# Petition — Burks v. Lasker > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385005_1107%3A01 ## Record - **Collection:** Supreme Court brief - **Document type:** Petition - **Published:** January 1, 1979 - **Citation:** 441 U.S. 471 ## Text —_— K 7: od “WAEL PODAK, rR. CLER IN THE Supreme Court of the United States October Term, 1977 HARRY G. BURKS, Jr., erai., Petitioners, Vv. HOWARD M. LASKER, et ano., Respondents. PETITION FOR WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT DANIEL A. POLLACK MARTIN I. KAMINSKY 61 Broadway New York, New York 10006 Counsel for Petitioners Burr, Chalker, Haire, Hutchison and Anchor Corporation LEONARD JOSEPH JOHN M. FRIEDMAN, Jr. 140 Broadway New York, New York 10005 Counsel for Petitioners Burks, 'Topkins, Kemmerer, Monroney, Phillips and Wade EUGENE P. SOUTHER ANTHONY R. MANSFIELD 63 Wall Street New York, New York 10005 Counsel for Petitioner Fundamental Investors, Inc. June 2, 1978 INDEX PAGE i Lhe Ce aN ha onde ckeesn 08 2 ee ae De ce ech esnedan eeen 2 EE cnc adouasns ee eendeesacwes 2 ae ee ec aecbabedans : 3 i dg cnc osetnesdeccevece 3 Reasons for Granting the Writ .................. 8 eM ee ee cv bede'ce cows 22 Citations CASES: Corbus v. Alaska Treadwell Gold Mining Co., ST eee re ae 11, 12 Cort Vv. Ash, 422 U.S. 78 (1975) .............. 13,14 Fogel v. Chestnutt, 553 F.2d 731 (2d Cir.), cert. denied, 429 US. o 4 ee a hee 17 In re Kauffman Mutual Fund Actions, 475 F.2d 257 (ist Cir.), cert. denied, 414 U.S. 857 te ar ee a ae 15, 16, 17 Santa Fe Industries, inc. v. Green, 430 U.S. 462 CS. ea es ee | 13,14 Tannenbaum v. Zeller, 552 F.2d 402 (2d Cir. EE Sa SE ap ee Se a Ae ee a 17 United Copper Securities Co. v. Amalgamated Copper Co., 244 U.S. 261 (1917) ............ 11,12 STATUTES: Investment Company Act of 1940, §§ 36(a), 36(b), 1S U.S.C. §$§ 80a-35(a), 35(b) (1970) 3, 17, 18, 19, 20, 21 Delaware General Corporation Law, 8 Del. Code S§ 141(a), 141(b) (1974) ...............3,13,14 Federal Rules of Civil Procedure. Rule 23.1 .... 15 a te —— ee a a a IN THE Supreme Court of the United States October Term, 1977 No. 78- Harry G. Burks, Jr., er. al., Petitioners, HowarD M. LASKER, ef ano., Respondents. PETITION FOR WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT Petitioners, Harry G. Burks, Jr.. Edward B. Burr, Thomas F. Chalker, John R. Haire, Harvey C. Hopkins,* S. P. Hutchison, Donald L. Kemmerer, A. S. Mike Mon- roney, Charles F. Phillips, Jeptha H. Wade, Anchor Cor- poration and Fundamental Investors, Inc., respectfully pray that a writ of certiorari issue to review the judgment of the United States Court of Appeals for the Second Circuit entered in this proceeding on January 11, 1978. * Deceased. Opinions Below The opinions of the District Court (Hon. Henry F. Werker) are reported at 404 F. Supp. 1172 (S.D.N.Y. 1975) and at 426 F. Supp. 855 (S.D.N.Y. 1977). The Dis- trict Court also filed an unreported opinion and order denying a motion for reargument on January 7, 1976. The opinion of the Court of Appeals is reported at 567 F.2d 1208 (2d Cir. 1978). All four opinions below are repro- duced in the appendix to this petition. Jurisdiction The judgment of the Court of Appeals was entered on January 11, 1978, and a timely petition for rehearing was denied on March 9, 1978. This Court’s jurisdiction is in- voked under 28 U.S.C. § 1254(1). Question Presented Plaintiffs*, two out of 90,000 shareholders of a mutual fund, seek to maintain a derivative action, purportedly on behalf of the fund, against the investment adviser and various directors of the fund for an investment loss sus- tained by the fund. The disinterested directors of the fund, who are not defendants in the lawsuit, exercising their business judgment and acting with the advice of independent special counsel, concluded that maintenance of the derivative action was contrary to the best interests of the fund and its shareholders, and instructed the fund’s litigation counsel to move to dismiss the derivative action. The District Court held, in its first opinion, that the disinterested directors had the power, as a matter of busi- ness judgment, to determine on behalf of the fund, not to prosecute the possible claim. After permitting extensive * In this petition respondents are referred to as “plaintiffs” ~ as “plaintiffs” and petitioners as “defendants.” PI 3 discovery on the issue of the independence of the dis- interested directors, the District Court held, in its second opinion, that the disinterested directors were truly inde- pendent and had acted in good faith in making this deter- mination. Accordingly, the District Court granted the motion to dismiss. The Court of Appeals, while agreeing that the disinterested directors had acted in good faith, held that the Investment Company Act of 1940 impliedly precluded the disinterested directors from exercising their business judgment to forego prosecution of the possible claim against the investment adviser and the other di- rectors. On this basis, the Court of Appeals reversed and remanded the case. Question: Are the independent and statutorily disin- terested directors of a mutual fund incapacitated, as a matter of law, from exercising their business judgment to determine whether the maintenance of a stockholder’s deri- vative action against the investment adviser and various directors of the fund for an investment loss is in the best interests of the fund and its shareholders: i.e., does the Investment Company Act of 1940 require that a stock- holder’s derivative action be permitted to proceed, in any and all events, even though the independent and statu- torily disinterested directors have concluded, in the good faith exercise of their business judgment, that mainte- nance of the derivative action is contrary to the best interests of the fund and its shareholders? Statutes Involved The statutes involved in this case are the Investment Company Act of 1940, 15 U.S.C. §§ 80a-35(a), 35(b), (1970) and the Delaware General Corporation Law, 8 Del. Code §§ 141(a), 141(b) (1974). Statement of the Case This case arises out of the purchase in 1969 by Funda- mental Investors, Inc. (“Fundamental”), a mutual fund, 4 of $20 million of the commercial paper of Penn Central Transportation Company (“Penn Central”) from Gold- man, Sachs & Co., a leading commercial paper dealer. At the time of the purchase, Penn Central commercial paper was rated “prime” (the highest rating) by the Na- tional Credit Office, a subsidiary of Dun & Bradstreet, Inc., the