct. 795, 28 L.

Ed.2d 77 (1971). In the present case

the conclusion is inescapable that the

parties in Horenstein/Ruskay intended

their release to discharge all persons in-

volved in the CIC acquisition transac-

tion. The memoranda in support of the

settlement point out that a major factor

motivating the defendants to settle was

the imminent sale of their stock to CIC.

The defendants desired to remove all po-

tential clouds on that stock before trans-

ferring it to CIC. It is inconceivable

that the parties could have intended to

remove liability from the sellers only to

cast it upon the buyers. The plaintiffs

must have intended to release al! parties

to the transaction.

¥ This leaves for consideration the re-

maining two claims asserted by plain-

tiffs in the present cases. As mentioned

above, these claims relate to profits

made under the advisory and underwrit-

ing agreements between United and

W & R after the CIC acquisition and

profits made under the amended 1971

advisory agreement.

3 Ye

272 $42 FEDERAL SUPPLEMENT

It is clear that these claims constitute

causes of action separate and distinct

from any asserted in the Horen-

stein/Ruskay suits and are not barred

by the prior actions.

Defendants’ motion for summary

judgment is disposed of in accordance

with the above opinion.

So ordered.

city =

APPENDIX E

Notice of Horenstein-Ru-kay Settlement Hearing

NOTICE OF SETTLEMENT HEARING

UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK, Fred

Horeasteia and Joseph Sciuto, Plaintiffs, againse Waddell and Reed, Inc., Joe Jack Merriman,

Chauncey L. Waddell, Cornelius Roach, United Funds, Inc, aod Kansas City Securities Corpo-

ration, Defendants, 67 Civ. 4175, Action No. 1.

UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK, Sophie

Ruskay, Plaintiff, agaiase Joe Jack Merriman, Chauncey L. Waddell, Cornelius Roach, Cameron K.

Reed, Robert W. Wagner, Waddell & Reed, Inc, Kansas City Securities Corporation and United

Funds, Inc, Defendants, 69 Civ. 276, Actioa No. 2.

TO THE SHAREHOLDERS OF UNITED FUNDS, INC.

NOTICE IS HEREBY GIVEN that a hearing will be held at Room 1306 of the United

States Courthouse at Foley Square in the Ciry, County and Seate of New York at 11 o'clock io

the morning of the 6ch day of April, 1970 pursuant ro an order of this Court, dated December 24,

1969, to derermine whether the proposed sertlement and compromise of the above entitled share-

holder actions brought derivatively on behalf of and in the right of United Funds,Ioc (“United”)

should be approved and confitmed by the Court in accordance with the Federal Rules of Civil

Procedure as fair, reasonable and adequate and, if such sertlement and compromise be approved,

the allowances, if any, to be made to plaintiffs for legal fees and other expenses. The hearing

may be adjourned from time to time by the Court ar the hearing or at any adjourned session

thereof withour further notice.

Aay shareholder of United who desires to do so may appear at such hearing and show

cause, if any he has, why che settlement and compromise hereinafter described should not be

approved, and why these actions should not be dismissed on the merits and with prejudice, ana

may present any evidence that may be proper and relevant to the issues to be heard; pio

vided, however, that no person not a party shall be heard and no papers or briefs submitted

by any such persoa shall be received and considered except by special permission of the Court,

unless on or before the 27th day of March, 1970, notice of intention to appear and copies of

such papers and briefs are filed in the Court and served upon Messrs. Bass & Friend, 16 West 61st

Sereet, New York, N. Y. (Counsel for plaintiffs in Action No. 1); oa Joseph A. Ruskay, Esq.,

122 Ease 42nd Street, New York, N. Y. 10021 (Counsel for plaintiff in Action No. 2); and on

. Messrs. Valicenti Leighton Reid & Pine, 70 Pine Screet, New York, N. Y. 10005 (Counsel for the

defendants other than Unired).

SUMMARY OF THE ISSUES AND CONTENTIONS

The Horensteim action (Action No. 1) was filed oa October 26, 1967. The plaiariffs’

amended complaint in that action, filed June 6, 1968, alleges, in substance, thar the affairs of

United and its Board of Directors were dominated and controlled by Waddell & Reed, Inc.

(“W&R”") {its investment adviser and manager) and the defeadaots who are associated with

W&R; that che defendants were engaged in a conspiracy to enrich themselves and their associates

sia

at the ex of United; that W&R has exploited its power over the execution of the portfolio

pant a United by directing the execution of such transactions to its wholly-owned subsidi-

ary Kansas City Securities Corporation (“KCSC") and to other brokers or dealers who share

their commissions or discounts on such transactions, directly or indirectly, through so-called “give-

ups” and/or various reciprocal arrangements with KCSC and other brokers or dealers who fur-

nish information or services to W&R or who sell shares of United; that such practices have de-

prived United of the best execution of its portfolio transactions and have resulted in the execu-

tion of United's portfolio transactions at less favorable prices than were otherwise available

and/or at higher brokerage coscs; that such practices have enabled W&R and the defendans

associated with it to derive substantial profics and benefits by reducing the com to W&R of

performing the invescment advisory and management services required by it contract with

United as well as by increasing the management fee of W&R through stimulating thereby the

sale of United's shares. Such complaint further alleges chat the formulae in effect at various times

since September 1, 1965 for the reduction of the management fee payable by Unired to W&R by

an amount equal to a portion (currently 5096) of the net incume of KCSC is intproper and illegal

ro the extent such arrangement permits W&R to benefit from the commissions or discounts paid

by United for the execution of its portfolio transactions; and that the annual approval by United's

shareholders of the terms of the investment advisory and management cootracts with W&R in ef-

fect since 1965 which provide for such formula was procured by proxy statements for the annual

meetings of such shareholders which were “false or fraudulent” in that they failed to disclose the

alleged acts and practices of che defendants and their intent to engage in such acts and practices.

