# Appendix — Burks v. Lasker > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385005_1107%3A04 ## Record - **Collection:** Supreme Court brief - **Document type:** Appendix - **Published:** January 1, 1979 - **Citation:** 441 U.S. 471 ## Text APPENDIX IN THE Supreme Court of the United States October Term, 1978 No. 77-1724 Harry G. Burks, Jr., et al., Petitioners, Howarp M. Lasker, ef ano.. Respondents. ON WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT PETITION FOR CERTIORARI FILED JUNE 2, 1978 CERTIORARI GRANTED OCTOBER 2, 1978 — INDEX Relevant Docket Entries .................cccecces Oprmnions or THE District Court AND Court or APPEALS: First Opinion of the District Court, 404 F.Supp. I Unreported Opinion and Order of the District Court Denying Reargument, January 6, 1976 ... Second Opinion of the District Court, 426 F.Supp. Oe SMT, CIUUD vn caccccecccesccudccavas Opinion of the Court of Appeals, 567 F.2d 1208 (2d re crn eerie | s: Ns do teen te eh endess Hudbcnes he 48s Papers on Motion To Dismiss: ; Affidavit of Roger T. Wickers sworn to January 27, 1975, in Support of Motion to Dismiss ......... Affidavit of Leon T. Kendall sworn to January 23, 1975, in Support of Motion to Dismiss ......... Exhibit A to Affidavit of Leon T. Kendall, Bio- graphical sketch of Stanley H. Fuld (not re- printed in Appendix) Exhibit B to Affidavit of Leon T. Kendall, Report of Stanley H. Fuld to Board of Directors of Fundamental Investors, Ine., dated December re er ee ee eee Exhibit C to Affidavit of Leon T. Kendall, Sup- plemental Report of Stanley H. Fuld to Board of Directors of Fundamental Investors, Inc., A. . 81 Gated Doeoswmber BG, BOGE ...cccccceccccceses i \.112 Exhibit D to Affidavit of Leon T. Kendall, Min- utes of meeting of Board of Directors of Fund- amental Investors, Inc., dated December 18, MOPS cb vetendceuccessecssesdievacaccucdesse d \. 117 Attachments to Minutes of December 18, ee ee Pere rrr rrr. t il Exhibit E to Affidavit of Leon T. Kendall, Letter from William J. Stephens to Leon T. Kendall, dated December 31, 1974 ...........0-+-00055 A. 131 Exhibit F to Affidavit of Leon T. Kendall, Min- utes of meeting of the Board of Directors of Fundamental Investors, Inc., dated January 6, SS, (ihn eos ck b 0 Ned hbhee ban eNaedahee A. 137 PAGE Supplemental Affidavit of Roger T. Wickers sworn to May 7, 1975, in Support of Motion to Dismiss A. 142 Excerpts from Defendants’ Reply Memorandum, referred to in Supplemental Affidavit of Roger ee WE coc 24 Kh Ca kee ee ak eae aueeses A. 143 Papers on RENEWED Motion To Dismiss: Affidavit of Roger T. Wickers sworn to July 23, 1976, in Support of Renewed Motion to Dismiss A. 145 Affidavit of James C. Sargent sworn to September 17, 1976, in Opposition to Renewed Motion to NN ie Cee ied uence cach nese ene ile ONO Excerpt from minutes of meeting of Board of Directors of Fundamental Investors, Inc. of ee NE es by oc Ca dkenees icenestiscess-> & Seward & Kissel Memorandum dated January 6, DE vdeateluctcbewsucobeawdet subanskcae es A. 158 Reply Affidavit of Roger T. Wickers, sworn to November 9, 1976, in support of Renewed Motion ba TE. cn nay cdlbawe cenbdesstncestheseens 4 A. 162 Appendix A to Reply Memorandum in Support of Renewed Motion to Dismiss, Chart of Rela- tionship of Disinterested Directors and De- IEE OP a eg ig AEG ERIE RED OS TE OPO Orders of Court of Appeals, March 9, 1978, Denying Rehearing and Rehearing in bane ............... A.170 A.1 Relevant Docket Entries United States District Court for the Southern District of New York February 5, 1973—Filed complaint and issued summons. November 12, 1973——Filed Orvex that the motion of defend- ants is hereby granted and ordered, that all further actions are stayed until twenty days following the trial or other determination of the claims asserted by Funda- mental Investors, Inc. against Goldman, Sachs & Co. in the action entitled: Welch Foods, Inc., et al. v. Goldman, Sachs & Co., 70 Civ. 4811 (the Welch action), or until further order of this Court; ordered that this order is granted without prejudice to an application by plaintiffs to vacate the same should it appear that the claims asserted by Fundamental Investors, Inc. against Gold- man, Sachs & Co. in the Welch action are not being prosecuted with reasonable diligence——Gurfein, Jr. (m/n) February 8, 1975—Filed deft. Fundamental Investors, Ine.’s affdvt. and notice of motion to dismiss under Rule 12(b)—ret. 2-20-75. September 26, 1975—Filed Oprrnton #43128 .. . that the motion under Rule 12(b) by Tue Fwwnp, joined by all defendants is denied without prejudice to renew the same upon the completion of discovery.—So ordered—Werker, J.m/n October 14, 1975—Filed pltf’s affdvt. and notice of motion for reargument of Court’s opinion #43128—ret. 10-27-75. January 7, 1976—Filed Order that plaintiffs’ motion for reargument based on Judge Gagliardi’s decision on Boyko v. The Reserve Fund, Inc., is denied. Werker, J. m/n. A.2 Docket Entries July 30, 1976—Filed deft. Fundamental Investors affdt. of Roger Wickers in support of renewed motion to dismiss. September 20, 1976—Filed deposition of Louis Frederick Laun dtd. 4-6-76. September 20, 1976—Filed deposition of William J. Stephens dtd. 2-26-76. September 20, 1976—Filed deposition of Mary S. O’Connor dtd. 3-9-76. September 20, 1976—Filed deposition of John R. Haire dtd. 2-10-76. September 20, 1976—Filed deposition of Beryl Robichaud dtd. 3-9-76. September 20, 1976—Filed deposition of Leon T. Kendall dtd. 2-26-76. September 20, 1976—Filed continued deposition of Leon T. Kendall dtd. 3-24-76. September 20, 1976—Filed plaintiffs’ deposition exhibits (re depositions of Haire, Kendall, O’Connor, Stephens, Robichaud and Laun). January 12, 1977—Filed Ortnion #45516 . . . Summary judgment is granted to the defendants—Werker, J. m/n. January 17, 1977—Filed JupemMent anp Orper that defend- ants have judgment against the plaintiffs dismissing the complaint.—Clerk. m/n. January 27, 1977—Filed pltfs notice of appeal to the USCA for the 2nd Circuit from final judgment dismissing action and from prior rulings that produced final judgment.— copies mailed. A. 3 Relevant Docket Entries United States District Court of Appeals for the Second Circuit = August 31, 1977—Argument heard (By: Lumbard, Oakes, Meskill, C.J.J.) January 11, 1978—Judgment reversed, Lumbard, C.JJ. January 25, 1978—Filed petition for rehearing and rehear- ing en bane, appellee, pfs. March 9, 1978—Filed order denying petition for rehearing. March 9, 1978—Filed order denying petition for rehearing en banc. June 2, 1978—Call from Supreme Court that petition was filed today. October 6, 1978—Filed certified copy of order of Supreme Court that writ of certiorari is hereby granted [October 2, 1978]. OPINIONS OF THE DISTRICT COURT AND COURT OF APPEALS A.9 First Opinion of the District Court UNITED STATES DISTRICT COURT, S.D. NEW YORK. Sept. 24, 1975. As Amended October 17, 1975. fay Vv Howarp M. Lasker and Irvine Go.pBera, Plaintiffs, Vv. Harry G. Burks, Jr., et al., Defendants. No. 73 Civ. 552 (HF W.) MemoranpuM Decision anp OrDER Werke, District Judge. This is a shareholders’ derivative action brought bv two stockholders on behalf of Fundamental Investors, Inc. (‘‘Fundamental’’ or the ‘‘Fund’’), a registered investment company under the Investment Company Act of 1940, 15 U.S.C. § 80a-1 et seq. The defendants are the Fund’s invest- ment adviser, Anchor Corporatien (‘*Anchor’’), a regis- tered investment adviser under the Investment Advisers Act of 1940, 15 U.S.C. § 80b-1 ef seq., and several former and present members of the Board of Directors of the Fund. The dispute between the parties centers around the Fund’s purchase, on Anchor’s recommendation, of $20 million in commercial paper of the now bankrupt Penn Central Trans- portation Company. As described in detail below the coin- A.6 First Opinion of the District Court plaint charges that in connection with the purchase of the Penn Central paper the defendants violated various sec- tions of the Investment Company Act, the Investment Ad- visors Act and the common law. The Fund, joined by all defendants, has now moved under Rule 12(b) of the Fed- eral Rules of Civil Procedure to dismiss this