most widely utilized commercial paper rating agency in the country. Fundamental had a portfolio composed largely of equity securities and worth approximately $1 billion. The Penn Central commercial paper was pur- chased by Fundamental as a short-term investment of un- employed cash, i.e., a temporary utilization of funds until they were needed for purchases of equity securities in the stock market. Commercial paper of major national cor- porations has traditionally been considered by the finan- cial community to be a cash equivalent. On June 21, 1970, Penn Central, the sixth largest corporation in the country, filed a Petition for Reorganiza- tion, and the notes purchased by Fundamental (and many other financial institutions, universities, charitable organiza- tions, etc.) were not paid at maturity. On November 4, 1970, Fundamental initiated an ac- tion, with three other plaintiffs, against Goldman, Sachs & Co. (“the Welch action”) under the federal securities laws for rescission of their purchases of the notes. The Com- plaint charged that Goldman, Sachs & Co., the exclusive dealer in Penn Central commercial paper, had withheld material, adverse non-public information on the financial condition of Penn Central. On February 5, 1973, more than three years after the purchase by Fundamental, two stockholders of Fundamen- tal commenced the instant derivative action (“the Lasker action”) purportedly on behalf of Fundamental. The Complaint charged Anchor Corporation (the investment adviser to Fundamenial) and all of the directors of Funda- 5 mental at the time of the purchase (i.e. 1969), with viola- tions of statutory and common law duties in making and retaining the investment for Fundamental in Penn Central commercial paper. On July 30, 1973, on motion of all defendants, and prior to joinder of issue, then District Judge Murray I. Gurfein stayed the Lasker action pending the resolution of the claims of Fundamental against Goldman, Sachs & Co. in the Welch action. On July 9, 1974, Fundamental settled the Welch action as follows: Goldman, Sachs & Co. took back the notes, paid Fundamental $5.25 million in cash and assigned to Fundamental a 73.75 per cent interest in the proceeds of the $20 million of notes in the Penn Central reorganiza- tion proceedings. On July 24, 1974, at their next regular meeting, the Board of Directors of Fundamental reviewed the status of the Lasker action, and determined that the five directors who (a) were not affiliated in any way with the investment adviser (Anchor), and (b) were not directors at the time of the events complained of in the Lasker action, and (c) were not defendants in the Lasker action, would, acting as a quorum pursuant to the by-laws and Delaware law, con- stitute the Board of Directors to decide what position Fun- damental should take regarding the Lasker action.* The * Plaintiffs argued below that the five disinterested directors could not be inde »endent because they had been nominated for their posi- tions on the Board by defendants in the Lasker action. The District Court, after reviewing the extensive discovery on the issue of inde- pendence, held that there was no evidence whatsoever that any of the five disinterested directors was influenced in any way by any defendant in the Lasker action. See 426 F.Supp. at 846. The testi- mony clearly shows that no defendant ever mentioned the Lasker action to any one of the five directors prior to, at the time of, or in connection with, his or her nomination to the Board. Indeed, the first time that any of the five disinterested directors focused, at all, on the Lasker action was at the July 24, 1974 meeting when they were designated a quorum to decide what position should be taken by Fundamental—this meeting occurred several years after most of them became directors, Each of the five disinterested directors was a person of high repute and achievement in business or government, and each was selected by the Directors Qualification Committee which, at all times, consisted of a majority of disinterested directors. - . an EA ceca ccc aaa Laas ccc 6 six other directors, i.e. the four who were affiliated with Anchor and the two who were not affiliated with Anchor but who were named as defendants in the Lasker action, determined to take no part in the decision. To assist them in their deliberations, the disinter- ested directors retained independent special counsel, Hon. Stanley H. Fuld, former Chief Judge of the State of New York. Judge Fuld had no previous connection with any of the parties. On December 5, 1974, after several months of investi- gation, Judge Fuld reported the results of his analysis in a comprehensive legal and factual memovandum, and advised: . “As a result of my analysis of the facts and the law, it is my Opinion that there was no violation by Anchor or by the Fund directors of any provisions of statute or of any common law or contractual obligation to the fund, in connection withthe acqui- sition and retention of the Penn Central commercial ” paper. ¢ Judge Fuld also identified and analyzed the alternative courses of action available to the directors, and concluded his memorandum as follows: “It is for the Board of Directors of the Fund to determine, in the exercise of its discretion and busi- ness judgment, which alternative to adopt.” After receiving Judge Fuld’s December 5, 1974 memo- randum, the disinterested directors carefully reviewed it and raised several questions regarding the subjects covered in the memorandum and the alternatives available to them. In response to these questions raised by the disinter- ested directors, on December 18, 1974, Judge Fuld deliv- ered a brief supplemental memorandum in which he advised, among other things, that whether or not a corporation seeks to enforce in the courts a cause of action for damages is, like other business questions, a matter of internal management, and is left to the discretion of the directors. On December 18, 1974, the disinterested directors held a special meeting devoted exclusively to this subject. At the meeting they discussed the entire matter with Judge Fuld at length, and questioned management about the details of the underlying transaction. After several hours of discus- sion, they adjourned the meeting and decided to give the matter further thought before reaching a decision. On January 6, 1975, having conferred further with Judge Fuld in the interim, the disinterested directors held another special meeting of the Board. After several hours of review and deliberation, they voted unanimously to instruct the fund’s litigation counsel to move to dismiss the Lasker action as contrary to the best interests of Fundamental. Their reasoning is set forth at length in the record and is quoted in the first opinion of the District Court.