In addition, the complaint in the Horenstein action (Action No. 1) alleges tbat the individual

defendants have been guilty of “other acts of mismanagement, malfeasance and noafeasance... —

as officers and/or directors of United.”

The complaint in the Ruskay action (Action No. 2), which was filed on January 23, 1969,

alleges matters substantially the same as those alleged in the Horenstein action and, in addition,

also alleges chat the defendants have caused excessive curnover of United's portfolio securities in

order to increase the benefir being derived from the commissions or discounts paid by United on

the purchase or sale of ius portfolio securities.

"The defendants have denied each and every allegation of wrongdoing on their part as

boch unwarranted and factually inaccurate; have disclaimed any liability therefor and have, in

addition, asserted affirmative defenses to the effect that the shareholders of United have ratified,

approved and shared in the benefit of the practices followed by W&R ia handling the execution

of United's portfolio wansacrions; that some or all of the claims are barred by laches and limia-

tions; and that the contentions advanced by the plaintiffs in these actions relating to the alleged

abuse by W&R of its control over the execution of United's portfolio transactions are repetitious

of substantially identical claims made in an earlier series of stockholder actions also brought pur-

porredly on behalf of United, including an action instiruted by the plaintiff in the Ruskey ac-

tion (Action No. 2), which claims were dismissed on their merits as part of a settlement ap-

proved, after a hearing on notice to all shareholders of United, by en order of the Supreme Court

of the Stare of New York, New York County, dated March 29, 1965. A

In October of 1968, plaintiffs in the Horenstein action (Action No. 1) instituted a separate

action in the Supreme Court of che State of New York, New York Country, alleging, io ef-

fect, that che formula arrangement by which KCSC is entitled to retain revenues directly or indi-

—

rectly derived from the execution of United's portfolio transactiuns in exchange for a pro-

portionate reduction in the management fees of WSR constituted a breach of the terms arranged

for the settlement of the previously mentioned series of earlier stockholder actions as well as a

violation of the 1965 order of that Court approving the settlement. The defendants assert that

such claims are based on a distorted interpretation of such settlement terms and that the acts

and practices of W&R found objectionable by plaintiffs have been authorized by the cerms of the

investment advisory and management agreemeass in effect becween W&R and United since 1965

pursuant to the requiremenss of the very settlement stipulation on which plaintiffs rely. Because

of the similarity of such issues with the previously described issues pleaded in the actions before

this Court, prosecution of such action has been stayed by an order of the Supreme Court, New

York County, dated May 12, 1969, pending the final determination of the actions pending in

this Court. The complaint of the piaintiffs in che Horenstein action before this Court has been

amended to include the allegations of their complaints before the Supreme Court of the State of

New York

By supplemental complaias filed by the Horenstein plaintiffs on Juoe 5, 1969 and by the

plaintiff in che Ruskay action on July 7, 1969, it is alleged that the defendants Waddell, Merri-

man and Rouch arranged co sell a majority of the voting shares of WSR held by chemselves and

members of their families ac a price of $S0 per shace; that such price was largely attributable to

the profics derived by W&R from the acts, transactions and practices complained of in their princi-

pal complaints; and that the proposed sale should be enjoined or the proceeds thercof sequeste-ed

for the benefit of United. The defendants involved ia such allegations have denied thar they are

accountable to United or its shareholders for the selling price of their W&R shares or that such

selling price was dependent on or affected by any of the improuprieties or wroogdoing alleged by

plaintiffs; and chat, after full disclosure on the matter, the shareholders of Uniced, oa June 3, 1969,

approved che reemployment of W&R as investment adviser and manager of United in the event

that coatrol of W&R should be acquired by the purchaser of their shares.

SUMMARY OF SETTLEMENT TERMS

- The Stipulation of Secctienient co be submitted for approval to the Court was arrived at :o

accomplish results deemed by both p!aiatiffs aod defendants to be in the bese interests of Unised

and, from the viewpoint of the defendaats, to avoid further expense, inconvenience and the dis

traction of burdensome and protracted litigation, as well as to put at rest all contentions or

controversies asserted or which might have been asserted on the basis of che marters and trans-

actions described or referred to in the various pleadings of the plaintiffs.