* (404 F. Supp. at 1176-77). The District Court, in its first opinion, endorsed the basic theory of the motion to dismiss (i.e. that the disinter- ested directors had the power, in the exercise of their business judgment, to determine that the corporate claim asserted in the derivative action should not be prosecuted), but denied the motion with leave to renew following dis- covery on the sole issue of the independence of the * Among the factors considered by the directors were the follow- ing: (a) Judge Fuld’s opinion that Anchor had not violated any law or contractual obligation, (b) the directors’ own determination that Anchor had acted in good faith in recommending the Penn Central investment, (c) the potential business disruption to Fundamental and its investment adviser if the action were to proceed, (d) the fact that numerous other respected institutional investors (including banks, hospitals, universities etc.) had made the same investment at the same time. 8 disinterested directors. The District Court wrote (404 F. Supp. at 1180): “If the minority directors were truly disinter- ested and independent the Court will not substitute its judgment for that of the Board.” At the conclusion of extensive discovery proceedings Fundamental renewed its motion to dismiss. The District Court granted the renewed motion and wrote (426 F. Supp. at 849): “Plaintiffs have not adduced any factual support for their conclusion that the members of the disin- terested quorum acted other than independently.” [emphasis supplied]. On January 11, 1978, in an opinion devoid of support- ing legal authority and contrary to all relevant precedents, the Court of Appeals reversed and remanded, concluding that, as a matter of law, the Investment Company Act of 1940 impliedly deprived the independent and statutorily disinterested directors of the fund of their power to deter- mine not to assert a possible corporate claim against the investment adviser and other fund directors for an invest- ment loss sustained by the fund. A timely petition for rehearing in banc was denied on March 9, 1978. Reasons for Granting the Writ The decision of the Court of Appeals—holding that, as a matter of law, disinterested directors of a mutual fund, acting in good faith and with the advice of independent counsel, lack the power to exercise their business judgment to terminate a stockholder’s derivative action against the invest nent adviser and various directors of the fund, main- tenance of which the disinterested directors have concluded to be contrary to the best interests of the fund and its share- 9 holders—raises an important question involving the extent, if any, to which the Investment Company Act of 1940 dis- places settled state law concerning corporate governance. This question has not been, but should be, settled by this Court.* The decision of the Court of Appeals for the Second Circuit is in conflict with principles enunciated by this Court, is in conflict with applicable precedent in the Court of Appeals for the First Circuit (as well as its own prior precedents), and raises issues of substantial public importance. The decision of the Court of Appeals, if allowed to stand, will undermine basic principles of corporate gov- ernance in the mutual fund industry.** Under this decision, mutual funds can be held hostage, ir compulsory litiga- tion, to the whims of a single stockholder. Such persons will be empowered to compel large public mutual funds, like Fundamental, to assert claims in litigation which dis- interested directors, who are the legally elected representa- * The importance of the case was expressly recognized by the Court of Appeals in the opening sentence of its opinion: “This appeal by two mutual fund shareholders raises an important question of first impression...” [emphasis supplied]. (567 F.2d at 1208). The importance of the case to the entire mutual fund industry, and to the ratione! utilization of the federal court system, is indicated by the amicus briefs filed in this case by Investors Diversified Services, Inc., the ~~ mutual fund complex in the country, and by the Investment pany Institute, the national association of mutual funds, investment advisers and underwriters. ** Although the Court of Appeals purported to confine its decision to the mutual fund industry, the central basis for its decision was a legal presumption that the independent directors could not pass fairly on plaintiffs’ proposed corporate claims against the investment adviser and their fellow directors. See fn.*, p. 15 below and 567 F.2d at 1212. However, this presumption cannot readily be confined to mutual fund corporations—the pessimistic view of human nature which underlies the presumption applies, if at all, to all directors of all corporations, not just to directors of mutual fund corporations. Thus, if the opinion below is permitted to stand, it may well have a serious impact on corporate governance beyond the mutual fund industry. 10 tives of all stockholders, have determined to be contrary to the best interests of those mutual funds and their many shareholders. The potentially harmful effects of the decision on mu- tual funds, their investment advisers and the federal courts are manifest. Invariably, some investments made by mu- tual funds will result in losses and others in profits. If the investment adviser and directors of mutual funds can be called to account in stockholder’s derivative actions on every investment that results in a loss, without the disinter- ested directors being able to deflect such suits, where ap- propriate, in the exercise of their good faith business judgment, there would be unlimited potential for litigation which could cripple the mutual fund industry. Every in- vestment decision (i.e. to buy, sell or hold) would become a potential subject for time consuming and expensive litiga- tion in the federal courts; management of mutual funds would become an impossibly hazardous business, and the federal courts would be thrust into the role of arbiters of the propriety of every unsuccessful investment decision. Thus, the effects of the decision below are extraordinarily severe, since each fund makes literally thousands of invest- ment decisions each year. In short, this case raises the fundamental question of whether the legally elected representatives of all stockhold- ers, or a single stockholder, who may well not have the broader interests of all stockholders in mind, will have the right to determine whether or not the mutual fund should assert a possible claim in litigation. sv oe MD om ll The decision of the Court of Appeals in this case is in conflict with principles enunciated by this Court. In a line of cases going back 75 years, this Court has held that the decision whether or not to prosecute litigation on behalf of a corporation rests solely with the board of directors. Absent fraud, corruption, or similar invalidating factors, the board’s exercise of business judgment is final and a stockholder’s derivative action does not lie. See, e.g., Corbus v. Alaska Treadwell Gold Mining Co., 187 U.S. 455 (1903); United Copper Securities Co. v. Amalgamated Copper Co., 244 U.S. 261 (1917). In Corbus, supra, this Court set forth the business judgment rule in the context of a litigation decision as follows: “The directors represent all the stockholders and are presumed to act honestly and according to their best judgment for the interests of all. Their judgment as to any matter lawfully confided to their discretion may not lightly be challenged by any stockholder or at his instance submitted for review to a court of equity. The directors may sometimes properly waive a legal right vested in the corporation in the belief that its best interests will be promoted by not insisting on such right. They may regard the expense of enforcing the right or the furtherance of the general business of the corporation in determin- ing whether to waive or insist upon the right. And a court of equity may not be called upon at the appeal of any single stockholder to compel the di- rectors of the corporation to enforce every right which it may possess, irrespective of other consider- ations. It is not a trifling thing for a stockholder to attempt to coerce the directors of a corporation 12 to an act which their judgment does not approve, or to substitute his judgment for theirs.” 187 U.S. at 463. This doctrine was subsequently reaffirmed by this Court in United Copper, supra. In that case, the plaintiff stockholder claimed that his corporation had been dam- aged by the defendants’ acuons in violation of the anti- trust laws. The board considered suing the defendants and refused to do so. This Court ruled that the stockholder could not then maintain a derivative action on behalf of the corporation. Justice Brandeis wrote: “Whether or not a corporation shall seek to enforce in the courts a cause of action for damages is, like other business questions, ordinarily a matter of internal management, and is left to the discretion of the directors, in the absence of instruction by vote of the stockholders. 244 U.S. at 263. The Court of Appeals in the case at bar legislated an exception to the business judgment rule inconsistent with the cases cited above and inconsistent with the structure of the Investment Company Act of 1940—the statute relied on by the Court of Appeals. If there is to be an exception to this rule, for mutual funds, that exception should be legislated by Congress and not by the courts. Neither the provisions of the Investment Company Act of 1940 nor the legislative history suggests that Congress ever intended any such exception. * * Indeed, the legislative history, which was not cited by the Court of Appeals, contradicts the result reached by the Court of Appeals in this case. See Point IV below. eee at ee ee ee wo ie 13 The decision of the Court of Appeals in this case is in conflict with applicable and controlling state law of cor- porate governance and the pronouncements of this Court on the deference to be given state law in such matters. This Court has specifically held that in the absence of any express federal statutory provision to the contrary, state law governs the powers of directors. Thus, in Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 479 (1977), this Court last year wrote: “Corporations are creatures of state law, and investors commit their funds to corporate directors on the understanding that, except where federal law expressly requires certain responsibilities of directors with respect to stockholders, state law will govern the internal affairs of the corporation.” [quoting from Cort v. Ash, 422 U.S. 78, 84 (1975)] {emphasis in original]. Fundamental, the mutual fund involved in this case, is a Delaware corporation.* Delaware General Corpora- tion Law, Section 141(a), empowers the board of directors of a corporation to manage the affairs of the corporation. No distinction is made under that law for mutual fund corporations. Management of the affairs of a corporation has long been held to include the power to decide whether or not to pursue a possible claim of the corporation in litigation. The District Court so held at bar, and the Court of Appeals did not take issue with this principle. The Court of Appeals, however, erroneously differen- tiated between mutual fund directors and directors of * Congress, when it enacted the Investment Company Act of 1940, left the organization of mutual funds to state law. Mutual funds are creatures of state law, not (like national banks, for example ) creatures of federal law. 14 other types of business corporations with respect to their business judgment power to maintain or not maintain litigation on behalf of the corporation.* In so doing, the Court of Appeals engrafted onto the Investment Company Act of 1940 new limitations on the powers of mutual fund directors not placed there by Congress and in conflict with the plan of corporate governance intended by the law of Delaware. The Court of Appeals did not and could not cite any provision of federal law which expressly overrides or abrogates the power of the directors under state law. The fact is that there is no such provision in the Investment Company Act of 1940 or in any other federal statute. Thus, the decision of the Court of Appeals is in conflict with the principles clearly enunciated by this Court in Santa Fe and Cort, supra. The Court of Appeals simply created a rule of federal law where none exists. In this case, the Delaware law must be given effect since there is no federal law expressly (or, as shown in Point IV, im- pliedly) overriding Delaware law. The decision of the Court of Appeals for the Second Circuit in this case is in conflict with the decision of the Court of Appeals for the First Circuit in Jn re Kauffman Mutual Fund Actions, 479 F.2d 257 (1st Cir.). cert. denied, 414 U.S. 857 (1973). The Court of Appeals in this case singled out mutual fund directors and, without warrant, distinguished them * The Court of Appeals also erroneously stressed the fact that the decision at bar was reached by a “minority” of the board, disre- garding the fact that the “minority” of five disinterested directors indisputably constituted a lawful quorum under Delaware General Corporation Law Section 141(b) and under Fundamental’s certificate of incorporation. 