The Stipulation of Settlement provides, in substance, that the defendants will pay or cause

to be paid to United « total of $650,000 of which sum a total of $500,000 will be paid by KCSC

or W&R ia five annual installments each in the amounc of $100,000 commencing within thirty

(30) days of the effective date of the Stipulation of Secrlement. Thus, if the sectlement is approved

and the action instituted by the Horenstein plaintiffs in the Supreme Court of che State of New

York, New York County, is finally dismissed (which result is anticipated because of the sertle-

ment), Unired will receive the sum of $250,000 withia thirty (30) days of the effective date of

the settlement and additional installments of $100,000 within thirty (30) days of the next four

(4) anniversaries of the effective date of the settlement

«= San

384

The Settlement Stipulation further provides that the amount of each installment, to the

extent paid by KCSC, may be treated as a deduction in the computation of the net income of

KCSC for purposes of the formula under which the management fee of United is reduced by a

portion of the net income of KCSC as provided in the investment advisory and management

agreement now or hereafter in effect berween United and W&R. In che evenc the Stipulation of

Settlement is approved and becomes effective, United will execute and deliver a release which

will discharge all of the defendanss of and from any further liability with reference to any or all

of the matters or transactions described or referred co in che various pleadings by che plaintiffs.

ALLOWANCES OF EXPENSES AND ATTORNEYS’ FEES

If che Court approves the settlement and orders the entry of judgment dismissing these actions

in accordance therewith, petitions will be filed by che above-named attorneys for che plaintiffs in

both actions for allowances of fees and expenses which will noc exceed the amount of Two

Hundred Twenty-five Thousand Dollars ($225,000); and a date will be fixed by the Court, oo

notice to all who appear at the hearing herein noriced, for considering such petitions. Payment

of all such allowances will be made by Unired our of che benefits and proceeds to be obcained

by it as a result of the sertlemenc.

EXAMINATION OF PLEADINGS AND PAPERS IN THE ACTION

The foregoing references to the Stipulation of Settlement, the pleadings and other documents

in this action are only summaries thereof. The complere texts are on file with the Clerk of the

Uniced Scaces District Court for che Southern District of New York at che United States Court-

house, Foley Square, New York, N. Y. and available for inspection chere by any shareholder of

United in person or by attorney during regular business hours. Copies of the schedules and docu-

ments elicited and produced in the course of discovery proceedings will be available for inspection

at the offices of the counsel for che parties hereinabove described by any shareholder of United or

their attorney during regular business hours.

Dated: Kansas Ciry, Missouri

December 31, 1969

UNITED FUNDS, INC.

By Rodney O. McWhinney

Secretary

39a

APPENDIX F

Excepts From Horenstein-Ruskay Plaintiffs’

Memorandum in Support of Proposed Settlement

UNITED STATES DISTRICT COURT

SOUTHERN DISTRICT OF NEW YORK

FRED HORENSTEIN and JOSEPH SCIUTO,

Plaintiffs, Action No. l

-against-

67 Civ 4175

WADDELL & REED, INC., JOE JACK MERRIMAN,

CHAUNCEY L. WADDELL, CORNELIUS ROACH,

UNITED FUNDS, INC., AND KANSAS CITY

SECURITIES CORPORATION,

Defendants.

SOPHIE RUSKAY,

Plaintiff,

-against-

Action No. 2

JOE JACK MERRIMAN, CHAUNCEY L. WADDELL,

CORNELIUS ROACH, CAMERON K,. REED, 69 Civ 276

ROBERT W. WAGNER, WADDELL & REED, INC.,

KANSAS CITY SECURITIES CORPORATION and

UNITED FUNDS, INC.,

Defendants.

MEMORANDUM OF PLAINTIFFS IN ACTION

NO. 1 IN SUPPORT OF THE PROPOSED

SETTLEMENT,

Plaintiffs in action no. 1 submit this memorandum

in support of the proposed settlement. eeece

40a

Vi. THE CAUSE OF ACTION TO RESTRAIN THE SALE OF

W_& _R_SHARES _

On June 5, 1969, plaintiffs filed a supplemental

complaint, pursuant to the order of Judge Tyler dated

May 26, i969, to enjoin defendants from selling a

controlling interest in W&R, or, in the alternative,

to impress a trust upon the proceeds of said sale.

The action was brought to safeguard the recovery which

plaintiffs would receive upon a successful conclusion

of this litigation.

The cause of action rested upon the theory that

“se individual defendants Merriman and Waddell were

a20ut to sell a majority of the common stock of W & R

to Continental Investment Cerp.; that a substantial

portion of the valve of the W & R shares »being sold was

attributable to the gains of W&R from the illegal

rractices alleged ir the complaint; that this incre-

ment was an asset to 'inited; and that the shareholders

of W& 2, including defendants Merriman and Waddell,

intended to convert *his asset to their own use. It

was further alleged that in order to protect United

and its shareholders and to avoid irreparable harm if

“he selling shareho'ders were allowed to dispose of

a nD 5 0 el a

ae ee ne

4)a

their W & R stock and do as they pleased with the

proceeds, the sale either should be enjoined or

the proceeds impressed with a trust.

The issue raised by the suprlemental complaint

has become moot and is not a factor to be considered

by the Court in passing upon the proposed settlement.

In June, 1969, the sale was consummated and approved

by United shareholders who also approved continuation

of the Investment Management Contract. Moreover,

there is no longer any need to secure any recovery

since the proposed settlement makes adquate provision

for payment of the $650,000.