15 from directors of all other types of corporations. Thus, the Court of Appeals wrote (567 F.2d at 1212 n.14): “We base our decision on the unique nature of the investment company and its symbiotic relation- ship with its investment adviser; we need not reach questions of the exercise of a similar power by directors of other types of corporations.”* The notion that mutual fund directors—especially the disinterested directors—are under a special disability vis-a- vis directors of other types of corporations in exercising business judgment concerning the maintenance of litiga- tion, has been firmly rejected by the Court of Appeals for the First Circuit in the leading case of Jn re Kauffman Mutual Fund Actions, 479 F. 2d 257 (lst Cir.) , cert. denied, 414 U.S. 857 (1973), a case not even cited by the Court of Appeals below.** The Court of Appeals for the First Cir- cuit there wrote (479 F.2d at 266-267): “ _. the underlying business judgment may be suf- ficiently unsound to call for correction. But it does not follow that it is to be conclusively presumed in such a case that an unaffiliated, or disinterested director, if demand were made upon him, would be * As noted above at p. 9, this attempt by the Court of Appeals to limit the scope of its ruling is illusory. The central basis for the decision of the Court of Appeals was the | presumption that, be- cause the independent directors had to work and interact with their fellow directors, “[i]t is asking too much of human nature to expect that the disinterested directors will view with the necessary objectivity the actions of their colleagues in a situation where an adverse deci- sion would be likely to result in considerable expense and liability for the individuals concerned.” 567 F.2d at 1212. How the “unique nature” of the mutual fund industry supports application of such a presumption is not explained, nor can it be. In any event, applica- tion of such a presumption in the context of mutual funds conflicts with settled law in another circuit, as shown in Point III. ** The result reached by the Court of Appeals at bar also renders meaningless Rule 23.1 Fed. R. Civ. P. Why have a rule requiring demand on directors if the directors have no power to act? 16 unable to exercise an independent judgment in con- sidering what new course to take.” [footnote and citation omitted]. “Nor do we think that an exception is to be made in the case of unaffiliated directors of a mu- tual fund on the ground that since they are expected to be sensitive to misconduct of this variety they are automatically incapacitated from performing their duties—their approval or acquiescence making them ‘wrongdoers’—once a stockholder alleges a corporate injury stemming from the adviser-fund relationship. Apart from the fact that this, again, would enable a plaintiff to try his case on the merits in order to determine whether he had a right to bring it, it would be a misconception of the nature of unaffiliated directors. Normally self-dealing by any corporate directors is suspect. Congress rec- ognized, however, that a certain type of self-dealing is endemic in a mutual fund, and must be permitted. In order to make sure that the directorate not be top-heavy, it [Congress] provided for a minimum number of directors who would not be so interested. We do not believe it should follow from this that, as directors required to be disinterested in a par- ticular transaction, they differ in their fiduciary obligations from a disinterested director in any other corporate venture. All disinterested directors must ‘act honestly and according to their best judg- ment for the interests of all.’ [citation omitted]. When corporate action, or inaction, is subsequently challenged, their duty is not extinguished, but rather, refocused. After a demand provides them with ‘full knowledge of the basis for the claim, [citation omitted], it is for the directors, who have ‘the advantage of familiarity with the enterprise, with those who have conducted it and with the rec- ord of success or failure’ [i.e., the disinterested 17 = directors] to decide on the appropriate corporate response. {citation omitted]. To the extent that they are ‘watchdogs’ they should be given the oppor- tunity, not deprived of it.” (emphasis supplied). At bar, under the per se rule of disqualification adopted by the Court of Appeals, the disinterested directors were improperly deprived of their opportunity to serve as “watchdogs” of the fund’s best interests because they were presumed to be legally incapable of deciding on the appro- priate corporate response. IV. The reasoning of the Court of Appeals, insofar as it purports to find a basis for its holding in the Investment Company Act of 1940, does not withstand analysis.* This action is brought under Section 36(a) of the In- vestment Company Act of 1940. The Court of Appeals * The decision below also conflicts with two earlier decisions by the Court of Appeals for the Second Circuit under the Investment y Act of 1940: Fogel v. Chestnutt, 533 F.2d 731 (2d Cir. 1975), cert. denied, 429 U.S. 824 and Tannenbaum vy. Zeller, 552 F.2d 402 (2d Cir. 1977). In Fogel supra, Judge Friendly wrote (553 F.2d at 749-50): had mandated ieentens directors in order ‘to supply an independent check on management and to provide a means for the ntation of shareholder interests in invest- ment company * [citation omitted). The minimum re- quirement to cette | the Fund's independent directors to dis- charge these duties with respect to recapture was a careful investigation of the possibilities performed with an eye eager ? discern them rather than shut against them, and, if these bilities were found to be real, a —s of their legal difficul- ties and their economic pros and cons. It would have been still better to have the investigation or recapture methods and their legal consequences performed by disinterested counsel furnished to the independent directors. ‘If this had been done and the in ndent directors had concluded that, because of legal doubts, business considerations or both, the Fund should make no effort at recapture, we would have a different case 18 erroneously equated Section 36(a) of the Investment Company Act of 1940 with Section 36(b).* The Court of Appeals reasoned that since Congress, in the 1970 amendments to the Investment Company Act of 1940, “specifically provided in Section 36(b) that shareholders may sue derivatively to recover excessive fees paid to the adviser,” it “would surely be anomalous” not to imply the same power for the alleged violations of Section 36(a) of the Investment Company Act of 1940 sued upon here. (567 F.2d at 1212). Why it “would surely be anomalous” is not explained, nor is any authority offered for the proposition. Section 36(b) was enacted into law by Congress in 1970 as an amendment to the Investment Company Act of 1940 —it is a unique and highly specific section dealing solely with the compensation of investment advisers. Section 36(b) expressly created a right of action by a shareholder of a mutual fund against the investment adviser for breach of fiduciary duty with respect to investment advisory fees, irrespective of whether the disinterested directors have, in the exercise of their business judgment, approved those fees. If Congress had intended to provide in Section 36(a), a far broader section than Section 36(b), the unique mecha- nisms of Section 36(b), it could and would have done so in the 1970 amendments—it did not do so. The Court of Appeals improperly added such a provision to Section 36(a) where Congress saw fit not to do so. The legislative history, which was not cited by the Court of Appeals, supports defendants’ view. Thus, Sen- ate Report No. 91-184, which accompanied the 1970 amendments, states: “Although section 36(b) provides for an equit- able action for breach of fiduicary duty as does sec- tion 36(a), the fact that subsection (b) specifically * Section 36(a) deals with breaches of fiduciary duty; Section 36(b) deals solely with compensation of investment advisers. 19 provides for a private right of action should not be read by implication to affect subsection (a).” {em- phasis supplied]. 3 U.S. Code Cong. & Ad News, 9ist Congress, at p. 4911 (1970). The foregoing passage, although focusing on the ex- istence of a private right of action, a subject not at issue in this case, indicates that Congress did not intend that the new Section 36(b) be read to affect, in any way, Section 36(a), i.c., Old Section 36. In short, the subject of investment ad- viser compensation, covered by Section 36(b), is sui generis. Moreover, the Report expressly reaffirmed Congress’ intent not to disturb the authority of disinterested directors to manage the affairs of a mutual fund in the exercise of their business judgment, consistent with settled state law concerning corporate governance: “These provisions highlight the fact that the section is not designed to ignore concepts de- veloped by the courts as to the authority and respon- sibility of the directors. Indeed, this section is de- signed to strengthen the ability of the unaffiliated directors to deal with these matters and to provide a means by which the Federal courts can effectively enforce the federally-created fiduciary duty with re- spect to management compensation. The section is not intended to shift the responsibility for managing an investment company in the best interest of its shareholders from the directors of such company to the judiciary.” (Emphasis supplied] /d., at p. 4903. A fortiori, if Congress in Section 36(b), which contains an express right of action, did not intend to shift the re- sponsibility for managing an investment company from the directors to the judiciary, it necessarily follows that Con- gress, in Section 36(a), where there is no such express right, did not intend to shift the responsibility for manag- ing an investment company from the directors to the judiciary. 20 At bar, the District Court correctly analyzed and rejected the plaintiffs’ argument based on the public policy of the Investment Company Act of 1940 and held (404 F.Supp. at 1179-80): “This Court cannot accept plaintiffs’ argument that because the allegations of the complaint con- cern violations of the Investment Company Act and the Investment Advisers Act, the Board has no power to exercise its business judgment because of the strong public policies behind those Acts. Un- like § 16(b) of the Securities Exchange Act which allows shareholders to bring suit if the directors decline a demand, Congress has made no such statutory provision with respect to suits brought under the Investment Company and Investment Advisers Act. It is true that causes of action under those Acts are implied rights of action. [Citations omitted]. It does not necessarily follow that because the right is implied a derivative suit should always be allowed despite the good faith exercise of business judgment by the directors not to sue. This court is of the opinion that absent a statutory excep- tion, whether a cause of action is expressly author- ized or is ‘implied’ the directors of a corporation should be given the chance to perform their duties in running the business of the corporation including whether to prosecute a cause of action. If they have exercised their business judgment in good faith then a decision not to sue should be final.” On a motion by plaintiffs for reargument, the District Court specifically addressed and rejected the Section 36(b) argument, and held, in an unreported opinion and order (see appendix): “That section [36(b)] specifically gives a security holder a cause of action against the investment 21 adviser or an affiliated person on behalf of the investment company with respect to the receipt of compensation. The question of who should deter- mine whether or not the corporation is to sue is dif- ferent under section 36(a) . . . where the basis for suit is the more general claim of violation of fiduci- ary duty and where no cause of action is given in the statute to a security holder on such a claim.” The District Court correctly perceived the distinction between Sections 36(a) and 36(b); the Court of Appeals either misperceived or ignored the distinction. * * * In sum, in this case the disinterested directors of the mutual fund, after the fund had received a substantial