APPENDIX G

Opinion of the District Court Approving

the Horenstein-Ruskay Settlement

Number 315—119

6-10-70 New Court Decisions

Horenstein v. Waddell & Reed, Inc.

{192,678} Horenstein, et al. v. Waddell & Reed, Inc., et al.

United States District Court, Southern District of New York. No. 67 Civ 4175.

May 26, 1970. Memorandum opinion in full text.

Investment Advisers—Give-Upe—Reciprocal Arrangements—Churning—Settiement

of Action Approved.——The settlement of several derivative suits against the investment

adviser of « mutual fund is approved as fair and reasonable in light of the limited chance

of the shareholders’ success at a trial of the matter and in view of the lack of substance

of the objections to the proposed settlement. The evidence appears to be to the effect

that the adviser had discharged its obligation conscientiously and in accordance to the

98,973~

ee aaah Fe

contemporary rules of the securities exchanges. Liability for the alleged churning, give-

ups and reciprocal arrangements appears to be remote in this case.

See $22,721 and 22,725, “Exchange Act—Manipulation” division, Volume 2 and

1 56,365, “Investment Advisers Act” division, Volume 3.

Bass & Friend (Solomon H. Friend, of Counsel), New York, N. Y. for Plaintiffs

Fred Horenstein and Joseph Sciuto.

Joseph A. Ruskay, New York, N. Y. for Plaintiff Sophie Ruskay.

Valicenti, Leighton, Reid & Pine, New York, N. Y. for Defendants Joe Jack Merri-

man, Chauncey L. Waddell, Cornelius Roach, Robert W. Wagner, Waddell & Reed, Inc.

and Kansas City Securities Corporation. (Albert D. Jordan, of Counsel).

Kelley, Drye, Newhall, Maginnes

& Warren (Francis S. Bensel, of Counsel), New

York, N. Y., Attorneys for Defendant United Funds, Inc.

Lasker, District Judge: This is an appli-

cation, pursuant to Rule 23 of the Federal

Rules of Civil Procedure, for approval of

a proposed settlement of two derivative

actions, heretofore consolidated, brought

by the shareholders of United Funds, Inc.

(“United”)' against Waddell & Reed, Inc.,

United's investment advisor, manager and

underwriter (“W & R"), certain officers

and directors of W & R, and Kansas City

Securities Corporation (“KCSC”), a wholly

owned subsidiary of W & R. Notice of a

hearing on the merits of the settlement

was mailed to 518,000 shareholders of United

in accordance with the order of this court

dated December 24, 1969. Five objections

to the proposed settlement have been re-

ceived—two in letter form only. Pursuant

to the order of December 24, 1969, a hear-

ing was held on April 6, 1970, at which all

present were given an opportunity to be

heard and to object to the proposed seitle-

ment. Two of the objectants appeared in

person. I comment below both on the ob-

jections received by letter and those pre-

sented at the hearing.

[Violations Alleged]

The Horenstein action alleges violations

of the Investment Companies Act of 1940,

15 U.S. C. § 80a-1, et seq., the Investment

Advisors Act of 1940, 15 U. S. C. § 80b-1,

et seq. the Securities Exchange Act of

1934, U. S. C. § 78, et seq., and of defend-

ants fiduciary obligations under state law.

The plaintiffs in the Horenstein action to-

gether own about 20,000 shares of United.

An amended and a supplemental complaint

were filed on June 4, 1968, and June S, 1969,

respectively.

The Horenstein plaintiffs, in September

1968, filed a derivative action on behalf of

United in New York Supreme Court, New

York County, against the defendants here.

The state proceedings have been stayed

pending the determination of the case in

this court.

The Ruskay action charges matters sub-

stantially the same as those described in

the Horenstein complaint, but adds the al-

legation that the defendants have engaged

in “churning”—that is, causing an excessive

turnover of United's portfolio for the bene-

fit of W & R and KCSC.

The defendants have denied all material

allegations of the complaint and asserted

a variety of affirmative defenses.

(Charges)

The substance of plaintiffs’ charges is (1)

that the affairs of United and its board

of directors were controlled by W & R

and the individual defendants; (2) that W

& R exploited its power over the execution

of United's portfolio transactions by di-

recting the execution of such transactions

to its subsidiary KCSC, and other brokers

' United is managed open-end invetment com-

pany usually referred to as a mutual fund.

Federal Securities Law Reports

1 92,678

atte a trachea. Berta cee We em

ee ee

98,974

Number 315—120

New Court Decisions €10-70

Horenstein v. Waddell & Reed, Inc.

or dealers who shared their discounts on

such transactions through so-called “give-

ups” and reciprocal arrangements; (3) that

the practices followed have deprived United

of the best execution of its portfolio trans-

actions; (4) that such practices have re-

duced W & R's costs and unjustly increased

its management fees; and (5) that the form-

ulae in effect at various times since Sep-

tember 1, 1965 for the reduction of the

management fee payable by United to W

& R by an amount equal to a portion

(currently 50%) of KCSC’s net income is

illegal to the extent that it permits W & R

to benefit from the commissions or dis-

counts paid by United for the execution of

its portfolio transactions, and that the ap-

proval of such an arrangement by United's

shareholders was procured by false or

fraudulent proxy statements.

As affirmative defenses, the defendants

allege the approval of United's shareholders

of the practices complained of, and that the

contentions advanced by the plaintiffs in

these actions are substantially identical to

claims made in an earlier series of stock-

holder actions on behalf of United which

were dismissed on their merits as part of a

settlement approved, after hearing on notice

to United's shareholders, by order of the

Supreme Court of the State of New York,

New York County, March 29, 1965.’

During the period covered by this suit,

W & R has furnished management and in-

vestment advisory service to United under

the terms of an investment advisory agree-

ment with United which has been approved

annually by United’s shareholders. Since

September 1965, KCSC, a securities broker

which is wholly owned by W & R, has

handled the execution of United's portfolio

transactions. KCSC executes securities

transactions for other customers as well.

Commencing in September of 1965, the

agreement between United and W & R

authorized W & R to direct the execution

of United's transactions and to direct “give-

ups” on such transactions to KCSC and to

provide for a reduction of the management

fee paid by United to W & R by a sum

set in the current contract at 50% of the

net income of KCSC (after provision for

taxes) from all sources.

Substantial pre-trial discovery has been

made by the plaintiffs, including the taking

of depositions of defendants Waddell, Mer-

riman and Roach; Jay B. Dillingham and

W. Hardy Hendren, unaffiliated directors of

United; Don Williams, a Vice President of

United and Senior Vice President of W

& R in charge of its investment management

division; George A. Baker, a Vice President

of United and a Vice President of W & R

and manager of its trading department;

Murray Sweet, an Assistant Vice President

of W & R; and Sherman Jones, President

of KCSC since October 1968. In addition,

as is normal in these cases, plaintiffs’ coun-

sel and well qualified accountants, David

Berdon & Co., have inspected and reviewed

in detail relevant documents, including

dealer commission business reports, United's

proxies, prospectuses, reports to stock-

holders, board of directors’ minutes, and

reports to the SEC; W & R's SEC reports

and reports to stockholders; KCSC’s in-

come statements, and other material.

Terms of Settlement

The proposed settlement provides for the

payment by defendants to United of a total

of $650,000 in two parts. $150,000 will be

paid to United within thirty days of the

effective date of settlement without possi-

bility of any reduction or offsets whatso-

ever. The remaining $500,000 will be paid

in the following manner:

KCSC or W & R will pay to United the

additional sum of $500,000 by a payment

of $100,000 within thirty days of the effec-

tive date of the settlement and payment of

a like sum of $100,000 within thirty days

of the next succeeding four anniversaries of

the said effective date.

[Tax Treatment}

Since the setilement agreement provides

that the armount of each installment, to the

extent paid by KCSC, may be treated as a

deduction in the computation of the net

income of KCSC for purposes of the formula

under which the management fee of United

is reduced by a portion of the net income

(after taxes) of KCSC (as provided in the

investment advisory and management agree-

ment), the ultimate benefit to United of

the proposed $500,000 payment may he re-

duced—at present tax rates—by approxi-

mately $23,000 a year,*—that is, to a mini-

mum of $385,000, which, added to the $150,-

* Defendants also put forth the affirmative

defenses of laches and statute of limitations.

These defenses have not been presented or dis-

cussed in the papers submitted in support of

the proposed settlement.

f 92,678

* The figure of $23.085 Is set forth in the letter

of March 26, 1970 from Philip A. Loomis. Jr.,

General Counsel of the Securities and Exchange

Commission, to Judge Palmieri of this court

(Continued on next page.)

@ 1970, Commerce Clearing House, Inc.

44a

Number 315—121

6-10-70 New Court Decisions

98,975

Horenstein v. Waddell & Reed, Inc.

000 certain, would constitute a net recovery

of not less than $535,000.

* ¢* 6s

The propriety of the proposed settlement

should be measured by the likelihood or

unlikelihood of plaintiffs’ success in the

suit and by the quality of the objections

made to the settlement. Analysis of the

mate-ial before me indicates that the likeli-

hood of plaintiffs’ success is not great, and

that the objections are too weak and insub-

stantial to preclude approval of the settle-

ment. I treat first the likelihood of plain-

tiffs’ prevailing on the charges they have

brought.

1) Alleged domination of United by W &

R and its directors. The substantial discovery

on this point establishes that of the 13 di-

rectors on United's board only four were

affiliated with W & R. The other nine were

active in businesses unrelated to W & R,

and their actions as United directors were

clearly taken independently of the effect on

W & R, and in the best interest of United.

Nor has evidence’been produced that the

W & R affiliated directors used undue in-

fluence or violated their fiduciary duties as

directors of United. Under the circum-

stances, it appears that plaintiffs would fail

to prove the allegation of dominance of

United by W & R and its directors.

2) Best execution prices. Although the

plaintiffs charge that W & R deliberately

put transactions through KCSC on the

Pacific Coast Exchange (for KCSC’s bene-

fit), even though they could have been ar-

ranged on other markets at prices more

favorable to United, the evidence fails to

meet the allegation. The depositions of

Waddell, Merriman and Baker support the

proposition that W & R _ conscientiously

discharged its obligation to find the best

prices for United’s transactions. While it

is true that the especially large block of

500,000 shares of Monsanto was sold at 2%

points below market, discovery established

that there were sound business reasons for

making such a sacrifice in order to ease

United out of its heavy position in a stock

which for good reason was believed to be

seriously on a downward path.