settlement of its investment loss, and based on the advice of eminent, independent counsel, made a good faith deter- mination, in the exercise of their business judgment, that maintenance of this derivative action was contrary to the best interests of the fund and its shareholders. In so doing the directors exercised managerial power granted under state law. The Court of Appeals concluded that such state law power could not be exercised because of a sup- posed congressional intent. However, that intent is nowhere expressed in the Investment Company Act of 1940 and is in fact negated by the legislative history of the Investment Company Act of 1940. The decision below does violence to prior decisions of this Court and conflicts with a decision in another cir- cuit. It presents an important question of federal law which should be decided by this Court concerning the construction of the Investment Company Act of 1940 and the deference to be given by federal courts to state law powers concerning corporate management. For the foregoing reasons, a writ of certiorari should issue to the United States Court of Appeals for the Second Circuit. June 2, 1978 22 CONCLUSION Respectfully submitted, DANIEL A. POLLACK MARTIN I. KAMINSKY 61 Broadway New York, New York 10006 Counsel for Petitioners Burr, Chalker, Haire, Hutchison and Anchor Corporation LEONARD JOSEPH JOHN M. FRIEDMAN, JR. 140 Broadway New York, New York 10005 Counsel for Petitioners Burks, Hopkins, Kemmerer, Monroney, Phillips and Wade EUGENE P. SOUTHER ANTHONY R. MANSFIELD 63 Wall Street New York, New York 10005 Counsel for Petitioner Fundamental Investors, Inc. APPENDIX Opinion of the District Court, September 24. 1975 1172 States v. Bettenhausen, 499 F.2d 1223 (CA10 1974). As stated in United States v. Fancutt, 491 F.2d 312, 314 (CA 10 1954): “Jury verdicts in criminal cases are to be rendered on the facts as dis- closed by evidence and the law as pronounced by the court. That which the prosecutor thinks, believes or knows are not to be given considera- tion. Such argument is improper.” The issue in this type of proceeding, however, is not whether the actions of the district attorney were error but whether the conviction of the petition- er was the result of an unfair trial in violation of the Fourteenth Amendment. Sampsell v. People of the State of Cal- tifornia, 191 F.2d 721 (CA9 1951). it is only where criminal trials in state courts are conducted in such a manner a3 amounts to a disregard of that funda- mental fairness essential to the very con- cept of justice that due process is of- fended and federal court interference is warranted. Chavez v. Dickson, 230 F.2d 727 (CAS 1960). After careful con- sideration of the record, it cannot be said that the efforts of the prosecutor re- sulted in a denial of the fundamen:zal fairness essential to the concept of jus- tice. As pointed out in United States v-. Fay, 350 F.2d 400, 401 (CA2 1965): “(For] whatever error the state court may have committed in failing to grant a new trial, the defect in the trial did not attain constitutional pro- portions. The prosecutor’s conduct did not create a situation so prejudicial to the appellant that he was denied a fair trial within the meaning of the due process clause of the Fourteenth Amendment. “Conduct of state prosecutors which it was contended was unfair and pre)- udicial has consistently been held on collateral attack in the federal courts to fall short of constituting a lack of due process. [Citations omitted.)" This is not a case where the comment of the prosecutor infringed upon any 1a 404 FEDERAL SUPPLEMENT specific guarantees of the Bill of Rights. It is not a case where the prosecutor consistently and repeatedly misrepre- sented the evidence before the jury. Cf. Miller v. Pate, 386 U.S. 1, 87 S.Ct. 785, 17 L.Ed.2d 690 (1967). It is not a case where there was non-disclosure by the prosecution of specific evidence favora- ble to the accused. Cf. Brady v. Mary- land, 373 U.S. 83, 83 S.Ct. 1194, 10 L. Ed.2d 215 (1963). There was otherwise no unfair manipulation of the evidence so as to have an effect on the jury’s de- termination. The evidence of guilt was strong. In fact, the petitioner admitted guilt but relied upon the defense of en- trapment. The actions of the prosecu- tor constituted only the ordinary trial errors of a prosecutor, not that sort of flagrant misconduct necessary to estab- lish a denial of constitutional due proc- ess for relief on collateral attack. See Donnelly v. De Christoforo, 415 U.S. 637, 94 S.Ct. 1868, 40 L.Ed.2d 421 (1974). Accordingly for the foregoing reasons the Petition for Writ of Habeas Corpus will be denied. It is so ordered. 2 (2 [eer sewete trart=> > Howard M. LASKER and Irving Goldberg, Plaintiffs. v. Harry G. BURKS, Jr., et al. Defendants. No. 73 Civ. 552 (HFW.) United States District Court, S. D New York. Sept. 24, 1975. As Amended Oct. 17, 1975. Two stockholders of registered in- vestment company brought shareholders’ derivative action against company’s in- LASKER v. BURKS za 1173 Cite as #04 F Supp. 1172 (1975) ,estment advisor and several former and present members of the company’s board of directors. On the company’s motion to dismiss, the District Court, Werker, J., held that an independent minority of the company’s board of directors, who constituted a quorum, had the power to decide what position the company should take in the suit; that the strong public policies behind the Investment Company Act and the Investment Advisers Act did not bar the board of directors from ex- ercising its business judgment on the suit; that the board's decision not to sue was not tantamount to an illegal ratification; and that a question of fact existed as to whether the minority directors were truly disinterested and independent. Motion denied without prejudice. 