3) Third and fourth market transactions.

Although plaintiffs charge that W & R

for its own reasons avoided utilization of

the third and fourth markets, causing United

to incur excess brokerage commissions, the

evidence establishes, to the contrary, that

the third market was used where appropri-

ate and that the use of the fourth market

was impractical in execution of United's

transactions.

4) “Giveups” and reciprocal brokerage.

Although the use of “giveups” (a practice

now terminated by Stock Exchange rules

but never yet declared illegal or disap-

proved by the Stock Exchange during the

period in which such “give ups” occurred)

and reciprocals constitute! normal practice

within the mutual fund industry over a

period of time, plaintiffs nevertheless allege

that they were improper in the instant

case. At the outset it is important to note

that no court decision (nor S. E. C. ruling)

has ever outlawed such practices. As

stated in Lessac v. Television-Electronics

Fund, Inc, CCH Fed. Sec. L. Rep. 9 92,305

(S. D. N. Y. 1968),

. with respect to the cause of ~

mee A oy allocations and ‘give ups’,

sed a that despie attacks by -!

Committees and the SEC there has not

y Ay ruling on the sub-

Ft - ap 4 s area of law is still un-

settled. For these reasons, it seems best

also that the plaintiffs in the second case

settle this cause of action.”

The practice of “give ups” arose because,

for example, until recently brokerage com-

missions on the New York Stock Exchange

were the same for ten 100-share orders as

for one 1000-share order, although it is ob-

vious that the cost to the broker of trans-

acting the single large order would be

notably less than in the execution of 10

smaller orders. In order to secure such

profitable business on large orders, the

broker is often willing to “give up” part of

his commission to another broker as di-

rected by the institutional broker. The

complainants here charge that W & R

directed “give ups” to brokers in return for

investment information, or to brokers who

sold United shares, or that W & R di-

rected “give ups” to KCSC in the form of

cash “give ups” for which no service was

ever rendered.

[Reciprocals]

Reciprocals evolve when a broker (here

W & R) places its client’s (United's) busi-

ness with another broker on the condition

that such other broker reciprocate to the

origimating broker (as charged here, to

- KCSC).

(Footnote 3 continued.)

relating to the proposed settlement. The letter

specified three possible alternative computa-

Federal Securities Law Reports

tions. I am satisfied from my study of the

case that the computation which results in the

figure of $23,085 is the correct alternative.

1 92,678

tnt Bn

oe es eT

98,976

Although these practices have been criti-

cized, they have, as stated above, never

been held illegal, and furthermore, under

the Stock Exchange rules, a broker is for-

bidden to rebate to its customer any portion

of its commissions. Consequently in or-

dinary circumstances the fund is prevented

from reducing its brokerage costs. In view

of the apparent permissibility of such prac-

tices (prior to the time they were discon-

tinued by Stock Exchange ruling), it is

highly doubtful whether this portion of

plaintiffs’ complaints could be sustained.

But there are other reasons why plaintiffs

would be unlikely to prevail here as to the

“give ups” and reciprocals:

a) By the terms of the W & R-United

agreement, a portion of the commisisons

(50%) generated by the United portfolio

brokerage transactions is credited towards

the payment of United's fee to W & R.

b) The settlement here is in an amount

substantially in excess of the value of the

“give ups” that have not been credited to

United's fee obligations.‘

c) Discovery in this case has demon-

strated that in all instances save one (cash

“give ups”) commissions earned by brokers

from the direction of “give ups” or recipro-

cal business required the receiving brokers

to perform services.

For these reasons it is clearly ynlikely

that the plaintiffs would succeed on this

branch of their suits. An additional reason

for approval of the proposed settlement in-

sofar as “give ups” are concerned is that

the settlement will assure United's recovery

of the remaining portion of net profits,

after provision for income taxes, attribu-

table to cash “give ups” received by KCSC

from its inception in 1965 to December 5,

1968, the date when “give ups” were abol-

ished by the Stock Exchange.

5) Alleged violation by IV & R of the stip-

ulation of settlement of the prior stockholder

suits. It is claimed that defendants’ practices

violate a judgment and order entered in the

New York Supreme Court, New York

County, March 29, 1965, in settlement of

several prior derivative actions which at-

tacked as excessive W & R's management

fees. The stipulation of settlement there

provided that W & R shou!d. neither seek

nor accept any increase in the “rat- of

compensation” over and above the rates

New Court Decisions

Horenstein v. Waddell & Reed, Inc.

Number 315—122

6-10-70

provided in a proposed investment manage-

ment agreement. Plaintiffs claim that the

receipt by W & R of net profits retained

by KCSC arising from United transactions

constituted an increase in W & R's rate of

compensation. There are substantial ob-

stacles to the plaintiffs’ succeeding in prov-

ing this cause of action:

a) The discovery clearly indicates that

KCSC was organized for the primary pur-

pose of recapturing for United shareholders

a portion of the brokerage commissions

attributable to Uvited’s transactions.

b) United’s shareholders ratified the

terms of settlement of the earlier litigation.

Thereafter, having been kept fully informed

of the organization of KCSC and of the

terms of the proposed W & R-United

agreement, United's shareholders approved

the first W & R-United agreement and an-

nually reapproved and ratified renewals

thereof. Such approval and reapprovals

were supported by an overwhelming ma-

jority of the shareholders, who voted in

person or by proxy. Furthermore, no evi-

dence or argument has been offered in the

material before me to establish that there

is any support for the allegation that such

stockholder approval was procured by false

proxy statements; indeed, there seems to

be no basis for that charge.

c) There are, at the least, serious ques-

tions as to whether W & R's receipt of a

portion of KCSC’s commissions constituted

an increase in W & R's “rate of compensa-

tion” within the meaning of the settlement

stipulation in the earlier litigation.

6) The “churning” charge. In spite of the

voluminous documents inspected and studied

both by counsel and accountants, and the

depositions taken, no evidence has been

forthcoming to support the charge of churn-

ing. Although proof of such a charge is at

best difficult, in view of the numerous

justifiable reasons for which sales and pur-

chases are made, nevertheless here the

proof is utterly deficient. The difficulty of

proving churning in any event is probably

the reason why, as stated in the Horen-

stein plaintiffs’ memorandum, “{c}ounsel

have been unable to find a single case sup-

porting the proposition that the turnover

rate of transactions in portfolio securities

of a mutual fund constitutes 2n actionable

wrong and gives rise to a cause of action.”

Certainly in theory the deliberate engage-

* Fifty percent (50%) of the ‘‘giveups” has

previously been ~ Ng wy to United from profits

realized by KCSC. The remaining 30% Is com-

puted to amount to approximately $283,780.27

£ 92,678

(see Memorandum of Plaintiffs in Action No. 1

in Suport of the Proposed Settlement, p. 14).

This computation has not been ~ntested

4G.

Number 315—123

6-10-70

New Court Decisions

98,977

Horenstein v. Waddell & Reed, Inc.

ment by an investment advisor in “churn-

ing,” which, almost by definition, would be

inimical to the interests of the managed

fund, may be actionable. But here the evi-

deace is lacking to support the charge.

[ Objections}

Having discussed the possibilities oi plain-

tiffs success in the instant case, I turn to

the five objections presented by letter or in

person at the hearing.

1) The objection of William W. George

(presented by letter only) is restricted to

requesting the court to “consider the con-

sequences of permitting a mutual fund

manager to enter a plea of laches for any

offense and not be concerned about the

details of the case before you.” In view of

the fact that the defense of laches has not

been presented by any of the parties as a

basis for the approval of settlement and

that the “details of the case” have been

considered in depth, the objection is dis-

missed as unmeritorious.

2) The letter objection of E. W. Kelley,

Custodian for Karen Kay Kelley (owner of

983.198 shares), includes no attack on the

merit of the settlement, but merely requests

that the writer be advised of the time and

place of the hearing on proposed attorneys’

fees. He will be so advised.

3) The letter objection of T. H. Willcox,

Jr., an attorney, on behalf of his minor

children’s fund in the name of their mother

as Custodian, states: “I kno.v nothing of

the merits of the cause, but would hazard

a guess that the claims are largely without

merit.” He clearly does not object to the

terms of the settlement, but does request

an opportunity to challenge the proposed

attorneys’ fees and will be granted that

right.

4) The objection of Heizer Wright, as

Trustee for Frances Wright, was made by

letter and in person at the hearing. Mr.

Wright sets forth several complaints:

a) That the notice of settlement hearing

does not indicate the amount sought in the

complaints and that is therefore impossible

to determine whether the settlement is a

fair one.

[Damages Unspecified]

It is true that the notice of settlement

did not (and it is not uncommon that notices

of settlement do not) set forth the amount

sought in the complaints. An examination

Federal Securities Law Reposts

of the complaints here indicates that with

one exception the damages sought were

unspecified and unliquidated—apparently

being unknown to plaintiffs. The one excep-

tion is the Second Verified Amended Com-

plaint in the Horenstein action (p. 29, { G),

praying damages “in the amount of $2,064,000,

plus such additional after August

31, 1967, which United has suffered.” While

even this complaint leaves unclear the pre-

cise amount sought by plaintiffs, it is evi-

dent that even the minimum amount pro-

posed of $535,000 (much less the possibic

maximum of $650,000) would constitute a

respectable settlement in relation to the

$2.064,000 figure named (considering plain-

tiffs’ difficulties in this case); and even were

the ultimate damage to be shown. for ex-

ample, double the $2,064,000 specified, I

find that the settlement would be

fair and reasonable.

b) That W & R and KCSC are not pro-

hibited by the settlement from further deal-

ings with United.

Here it suffices to say that the W & R-

United agreement runs for only a year at

a time and must be and has been regularly

ratified: and approved by the shareholders

of United, who are free to discontinue it

at the end of any annual period. It seems

evident that by their constant approval and

reapproval of the agreement in the past,

the United shareholders have found it bene-

ficial to them; but in any event, since they

are free to discontinue it in relatively short

order, there is no need to include in the

settlement agreement the prohibition sug-

gested by the objectant, nor indeed has

anyone except this objectant suggested that

the W & R-United agreement should be

discontinued.

c) That “the matters set forth in the

Notice of Settlement Hearing suggest crim-

inal liability as well as civil liability” and

that “there should be notice to, and in-

vestigation by, the Securities Exchange

Commission.”