1. Corporations ©310(1) In stockholders’ derivative suit against, inter alia, several company di- rectors, disinterested directors, who were minority of board, constituted quorum, and were designated by full board to make decision as to company’s position in the suit, had power to exercise their business judgment as to what position company should take. Fed.Rules Civ. Proc. rule 23.1, 28 U-.S.C.A. 2. Corporations C310(1) Absent fraud or corruption or other factors, stockholders cannot force corpo- ration to sue. Fed.Rules Civ.Proc. rule 23.1, 28 U.S.C.A. 3. Corporations =310(1) Strong public policies behind Invest- ment Company Act and Investment Ad- visers Act did not deprive corporate board of directors of its power to ex- ercise business judgment over stockhold- ers’ derivative action. Investment Com- pany Act of 1940, § 1 et seq., 15 U.S.C.A. $ 80a-1 et seq.; Investment Advisers Act of 1940, § 201 et seq.. 15 U.S.C.A. § 80b-1 et seq.; Fed.Rules Civ.Proc. rule 23.1, 28 U.S.C.A. 4. Securities Regulation 218, 223 Causes of action under Investment Company Act and Investment Advisers Act are implied rights of action. Invest- ment Company Act of 1940, § 1 et seq., 15 U.S.C.A. § 80a-1 et seq.; Investment Advisers Act of 1940, § 201 et seq., 15 U.S.C.A. § 80b-1 et seq. 5. Corporations . . * . (iv) any person or partner or employee of any person who at any time since the begin- ning of the last two fiscal years of sucn company has acted as legal counsel! for such company - ae ee! 218 LASKER v. BURKS 851 Cite as 426 F.Supp. 844 (1977) jaw firm had acted as legal counsel to the Fund during the last two fiscal years. They question whether the minority di- rectors could arrive at a disinterested deci- sion when they were advised by an attorney who was “interested.” Second, the plain- riffs contend that it was improper for his firm to counsel parties with divergent inter- ests, namely the Fund and the disinterested quorum. All attorneys providing legal counsel to mutual funds become, by definition, “inter- ested persons” for some period of time. Under § 10 of the Investment Company Act, 15 U.S.C. § 80a~10, only 60 percent of the members of the board of a registered company may be interested persons. Desig- nating Souther as an interested person, ’ therefore, only serves to limit his participa- tion on the Board as a director. It does not mean that the minority directors were in- terested in the suit, that their deliberations were somehow subject to improper influ- ence or that they lacked the necessary de- gree of independence. Plaintiffs nevertheless suggest that in ac- cordance with Judge Frankel’s recent deci- sion in Papilsky v. Berndt, CCH Fed.Sec.L. Rep. © 95,027 (S.D.N.Y.1976), it was improp- er for Souther to advise both the Fund and the minority directors. However, in Papil- >t the law firm advising the fund also served as the investment adviser’s counsel, and, as Judge Frankel noted, there was no ‘suggestion to the Board that, because of che possible conflict of interest, the inde- vendent directors should seek disinterested counsel.” Id. at 90, 133. In the instant action, independent legal advice for the mi- nority directors was not only recommended, ‘ was also obtained. Moreover, there was no conflict of interest on the part of South- 14, 1970, Pub.L.No. 91-547, 84 Stat. 1413. 998 selects its portfolio and administers its daily business.” Id. at $08. See also Tannenbaum v. Zeller, 552 F.2d 402 (2d Cir. 1977). - Moreover, in many instances where no specific saline is granted by statute the courts have inferred that stock- holders may bring suit. See, e.g., Abrahamson v. Fleschner, No. 75-7203, slip op. at 6227-29 (2d Cir. Feb. 25, 1977) and cases cited therein. It would surely be anomalous to hold that the statutorily disinterested directors could determine not to pursue litigation against their co-directors for lia- bility which may amount to many millions of dollars, and foreclose the stockholders from continuing such litigation, while at the same time stockholders by statute are em- powered to recover excess fees paid the adviser and under- writer. In the ordinary routine business of running an invest- ment trust, the disinterested directors must constantly deal with interested directors in a spirit of accommodation. In- deed, they are compelled for the most part to rely on the information and expert advice provided br the adviser and the majority directors.** The continued service of the “statutorily” disinterested directors, for which in this case they were paid from $11,000 to $13,000 per annum, de- pends almost entirely on the establishment of satisfactory working arrangements between them and the majority re- sponsible for their selection. It is asking too much of hu- man nature to expect that the disinterested directors will view with the necessary objectivity the actions of their colleagues in a situation where an adverse decision would be likely to result in considerable expense and liability for 11 See Comment, supra note 9, at 702. 12 In addition to their role as directors of the Furcd. each of the fra minority directors served on the boards of fire other Anchor aAliated funds, and all but one of the directors sat oo a sirth Anchor relare board. 999 32a the individuals concerned." Correspondingly, it cannot be expected that the public or the Fund’s stockholders would believe that these five statutorily disinterested directors could act with that impartiality and objectivity which the public interest requires. It follows that disinterested direc- tors of an investment company do not have the power to foreclose the continuance of nonfrivolous litigation brought by shareholders against majority directors for breach of their fiduciary duties. Of course here we do not reach the . question of whether a court should defer to the decision - of statutorily disinterested directors of an investment com- pany tc terminate a shareholder derivative suit which the court finds to be frivolous. Our conclusien makes it unnecessary to consider the find- ings of the district court that the disinterested directors were sufficiently independent to determine that the litiga- tion be ended.'* We have no doubt that the five minority directors acted in good faith in all that they did. Reversed and remanded for further proceedings. 13 See Fogel v. Chestnutt, 533 F.2d 731, 750 (2d Cir. 1975); Nutt, A Study of Mutual Fund Independent Directors, 120 U.Pa.L.Rev. 179, 216 (1971). 14 Similarly, the plethora of cases cited by counsel dealing with the powers of boards of directors to terminate stockholder derivative suits and the effect of the demand requirement under Fed.R.Civ.P. 23.1 are inapposite. We base our decision on the unique oature of the investment company and its symbiotic relationship with its investment adviser; we need not reach questions of the exercise of similar power by directors of other types of corporations. Moreover, none of these cases inrolres the situation here, where the termicating directors owe their position as directors to the defendacts in the suit. 1900 COO —— --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385005_1107%3A01. Public record. Not legal advice.