The short answer to these contentions is

that matters of criminal liability are the

responsibility of the Executive branch of

the government and that the S.E.C. has

beer fully informed of the terms of the

proposed settlement (having had before it,

on the orders of this court, all the material

submitted to the court) and has presented

no objection to the settlement.

d) That the notice of settlement hearing

is insufficient because sent by “junk mail.”

1 92,673

47a

98,978

[Notice Mailed]

In answer to this contention, it is suf-

ficient to state that the notice of hearing

was mailed in accordance with the approval

and order of this court.

5) The final and most serious objection

is raised by Joan B. Sanger, holder of 4,255.341

shares of United Accumulative Fund.* The

burden of the Sanger objection (which was

brought to the attention of the office of the

General Counsel of the Securities and Ex-

change Commission by a letter from the

objectant’s attorney under date of April

16, 1970) is that the notice of settlement

hearing was deficient in that under the

title “Summary of Settlement Terms” the

possible reduction of the settlement sum

(from $650,000 to $535,000) is indicated by

formula only, and not in specific figures.

Though there can be no argument that a

statement in the notice of the minimum

amount recoverable in dollar figures would

have been preferable to the formula de-

scription, nevertheless this does not render

the notice fatally inadequate because (i)

the notice as phrased is clear warning that

the amount recoverable might be reduced

in accordance with the formula; (ii) the

formula was understandable to stockholders

who hrd in the past (a) litigated the W & R-

KCSC-United arrangement and (b) from 1965

through 1969 overwhelmingly approved the

terms of the W & R-KSCS-United agree-

ment which had been set forth in voluminous

detail in each year’s proxy material. The

court is satisfied that, in the context of

the history of this and the prior litigation,

and particularly in view of the annual re-

view of the W & R-United agreement in

precise terms, the notice of settlement hear-

ing adequately advised the shareholders of

United of the method of determining the

effect of the possible reduction and of the

possibility that the ultimate amount received

New Court Decisions

Horenstein v. Waddell & Reed, Inc.

Number 315—124

6-10-70

by United could well be reduced below

$630,000. Perhaps the best evidence of the

adequacy of the notice is the fact that Joan

Sanger herself, on receipt of the notice,

objected to the possibility of reduction

which she clearly noted as set forth in the

terms of settlement.*

[Settlement Approved]

On the basis of the analysis above, the

court is satisfied that, because of the lim-

ited chances of plaintiffs’ success in this

litigation and the lack of merit of the ob-

jections, the proposed settlement is fair and

equitable and should be approved. Beyond

these arguments, it is to be noted that on

a motion to review a proposed settlement

agreement “the role of the Court is limited

to the extent that its business judgment is

not to be substituted for that of the parties

who worked out the settlement, and... the

only question before us is whether the

settlement, taken as a whole, is so unfair

on its face as to preclude judicial approval.”

Gitcken v. Bradford, 35 F.R.D. 144, 151

(S.D. N.Y. 1964, opinion of Chief Judge

Ryan). As recently stated by Judge Wyatt

in Josephson v. Campbell, CCH Fed. Sec. L.

Rep. {92,347 at p. 97,658 (S. D. N .Y., Jan

24, 1969):

“There is a strong initial presumption

that the compromise is fair and reason-

able. This rests on a number of factors.

Counsel for plaintiffs is able and and

experienced, particularly in the specific

area with which these actions are con-

cerned. His judgment is entitled to great

weight...”

Upon al! the facts and circumstances

presented, I find the proposed settlement

agreement to be fair and reasonable and in

the best interests of all concerned, and it

is therefore appro ed.

Settle judgment and order on notice.

*United is constituted of several different

separate funds, each with different investor

See, of which United Accumuiative Fund

Ss one.

*It should be noted that it is not certain

that a reduction will in fact occur. The ac-

tuality of a reduction will depend on the ex-

istence of all three of the following contin-

gencles:

(1) That the W & R-United agreement is

still In effect at the time of the porticular pay-

ment from which a reduction might be made:

(2) That payment is made by KCSC rather

than by W & R:

(3) That payment is treated as a deduction

in the computstion of KCSC’s taxable income.

It Is to be further noted that, in accordance

with the tnstructions of the court, coples of

all papers before me on this motion were for-

1 92,678

warded to the Securities and Exchange Com

mission. In its letter of March 26, 1970 to

Judge Palmieri (see Footnote 3 above) the

Commission did not raise objections to the

proposed settlement. though it did observe that

the effect of the settlement might be to reduce

the maximum payment of $650,000 by $23.08

a year, as indicated in Footnote 3. By letter

of April 21, 1970, after examination of the

papers on this motion, the General Counsel of

the S. E. C. wrote as follows:

“Dear Judge Lasker:

“This refers to the letter of your clerk, A.

Howard Matz, of April 15. requesting our

views about the adequacy of the notice of the

settlement in the above entitled actions. After

reviewing the material we have no further

comments on the notice of settlement.’

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.