action on the ground that the independent members of the Board of Di- rectors of the Fund have unanimously determined that, in their business judgment, this action is contrary to the best interests of the shareholders of the Fund. BacKGROUND The Fund made its purchases of Penn Central 270-day notes from Goldman, Sachs & Co., in lots of $5 million each on November 26, December 2, 4 and 8, 1969. Unfortunately for the Fund and other holders of Penn Central commercial paper, Penn Central, on June 21, 1970, filed a petition for reorganization under section 77 of the Bankruptcy Act with the result that the notes were not paid at maturity or at any time to date. Faced with the possibility of a sub- stantial loss, the Fund and other plaintiffs instituted suit in the Southern District of New York on November 4, 1970 against Goldman, Sachs & Co., for rescission of their pur- chases of the Penn Central Notes. That action was entitled Welch Foods, Inc. v. Goldman, Sachs & Co., D.C., 398 F.Supp. 1393 (the ‘‘ Welch’’ action). The instant derivative suit was filed on February 5, 1973. Jurisdiction was predicated on section 44 of the In- vestment Company Act of 1940 (15 U.S.C. § 80a-43), section 214 of the Investment Advisers Act of 1940 (15 U.S.C. § 80b- 14) and pendent jurisdiction. The complaint alleges that in making the purchases of Penn Central commercial paper A.7 First Opinion of the District Court the Fund and Anchor relied solely and exclusively on Gold- man, Sachs & Co., and made no independent investigation of the financial condition of Penn Central or the quality of its commercial paper. By failing to make an independent investigation it is alleged that Anchor failed to meet its responsibility as the Fund’s investment adviser and that the Fund’s directors knew or should have known of, and acquiesced in, the failure of Anchor to meet its responsi- bilities and thus failed to meet their responsibilities as members of the Fund’s Board of Directors. Had an inde- pendent investigation been made it is alleged that a num- ber of material adverse facts concerning the financial con- dition of the Penn Central and the quality of its commercial paper would have been learned. As a result of their actions, or inactions, the defendants are charged with engaging in acts and practices constituting gross misconduct and a gross abuse of trust in respect of the Fund in violation of section 36 of the Investment Company Act. Anchor is also alleged to have violated section 206, the antifraud section of the Investment Advisors Act of 1940. Plaintiffs also claim that the defendants violated their common law fiduciary duty to the Fund and that Anchor, aided and abetted by the diree- tors, breached its investment advisory contract with the Fund. The complaint goes on to allege that from November 238, 1969 to June 21, 1970, the date Penn Central filed for re- organization, the financial condition of the Penn Central deteriorated. During this period it is alleged that Anchor and the Fund directors failed to commence a thorough and adequate investigation of, and keep under continuous re- view, the financial condition of Penn Central and the quality and safety of its commercial papers. It is also alleged that during this period the Fund’s directors failed in their obli- A.8 First Opinion of the District Court vations to make adequate attempts to resell the Penn Cen- tral commercial paper it held and that Anchor failed to advise the Fund of the advisability of selling the commer- cial paper. Plaintiffs again claim that these acts by the defendants violate section 36 of the Investment Company Act: that Anchor violated section 206 of the Investment Advisers Act; that all defendants breached their common law fiduciary duty; and that Anchor, aided and abetted, hy the Fund's directors breached its investment advisory contract. Finally, the complaint alleges that the defend- ants violated section 13 (a)(3) of the Investment Company Act by allowing the Fund to hold more than 10% of the securities of any one issuer (Penn Central) in contraven- tion of the Fund’s registration statement filed pursuant to section 8(b) of the Investment Company Act. Subsequent to the filing of this derivative action, all defendants moved to stay this action pending the resolution of the claims of Fundamental in the Welch action. The stay was granted by Judge Gurfein on November 12, 1973. Fundamental’s claims against Goldman, Sachs & Co., in the Welch action were settled on July 9, 1974. The terms of the settlement provided that Goldman, Sachs & Co. would take back the Penn Central notes, pay Fundamental #5,250,000.00 in cash and assign to Fundamental a 73.-75% interest in the proceeds of the notes in the reorganization proceedings. With the settlement of the Welch action, Fundamental had to determine what position to take in this suit. It is necessary to set forth in detail the actions taken by the Fund’s Board of Directors since it forms the basis of the defendants’ motion to dismiss. / Fundamental’s Board of Directors met on July 24, 1974 to review the settlement of the Welch action and to decide A.9 First Opinion of the District Court what position to take in this derivative action. Since five of the directors are defendants in this action and one is a director of Anchor, the Board determined that the remain- ing five directors who they considered disinterested would, acting as a quorum pursuant to the bylaws,' decide what position the Fund should take in this action. The five disinterested directors then decided to retain the Honorable Stanley H. Fuld, former Chief Judge of the New York (ourt of Appeals, to review the entire Penn Central matter and to report to the Board. After reviewing the complaint in this derivative action, the proceedings in the Welch action, the files of Anchor and the Fund relating to the purchase of Penn Central paper and after interviewing officers and employees of the Fund and analyzing th facts and the law, Judge Fuld sent a memorandum to the disinterested directors on December 5, 1974 in which he stated his opinion that there was ‘‘no viclstion by Anchor or by the Fund directors of any provi- sida ef statute or of any common law or contractual obliga- tion to the Fund, in connection with the aequisition and re- ‘ Section | of Article Eight of the Certificate of Incorporation of Fundamental provides that: “The number of directors which shall constitute the whole board of directors shall be such as from time to time shall be fixed by or in the manner provided ir the by-laws which shall also provide the number of directors which shall contsitute -a quorum; provided, that in no case shall a quorum be less than one-third of the total number of directors nor less than two directors.” Section 4 of Article Six of the By-Laws of Fundamental provides that: “Quorum: Except as otherwise provided by law, the Certifi- cate of Incorporation, or these By-Laws, at all meetings of the Board of Directors one-third of the directors then in office, but not less than three directors shall be necessary for the transaction of business.” A. 10 First Opinion of the District Court tention of the Penn Central commercial paper.’’ (Dee. 5, 1974 Memorandum at 2). Judge Fuld went on to discuss in detail each of the claims asserted in this suit. Finally, Judge Fuld defined and discussed three alternative courses of action which the disinterested directors might pursue, i. e., (1) seek realignment so as to become a plaintiff for the purpose of exercising control over and prosecuting the action; (2) conclude that the action is sufficiently lacking in merit and move to have the suit dismissed; and (3) take a neutral position and permit the action to proceed for the t'und’s benefit under the auspices of the present plaintiffs. After the disinterested directors reviewed his report and submitted questions to him, Judge Fuld sent a supple- mental memorandum to the disinterested directors on De- cember 18, 1974. In his memorandum Judge Fuld discussed in more detail the possibility that the Board should move to dismiss this suit as not being in the best interests of the Fund and the possible scope of judicial review of such a decision. The disinterested directors then met in a series of special meetings to consider Judge Fuld’s memoranda. The directors met with Judge Fuld; John R. Haire, Chairman and Chief Executive of Anchor; Donald L. Kemmerer and Checles F, Phillips, unaffiliated directors of Fundamental ; and Eugene Souther, litigation counsel to Fundamental in this action. Questions were posed by the directors to all of these in attendance concerning the merits of the derivative action and the alternatives open to the Fund’s Board. The disinterested directors again met in private and decided to give additional consideration to the problem and convey any questions to the designated Chairman of the dis- interested directors, Leon T. Kendall. A second special meeting of the disinterested directors was held on January 6, 1975. Upon review of the alter- A. 11 First Opinion of the District Court natives available, the directors present unanimously de- termined *? that the prosecution of this action was contrary to the best interests of the shareholders of Fundamenta! and that counsel should be directed to seek dismissal of the action. The factors considered by the directors in reaching their conclusion are summarized in the Kendall affidavit {/ 22, and are as follows: ‘*(a) Chief Judge Fuld’s opinion that there is no merit to the action and little likelihood of its success ; (b) The business interruption to Anchor, dis- traction of its personnel and the likely inability for it to attract and maintain personnel during pendency of the action necessarily would be harmful to the shareholders of Fundamental; (c) If the action were to proceed against Anchor with the acquiescence or under the control of Funda- mental, the adversary relationship that would be created between Fundamental and Anchor and the attendant serious distraction of Anchor’s personnel from their efforts on behalf of the shareholders of Fundamental would leave us no practical alternative but to re-remove Anchor as investment adviser and to seek to retain a new investment adviser; this would necessarily result in delay, uncertainty and an inevitable lapse in the management of Funda- mental’s affairs to the serious detriment of its share- holders ; 2 One director, Mary S. O’Connor, was not present at the meeting. She had previously told Mr. Kendall what her decision was. That vote was cattieeed by Mrs. O’Connor at a special meeting of the disin- terested aaden held on January 22, 1975. Even without her presence, four directors would constitute a quorum. A. 12 First Opinion of the District Court (d) Anchor had acted in good faith and in what it believed was in the best interests of Funda- mental’s shareholders in purchasing the Penn Central comercial paper ; (e) Anchor had acted reasonably and had fol- lowed proceedures prudent at the time in lizht of the then generally held belief that commercial paper was equivalent to cash; (f) A vast number of other institutional in- vestors, including many major banks in New York City and throughout the country and certain major mutual funds, had also believed that Penn Central was a sound business enterprise and had purehased Penn Central commercial paper at the time, and many such investors still held that paper when Penn Central petitioned for reorganization ; (x) To take no position at all and thereby to al- low two of the more than 90,000 sharehoiders to de- termine the course of this action would not be a deci- sion at all, but au avoidance of our obligation to all the shareholders; (h) Chief Judge Fuld’s advice that an invest- ment adviser is not a guarantor of Uie investments it makes and can only be charged for breaches of contract or of the standards applied by the pertinent statutes and regulations. Chief Judge Fuld had analysed the facts and law and had concluded that Anchor was not at fault and that there was little likelihood that Anchor would be held to have violated any statute or regulation or to have breached any agreement or duty; A. 13 First Opinion of the District Court (i) Given Chief Judge Fuld’s opinion, if the action were to proceed, there could be unnecessary costs to the shareho!ders of Fundamental for legal fees, both for its own counsel and for the director defendants, who would be entitled to reimbursement of counse! fees if they were found to be liable to Fundamental; and (j) Even if there were a recovery of the theoret- ical maximum amount of damages, the net result to the shareholders of Fundamental would be little more than a net recovery of 10 cents per share, or ap- proximately 2% of Fundamental’s net asset value. The remote chance of recovering that small amount was not worth the risk of the serious damage to Fundamental’s shareholders which proceeding with this action might produce.’’ Discussion The Fund now argues that the extensive consideration given to the alternatives available to the independent direc- tors culminating in their decision to seek dismissal of this suit was a good faith exercise of business judgment which eannot be upset by the two shareholder plaintiffs who would force Fundamental to maintain this action. The plaintiffs, of course, dispute this position. After empha- sizing, the merits of the claims they have asserted and criticizing the conclusions reached by Judge Fuld, plaintiffs make the following arguments in opposition to the defend- ants’ motion to dismiss: (1) because of the broad regulatory legislation embodied in the Investment Company and Invest- ment Advisers Act, the decision whether to prosecute viola- tions of that Act is not a matter of ‘‘business judgment’’ to A. 14 First Opinion of the District Court be decided by directors of a regulated fund; (2) to seek dismissal of the action would be tantamount to an unlawful ratification of defendants’ conduct; (3) if a majority of the board’s directors are disqualified, the existence of a ‘‘dis- interested’’ minority is irrelevant; (4) as a matter of law the minority directors are not ‘‘disinterested;’’ (5) the minority directors gave undue deference to Anchor in making their decisions; and (6) the motion is premature and defective under Rule 23.1. These arguments will now be considered. At the outset, the obvious should be stated—a share- holder’s derivative suit is an action brought on behalf of a corporation in which any recovery runs in favor of the cor- poration. Ordinarily, it is the corporation which would seek the right to enforce any cause of action it might have. Rule 23.1 of the Federal Rules of Civil Procedure requires that a complaining shareholder demand action from the board of directors before bringing suit.* The purpose of * Rule 23.1 provides: ; “In a derivative action brought by one or more shareholders or members to enforce a right of a corporation or of an unin- corporated association, the corporation or association having failed to enforce a right which may properly be asserted by it, the complaint shall be verified and shall allege (1) that the plaintiff was a shareholder or member at the time of the trans- action of which he complains or that his share or membership thereafter devolved on him by operation of law, and (2) that the action is not a collusive one to confer jurisdiction on a court of the United States which it would not otherwise have. The complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obiain the action he desires from the directors or comparable authority and, if necessary, from the shareholders or members and the reasons for his failure to obtain the action or for not making the effort. The derivative action may not be maintained if it appears that the plaintiff does not fairly and adequately represent the interests of the shareholders or members similarly situated in enforcing the right of the cor- poration or association. The action shall not be dismissed or compromised without the approval of the court, and notice of the proposed dismissal or compromise shall be given to share- holders or members in such manner as the court directs.” A.15 First Opinion of the District Court that ‘‘demand”’ rule ‘‘is to give the derivative corporation itself the opportunity to take over a suit which was brought on its behalf in the first place, and thus to allow the directors the chance to occupy their normal status as conductors of the corporation’s affairs.’’ Brody v. Chemical Bank, 517 F.2d 932 at 934 (2 Cir. 1957), citing In re Kauffman Mutual Fund Actions, 479 F.2d 257, 263 (1st Cir.), cert. denied, 414 U.S. 857, 94 S.Ct. 161, 38 L.Ed.2d 107 (1973). No demand was made on the Fund’s Board of Directors in this case because plaintiffs alleged (and it is not disputed) that the majority of the Fund’s directors are defendants charged with wrong doing and as such a demand would be futile.t While no set formula has been developed for deter- mining what facts must be plead in order to excuse a de- mand on the Board of Directors—see generally, 7A Wright & Miller Federal Practice & Procedure § 1831 (1972)—that issue is not presented in this case. Instead, this case pre- sents the rather unique situation where a designated inde- pendent minority of a Board has taken unilateral action with respect to a suit brought on behalf of the corporation. The decision of the independent directors was made after the settlement of the Welch action which put an end to the stay in this suit. Plaintiffs argue that even if suit were instituted at the present time (i.e., after settlement of the Welch action no prior demand on the Fund’s Board would have been necessary because the majority of directors would be disqualified. To allow a minority of the Board to seek dismissal of the suit would, it is argued, destroy the role of ‘‘presumptive disqualification.’’ * No issue has been raised concerning whether a demand on the shareholders was necessary. Plaintiffs’ complaint alleges that under applicable law and the Certificate of Incorporation and By-Laws of the Fund, the directors and officers are vested with the management of the Fund. Complaint €7(b). A. 16 First Opinion of the District Court While no case is directly in point, this circuit has recently considered an analogous issue in Brody v. Chemical Bank, supra. There, the district court had dismissed the deriva- tive causes of action in plaintiff’s complaint because the allegations in the complaint were insufficient to excuse a demand on the Board of Directors. Plaintiff had alleged futility of demand because the majority of directors were controlled by the defendant corporation. However, since institution of the suit, a new Board had been installed but no demand was made on it. The Seeond Cireuit agreed that a demand should have been made but remanded because of the gravity of the alleged wrongdoing. 482 F.2d 1111 at 1114 (2 Cir.) After remand, the plaintiffs filed a second amended complaint but made no demand on the Board of Directors because they alleged that a demand on the Board of Directors at the time the action was originally commenced would have been futile. The district court again dismissed the derivative counts and the Second Circuit affirmed on the reasoning that a demand should have been made on the new directors. Brody, supra at 934. In this case, within a short period after settlement of the Welch action and the dissolution of the stay, the Board of Directors met and designated the independent directors to make a decision as to the Fund’s position in this suit. In the Court’s view, the independent minority of directors had the power to decide what position the Fund should take. This is consistent with the policy that a cor- poration be given the opportunity to control a lawsuit brought on its behalf, that the Board be allowed to exercise its normal functions in running the corporation, and that a derivative suit should be resorted to as a last alternative. See 3B J. Moore, Federal Practice § 23.1.19, at 23.1-252-53 (2d ed. 1974) quoted in Brody, supra at 934. a A.17 First Opinion of the District Court Although the independent directors could properly move for dismissal of this action it is now necessary to de- termine whether good faith business judgment of the direc- tors can be used as a ground for dismissal. Defendants rely on a line of cases which hold that absent fraud or cor- ruption or other disqualifying factor, the good faith busi- ness judgment of the directors not to bring suit is final. See, e.g., Hawes v. Oakland, 104 U.S. 450, 26 L.Ed. 827 (1881); Corbus v. Alaska Treadwell Gold Mining Co., 187 U.S, 455, 23 S.Ct. 157, 47 L.Ed. 256 (1903) ; United Copper Securities Co. v. Amalgamated Copper Co., 244 U.S. 261, 37 S.Ct. 509, 61 L.Ed. 1119 (1917); Swanson v. Traer, 249 F.2d 854 (7th Cir. 1957); Ash v. TBM, 353 F.2d 491 (3d Cir. 1965), cert. denied, 384 U.S. 927, 86 S.Ct. 1446, 16 L.Bu 2d 531 (1966) ; In re Kauffman Mutual Fund Actions, 479 F.2d 257 (1st Cir.), cert. denied, 414 U.S. 857, 94 S.Ct. 161, 38 L.Ed.2d 107 (1973). Cf. Allegheny Corp. v. Kirby, 344 F.2d 571 (2d Cir. 1965), cert. dismissed, 384 U.S. 28, 86 S.Ct. 1250, 16 L.Ed.2d 335 (1966). As the Supreme Court recognized in United Copper, supra, the decision whether or not to sue is a matter of internal management, 244 U.S. at 263, 37 S.Ct. 509. Absent fraud or corruption or other factors, the stockholders can- not force the corporation to sue. ‘‘(Stockholders] cannot secure the aid of a court to correct what appear to them to be mistakes of judg- ment on the part of the officers . .. This rule applies whether the mistake is due to error of fact or of law, or merely to bad business judgment. It applies .. . where the mistake alleged is the refusal to assert a seemingly clear cause of action... .”’ Ashwander v. Voiley Authority, 297 U.S. 288, 348, 56 S.Ct. 466, 481, 80 L.Ed. 688 (1936). A. 18 First Opinion of the District Court The reasoning behind the ‘‘ business judgment rule’’ and its application to derivative suits was recently discussed in this district in Bernstein v. Mediobanca, Docket #73 Civ. 3549, (S.D.N.Y. Dee. 24, 1974) (Connor, J.). There the Court reaffirmed the business judgment rule although sum- mary judgment was denied, with leave to renew, because possible evidence of bad faith on the part of the Board of Directors in deciding not to sue was in the possession of the defendants and plaintiff was given an opportunity to dis- cover it. This court cannot accept plaintiffs’ argument that because the allegations of the complaint concern viola- tions of the Investment Company Act and the Investment Advisers Act, the Board has no power to exercise its busi- ness judgment becauge of the strong public policies behind those Acts. Unlike § 16(b) of the Securities Exchange Act which allows shareholders to bring suit if the directors de- cline a demand, Congress has made no such statutory pro- vision 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 ac- tion. Brown v. Bullock, 194 F.Supp. 207 (S.D.N.Y., aff’d 204 F.2d 415 (2d Cir. 1961); Bolger v. Laventhol, Krek- stein, Horwath & Horwath, 381 F.Supp. 260 (S.D.N.Y. 1974). It does not necessarily follow that because the right is implied a derivative suit should always be allowed de- spite the good faith exercise of business judgment by the directors not to sue. This court ‘s of the opinion that ab- sent a statutory exception, whether a cause of action is ex- pressly authorized or is ‘‘implied’’ the directors of a cor- poration should be given the chance to perform their duties in running the business of the corporation including whether A. 19 First Opinion of the District Court 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. The court must also reject plaintiffs’ argument that the decision not to sue was tantamount to an illegal ratification. Although it can be argued that derivative suits should be allowed when the Board has refused to sue on a non-ratifiable wrong—see Note, Demand on Directors and Shareholders as a Prerequisite To a Derivative Suit, 73 Harv.L.Rev. 746, 762 (1960); Rogers v. American Can Co., 305 F.2d 297 (3d Cir. 1962), the question of busi- ness judgment is separate from the question of ratification. S. Solomont &€ Sons Trust v. New England Theatres Oper- ating Corp., 326 Mass. 99, 93 N.I0.2d 241, 247 (1950). Many of the cases which established the business judgment rule and its relation to derivative suits have involved claims which were arguably non-ratifiable. See, e. g., United Cop- per, supra; Ash v. IBM, supra (antitrust violations). Another question which has _ been considered is whether the merits of the plaintiffs’ claim should be con- sidered in deciding whether the directors decision should be upheld. To do so would place the Court in the position of substituting its judgment for that of the directors which if made in good faith should not be disturbed. The court has carefully reviewed the many factors which the Board considered before making its decision not to sue. Although plaintiffs argue that there is more merit to their claims than Judge Fuld gave them, there were many other factors considered by the directors, as outlined in the Kendall Affidavit | 22—which led the directors to their decision. If the minority directors were truly disinterested and independent the court will not substitute its judgment for A. 20 First Opinion of the District Court that of the Board. Plaintiffs have not argued that the minority directors have acted fraudulently or corruptly. They have argued that they are not disinterested or inde- pendent because they occupy similar positions with other funds in the Anchor group and that Anchor controls the selection and nomination of the Fund’s directors. This assertion has been denied and it is alleged by the movant that these directors were nominated by a three man Diree- tors Qualification Committee of which two members were unaffiliated with Anchor. Interest or lack of independence would go toward the issue of good faith. I am constrained therefore to permit the plaintiffs to pursue discovery with respect to the rela- tionships of the minority directors and the Qualifications Committee to determine whether the minority directors were disinterested or independent. It would appear that all of the other questions resolved herein are dependent upon a resolution of this issue. The plaintiffs are to con- duct their discovery within 90 days from the date hereof. The motion is denied without prejudice to renew the same upon the completion of discovery. So ordered. ; A. 21 Unreported Opinion and Order of the District Court Denying Reargument UNITED STATES DISTRICT COURT Sovuruern District or New York Oo Howarp M. Lasker anv Irvine GOLDBERG, Plaintiffs, against Harry G. Burks, Jr., Eowarp B. Burr, Tomas F. CHALKER, Joun R. Harre, Harvey C. Hopkins, 8S. P. Hurcainson, Donato L. Kemmerer, A. S. Mrke Monroney, CHARLES F. Pumuirs, Jeprna Wave, Ancuor Corp., and Funpa- MENTAL Investors, INc., Defendants. Ly — ORDER Henry F. Werxer, D. J. Plaintiffs’ motion for reargument based on Judge Gagliardi’s decision in Boyko v. The Reserve Fund, Inc., 74 Civ. 3419 (S.D.N.Y. Sept. 31, 1975) is denied. This court finds that Boyko is distinguishable from the case at hand due to the fact that Boyko concerns Section 36(b) of the Investment Company Act, 15 U.S.C. § 80a-35(b). That section specifically gives a security holder a cause of action against the investment adviser or an affiliated person on behalf of the investment company with respect to the re. ceipt of compensation. The question of who should deter- mine whether or not the corporation is to sue is different under Section 36(a), 15 U.S.C. § 80a-35(a), where the basis for suit is the more general claim of violation of fiduciary duty and where no cause of actiou is given in the statute to a security holder on such a claim. So ordered. Dated: New York, New York January 6, 1976 Henry F. Werker U.S.D.J. ‘ isis | = A, 22 Second Opinion of the District Court UNITED STATES DISTRICT COURT, S. D. NEW YORK. Jan. 7, 1977. —— * — Howarp M. Lasker and Irvine GoLpBErc, Plaintiffs, Vv. Harry G. Burks, Jr., et al., Defendants. No. 73 Civ. 552 (HF'W). ()PINION Werker, District Judge. This action, brought derivatively by two shareholders on behalf of Fundamental Investors, Ine. (‘‘Fundamental”’ or the ‘‘Fund’’), a registered investment company, seeks to recover damages resulting from the Fund’s purchase of $20 million in 270-day notes issued by the now bankrupt Penn Central Transportation Company. The defendants are An- chor Corporation (‘‘Anchor’’), the régistered investment adviser to the Fund, and several past and present members of the Fund’s Board of Directors (‘‘Board’’). The defen- dants previously moved to dismiss this suit under Rule 12(b) of the Federal Rules of Civil Procedure because a voting quorum of disinterested directors found, in the ex- A. 23 Second Opinion of the District Court ercise of its business judgment, that maintenance of the suit would not be in the best interests of the shareholders of the Fund. In a memorandum decision on that motion, 404 F. Supp. 1172, this court held that the business judgment rule ' applied to the actions of the Fund and that it enabled the minority directors of the Board to seek dismissal of this suit provided only that they were ‘‘truly disinterested and independent.’’ However, the court permitted the plaintiffs to conduct discovery for a designated period of time to de- termine whether the minority directors were in fact disin- terested or independent, and the motion to dismiss was denied without prejudice to renew at the close of discovery. In accordance with that decision, the defendants have now renewed their motion to dismiss the instant action. The plaintiffs continue to argue that the motion should be deniel because, for various reasons, the minority directors did not, and could not, exercise their independent business judgment in moving to terminate this action. ' Under the rule, ““*. . . Questions of policy of management, ew of con- tracts or action, adequacy of consideration, la appropriation of corporate funds to advance corporate interests, are left solely to their honest and unselfish decision, for their powers therein are without limitation and free from restraint, and the exercise of them for the common and general interests of the corporation may not be questioned, although the results show that what they did was unwise or inexpedient.’ Politz v. Wabash R. Co., 207 N.Y. 113, 124, 100 N.E. 721, 724. Indeed, although the con- cept of ‘responsibility’ is firmly fixed in the law, it is only in a most unusual and extraordinary case that directors are held liable for negligence in the absence of fraud, or improper motive, or personal interest.” Bayer v. Beran, 49 N.Y.S.2d 2, 6 (Sup. Ct. 1944). A. 24 Second Opinion of the District Court I The facts surrounding this action have been described at length in my earlier memorandum decision ; nevertheless, some repetition of that discussion will facilitate an under- standing of the court’s action upon the present motion by the defendants. The complaint alleges, among other things, that Anchor breached its statutory, contractual and common law fiduci- ary duties by relying exclusively upon the representations of Goldman, Sachs & Co. (a seller of commercial paper), rather than independently investigating the quality and safety of the Penn Central 270-day notes purchased by the Fund. It is further alleged that the defendant directors knew or should have known of Anchor’s failure to meet its responsibility; that they violated their common law duties as corporate fiduciaries by acquiescing in Anchor’s omis- sions; that the financial condition of the Penn Central steadily worsened during the period from November 28, 1969 to June 21, 1970, the date that it filed for reorganiza- tion; and that during this period of decline all of the defen- dants failed to investigate and review the financial condi- tion of the Penn Central and the quality and safety of its commercial paper. It is also alleged that during this period Anchor failed to recommend, and the defendant directors failed to attempt, sale of the Penn Central paper held by the Fund. Prior to the institution of this action, the Fund and other plaintiffs brought suit against Goldman, Sachs seeking rescission of their purchases. See Welch Foods, Inc. v. Gold- man, Sachs & Co., 398 F.Sapp. 1393 (S.D.N.Y. 1974) (the ‘‘Welch’’ action). On the motion of all defendants to this action, Judge Gurfein, then a district court judge, granted A. 25 Second Opinion of the District Court a stay of further proceedings in this action pending resolu- tion of the Fund’s claims in Welch. Thereafter, on July 9, 1974 the Fund agreed to settle its claims against Goldman, Sachs. Under the terms of the settlement agreement, Gold- man, Sachs was to take back the notes and the Fund was to receive $5,250,000 in cash and a 73.75 percent interest in any proceeds of the notes obtained during the course of the Penn Central reorganization proceeding. With the claims of Fundamental in the Welch matter resolved, the Board once again faced the question of what to lo in the instant action. Briefly, the Board determined that five of its members were dininterested (the ‘‘disinterested quorum’’ or ‘‘minority directors’’) and therefore able to determine the proper course of action for the Fund.? The disinterested quorum then retained the Honorable Stanley H. Fuld, former Chief Judge of the New York Court of Ap- peals, to review the circumstances surrounding the purchase and retention of the Penn Central notes and prepare an opinion for its consideration. In a memorandum to the disinterested quorum dated December 5, 1974, Judge Fuld concluded that neither Anchor nor the defendant directors of the Fund had violated the law ‘‘in connection with the acquisition or retention of the Penn Central commercial paper.’’ Judge Fuld’s memorandum discussed several posi- tions that the disinterested quorum could take on behalf of the Fund, one of which was concluding that the suit lacked merit and moving to dismiss. The minority directors met with Judge Fuld at a special meeting of the disinterested quorum held on December 18, 1974 and requested that he submit a further memorandum before they took any action. * Under Article Eight of the Certificate of Incorporation of Funda- mental, a quorum of the Board may not be less than one-third of the total number of directors. Since the full Board consisted of ten mem- bers, there was no problem here. A. 26 Second Opinion of the District Court The minority directors also questioned several of the de- fendants before deciding at a second special meeting of the disinterested quorum, held on January 6, 1975, to seek dis- missal of the instant action.’ An affidavit submitted by the chairman of the disinterested quorum as part of the earlier motion to dismiss recounts ten factors that the disinterested quormn considered in arriving at its decision. The relevant portion of that affidavit appears in my earlier decision, 404 F.Supp. at 1176-77. II On the defendants’ initial motion to dismiss, this court considered and rejected the contention of the plaintiffs that the merits of their derivative claim should color the court’s consideration of the business judgment ‘‘defense.’’ The court also reviewed the claim of the plaintiffs that the strong public policy behind the Investment Company Act of 1940, 15 U.S.C. § 80a-1, et seq., and the Investment Advisers Act of 1940, 15 U.S.C. § 80b-1, et seq., precluded application of the business judgment rule to the actions of mutual funds. The court observed that ‘‘absent a statutory exception whether a cause of ac- tion is expressly authorized or is ‘implied’ the direc- tors 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. 404 F.Supp. at 1180. Both of these contentions have been reasserted in sub- stantially unchanged form in the plaintiffs’ papers in oppo- * As was noted in my earlier decision in this matter, although one of the five minority directors voted by proxy, even without her vote, the presence of four directors at the meeting constituted a quorum. A. 27 Second Opinion of the District Court sition to the renewed motion to dismiss. While a certain de- gree of tenacity is the mark of accomplished counsel, what the plaintiffs now seek is an opportunity to reargue the court’s prior decision after the time to do so has passed. To accede to that request would require the court to recon- sider arguments previously rejected without having been shown that there is a need to do so. Consequently, the court will only consider the question it did not reach be- fore: whether the minority directors were disinterested and independent. Since the parties have each submitted affidavits and excerpts from the extensive deposition testimony to assist in the disposition of the instant motion, the court must treat the motion as one for summary judgment under Rule 56 of the Federal Rules of Civil Procedure. Rule 12({b), Fed. R.Civ.P. Ill The plaintiffs first contend that the structure of the mutual fund industry, which subjects mutual funds to ex- tensive control by their investment advisers, precludes a finding of independence in this instance.* Specifically, they * In this regard, plaintiffs note Chief Judge Kaufman’s recent state- ment that: “The relationship between investment advisers and mutual funds is fraught with potential conflicts of interest. The typical fund ordinarily is only a shell, organized and controlled by a separately owned investment company adviser, which selects its portfolio and administers its daily business. Compensation for these services is determined under an advisory contract, the terms of which are all too often dictated to unwary or negligent fund directors and fund shareholders by the investment adviser.” re: v. Chestnutt Corp., Civ. No. 76-7156 (S.D.N.Y. Nov. 4, 1976). A. 28 Second Opinion of the District Court maintain that the large number of shareholders in the Fund coupled with the small size of each sharehkolder’s interest, makes proxy contests impossible to wage and ensures that the Board will only contain directors amenable to the poli- cies of the Fund’s management.’ The plaintiffs also sug- gest that the service of each minority director for compen- sation on the boards of other ‘‘Anchor’’ funds demon- strates their inability to act independently. In this vein, the plaintiffs maintain that business and personal relation- ships among the defendants and minority directors make it impossible to conclude that the disinterested quorum acted independently; that even if the minority directors acted in good faith, their lovalties must have been divided. Plaintiffs have not adduced any factual support for their conelusion that the members of the disinterested quo- rum acted other than independently. Although each of the minority directors knew someone on the Board at the time that he or she was nominated, the relationships which ex- isted between the minority directors and the defendant directors were de minimis, even as they are stated by the plaintiffs, and do not suggest that the business judgment rule should not be applied. There is also no reason to conclude that the busi- ness judgment rule is inapplicable merely because each minority director receives remuneration for service on th» boards of other ‘‘ Anchor’’ funds. Most corporate directors receive some compensation for their services, but absent a showing of improper motive they have always been per: . ® At about the time that the minority directors determined to seek the dismissal of this action, there were approximately 141,000 share- holders in the Fund. No shareholder had a beneficial interest greater than one percent. A. 29 Second Opinion of the District Court mitted to apply their business judgment to decisions in- volving derivative suits brought against the corporations they serve. See e.g., Warshaw vy. Calhoun, 43 Dei.Ch. 148, 221 A.2d 487 (Sup.Ct.1966). I am not persuaded that there is any meaningful distinction between remuneration by one corporation rather than several corporations similar in structure. This is not, after all, an instance where it is alleged that a minority director received payments from the investment adviser or other persons whose interests conflict with those of the Fund. The plaintiffs’ contention that a minority director of a mutual fund can never act independently given the re- lationship between mutual funds and their advisers par- allels, to some extent, their previously rejected argument that the business judgment rule should not apply to mutual funds registered under the Investment Company Act of 1940. In making this claim, plaintiffs apparently rely upon Fogel v. Chestnuti, 533 F.2d 731 (2d Cir. 1975), cert. de- nied, 429 U.S. 824, 97 S.Ct. 77, 50 L.Ed.2d 86 (1976), but that decision is inapposite. In the Fogel case, two mutual fund stockholders brought a derivative suit on behalf of a mutual fund against several affiliated fund directors and the advisor to the fund. The plaintiffs sought to recapture a portion of the brokerage commissions paid on fund trans- actions on the theory that the affiliated directors had ‘‘in- tentionally misled and misinformed the [f]und’s unaffili- ated directors by telling them that such recapture was not available to the [f]und.’’ Jd. at 737. Writing for the Fogel panel, Judge Friendly observed that : ‘Congress had mandated independent directors in order ‘to supply an independent check on manage- A. 30 Second Opinion of the District Court ment and to provide a means for the representation of shareholder interests in investment company af- fairs.’ [citation omitted]. The minimum requirement to enable the [f]und’s independent directors to dis- charge these duties with respect to recapture was a careful investigation of the possibilities performed with an eye eager to discern them rather than shut against them, and, if these possibilities were found to be real, a weighing of their legal difficulties and their economic pros and cons. It would have been still better to have the investigation of recapture methods and their legal consequences performed by disinterested counsel furnished to the independent directors.” Id. at 749-50. Significantly, Judge Friendly went on to observe that: ‘“‘If this had been done and the independent di- rectors had concluded that, because of legal doubts, business considerations or both, the [f]und should make no effort at recapture, we would have a different case.’’ Id. at 750. In the instant action, the minority directors were furnished with disinterested counsel who analyzed the lgal consequences of each alternative available to the disin- terested quorum. Morcover, the affidavit of the quorum chairman and the minutes of the special meetings indicate that the minority directors acted only after they had fully considered the options available to them. Clearly, then, under Fogel it was proper for them to determine what the Fund’s posture would be. A. 31 Second Opinion of the District Court IV The plaintiffs next contend that the lack of true inde- pendence and disinterestedness on the part of the minority directors is apparent from the manner in which they decided to seek dismissal in the instant action. In support of this claim, plaintiffs point to the actions of Roger T. Wickers, an Anchor vice-president who formerly served as the secre- tary to the Fund, and Fugene P. Souther, who was retained as special counsel to the Fund for the purposes of this liti- gation, as well as to the circumstances surrounding the meet- ings of the minority directors. At the direction of defendant Haire, Wickers explored the possibility of retaining special counsel for the disin- terested quorum. After contacting several distinguished attorneys, Wickers reported that Judge Fuld would be available to serve the minority directors and, at a Board meeting held on July 24, 1974, it was Wickers who pro- posed that a disinterested quorum act for the Fund in the instant action. Wickers also coordinated the arrangements for Judge Fuld’s investigation for the minority directors, who were residents of several different states. The plaintiffs maintain that ‘‘the inappropriateness of Wickers role as intermediary is manifest,’’ but I disagree. The plaintiffs have not set forth any facts in support of their suggestion that Wickers improperly influenced the deliberations of the disinterested quorum. Instead they have engaged in totally unsubstantiated supposition. For example, plaintiffs contend that Wickers retained Judge Fuld, but the sworn. affidavit of Wickers and the deposition of at least one minority director establish that Judge Fuld was retained by the minority directors to act upon instrue- tions communicated to him at the direction of the disin- A. 32 Second Opinion of the District Court terested quorum." In the absence of some factual support for the plaintiffs’ allegations, the court cannot conclude that it was improper for Wickers to coordinate the ad- ministrative details of Judge Fuld’s inquiry or that Wickers’ actions reduced the independence of the minority directors. It is the court’s opinion that the role of Souther was equally innocent. The plaintiffs advance two reasons why it was inappropriate for him to participate as he did in the deliberations of the disinterested quorum. First, they note that he was an ‘‘interested person’’ within the meaning of § 2 of the Investment Company Act, 15 U.S.C. § 80a-2(a)(19)(A)(iv)* because his law firm had acted as legal counse) to the Fund during the last two fiscal years. They question whether the minority directors could arrive at a disinterested decision when they were advised by an attorney who was ‘‘interested.’’ Second, the plaintiffs con- tend that it was improper for his firm to counsel parties with divergent interests, namely the Fund and the disin- terested quorum. All attorneys providing legal counsel to mutual funds hecome, by definition, “interested persons’’ for some period * Even if Wickers did retain Judge Fuld for the minority directors, I see nothing improper in that. In fact, in Fogel, supra, Judge Friendly suggested that it was desirable for disinterested counsel to be “fur- nished” to the independent directors.’ * Under the statute: “(19) ‘Interested person’ of another person means— (A) when used with respect to an investment company— * * * ” » (iv) oe nae ae at any time since the beginning of the last two fiscal years of ee ee See ae See eee Oe Dany . . A. 33 Second Opinion of the District Court of time. Under §10 of the Investment Company Aet, 15 U.S.C. §80a-10, only 60 percent of the members of the board of a registered company may be interested persons. Designating Souther as an interested person, therefore, only serves to limit his participation on the Board as a director. It does not mean that the minority directors were interested in the suit, that their deliberations were some- how subject to improper influence or that they lacked tie necessary degree of independence. Plaintiffs nevertheless suggest that in accordance with Judge Frankel’s recent decision in Papilsky v. Berndt, CCH Fed.See.L. Rep. § 95,027 (S.D.N.Y. 1976), it was im- proper for Souther to advise both the Fund and the minority directors. However, in Papilsky the law firm advising the fund also served as the investment adviser’s counsel, and, as Judge Frankei noted, there was no ‘‘suggestion to the Board that, because of the possible conflict of interest, the independent directors should seek disinterested counsel.’’ Jd. at 90, 133. In the instant action, independent legal ad- vice for the minority directors was not only recommended, it was also obtained. Moreover, there was no conflict of interest on the part of Souther or his law firm: they were retained to represent the Fund in the instant action and it was the disinterested quorum, acting for the Fund, which gave them their instructions as to how to proceed. The plaintiffs also contend that the presence of several defendants during the initial presentations of Judge Fuld and Souther at the first special meeting of the dis- interested quorum demonstrates the minority directors’ lack of independence. But the minutes of that meeting and the deposition testimony show that the minority directors in- ,vited those defendants to join the meeting so that they could A. 34 Second Opinion of the District Court answer questions raised by the minority directors. The minutes of the meeting also indicate that all of the de- fendants and counsel were excused before the disinterested quorum determined in executive session that it wished to review the pertinent documents and formulate further ques- tions to be answered before reaching any decision. In this context plaintiffs point to the allegedly mislead- ing nature of statements made to the minority directors by defendant Haire. The minutes of the first special meeting of the disinterested quorum state that Haire ‘‘questioned the ability of Anchor to attract and retain the highly quali- fied personnel they want and need if [the instant action] were being pursued with the acquiescence, if not under the control, of the Fund.’’ The plaintiffs consider this to be in sharp disagreement with Haire’s testimony at his dis- position that he ‘‘never at any time had any doubt that [Anchor] could continue to effectively serve the [F]und if . . . requested to continue or permitted to continue by the board or the shareholders.’’ Apparently to underscore the materiality of Haire’s discouraging words to the mi- nority directors, plaintiffs note the contents of an affidavit by the chairman of the disinterested quorum. ‘In that affi- davit, the quorum,chairman states that in reaching their decision the directors considered that: ‘*(e) If the action were to proceed against Anchor with the acquiescence or under the control of Funda- mental, the adversary relationship that would be created between Fundamental and Anchor and the attendant serious distraction of Anchor’s personnel from their efforts on behalf of the shareholders of Fundamental would leave us no practical alternative but to remove Anchor as investment advisor and to seek to retain a new investment advisor; this would A. 35 Second —— of the District Court necessarily result in delay, uncertainty and an inevi- table lapse in the management of Fundamental’s affairs to the serious detriment of its share- holders .. .’’ The court is of the opinion that Haire’s statements are neither inconsistent nor misleading. His assertions only indicate that he believed it would have been difficult, but not impossible, for Anchor to have continued its service to the Fund faced with this lawsuit. The affidavit of the disinterested quorum chairman shows only that the minor- ity directors reached a different conclusion: that prosecu- tion of the suit ‘‘would necessarily cause the Fund to seek to obtain a different investment adviser immediately.’’ Even if the minority directors erred in this determination, as I have noted in my previous decision, the court cannot upset their reasoned judgment without some showing that the independence of the disinterested quorum was imper- missibly curtailed. The plaintiffs have not presented any such evidence. V Finally, the plaintiffs contend that under Perlman v. Feldman, 219 F.2d 173, 178 (2d Cir.), cert. denied, 349 U.S. 952, 75 S.Ct. 880, 99 L.Ed. 1277 (1955), and Pepper v. Lit- ton, 308 U.S. 295, 306, 60 S.Ct. 238, 84 L.Ed. 281 (1939), the defendant directors bear the burden of proving by clear and convincing evidence that they did not breach their fiduciary responsibilities to the corporation and its stock- holders. The defendants argue that the plaintiff must shoulder the evidentiary burden because it is the exercise of business judgment by corporate directors which is chal- A. 36 Second Opinion of the District Court lenged. Bellis v. Thal, 373 F.Supp. 120, 124 (E.D.Pa.1974), aff'd, 510 F.2d 969 (3d Cir. 1975); Marco v. Bank of New York, 272 F.Supp. 636, 639 (S.D.N.Y. 1967), aff’d, 398 F.2d 628 (2d Cir. 1968); Warshaw v. Calhoun, supra, ‘The Perlman and Pepper cases relied upon by the plain- tiffs both involve self-dealing by corporate fiduciaries and are inapplicable here. As I noted in my earlier decision in this matter, the plaintiffs ‘‘have not argued that the minority directors have acted fraudulently or corruptly.’’ 404 F.Supp. at 1180. Moreover, the question before the court is not whether the defendants breached their fiduciary obligations to the corporation, but whether suit can pro- ceed against them at all given the decision of the nonde- fendant minority directors to seek dismissal of this action. It is therefore incumbent upon the plaintiffs to establish that the minority directors actions lacked inde- pendence. Marco v. Bank of New York, supra. The unsup- ported contentions of the plaintiffs clearly fail to meet this burden and, accordingly, it is the opinion of this court that the defendants, both corporate and individual, cannot be required to proceed to a trial. I[ hasten to add, however, that even if the defendants are required as a matter of law to negate any suggestion of unfairness arising from the decision to abandon the derivative claims raised in this suit they have done so. The exhibits presented to the court on both the earlier motion to dismiss and the instant motion show that the minority directors carefully evaluated the opinions tendered by both counsel involved in this action, that they considered the merits of the derivative claims asserted in the complaint, that they discussed the facts and circumstances surrounding the purchase and retention of the notes with several of the defendant directors and that A. 37 Second Opinion of the District Court they communicated extensively among themselves before reaching a decision to seek dismissal of this suit. To conclude that the disinterested quorum acted in response to pressure and without justification to immunize Anchor and the defendant directors from pos- sible liability would require this court to presume that bias exists based upon circumstances which seem entirely inno- cent. For example, as has been noted, the plaintiffs suggest that a finding of improper influence must follow from the fact that the minority directors each knew someone on the Board when they were first selected for nomination or election to the Board. But the existence of casual relation- ships among the directors, without more, cannot be taken as an indication that the minority directors were unable to reach an independent business decision. Similarly, be- cause the Investment Company Act terms an attorney whose advice is sought to be an ‘‘interested person,’’ plain- tiffs seek to suggest that the minority directors had an interest in the contested transaction which went beyond a generalized concern for the security of the Fund.* But here again it was obviously reasonable for the minority directors to consult with interested persons, rather than reaching a decision without speaking to either the directors involved in the transaction or counsel. “In a similar effort to brand a minority director as interested, plaintiffs point to the following testimony by director Stephens: “T remember commenting [at the July 24, 1974 board meeting] on what constituted a disinterested director because in my opinion no director could be disinterested, but I was told that was the proper term. Later Stephens explained that he didn’t like the term “disinterested” since he certainly was not “uninterested.” or A. 38 Second Opiaion of the District Court The court of appeals for this circuit has recently cautioned that summary judgmert may not be granted unless, drawing all reasonable inferences in favor of the nonmovant, no material factual issue is shown. Hey- man v. Commerce and Industry Insurance Co., 524 F.2d 1317 (2d Cir. 1975). However, the party opposing the motion must adduce something beyond conclusory allega- tions. Donnelly v. Guion, 467 F.2d 290 (2d Cir. 1972). Here, there has been no showing by the plaintiffs of facts which, if proven, would prohibit the defendants from hiding ve- hind the business judgment cloak. Accordingly, the de- fendants are granted summary judgment. SO ORDERED. A. 39 Opinion of the Court of Appeals No. 23, Docket 77-7060. UNITED STATES COURT OF APPEALS, Seconp Circuit. Argued Aug. 31, 1977. Decided Jan. 11, 1978. ray —— Howanrp M. Lasker and Irvine Gopsere, Plaintiffs-Appellants, v. Haney G. Burks, Jz., Eowarp B. Burr, Tuomas F. Cuacxen, Joun R. Hame, Harvey C. Hopkins, 8S. P. Hurcuson, Dowarp L. Kemmerer, A. S. Mrxe Mowroney, Cuanres F. Pairs, Jeeroa H. Wave, Ancnor Corporation AND FounpaMenTat Investors, Inc., Defendants- Appellees. i. a Lumsarp, Cireuit Judge: This appeal by two mutual fund shareholders raises an important question of first impression: can minority directors: of a registered mutual fund, who were nominated by the majority directors of the fund to be ‘‘independent”’ directors pursuant to the requirements of the Investment Company Act, 15 U.S.C. § 80a-10(a), terminate a non- frivolous stockholder’s derivative action against the fund’s majority directors and its investment adviser? We are of the view that to permit such action by those ‘‘independent’’ ‘— A A A Sa A. 40 Opinion of the Court of Appeals minority directors of a registered mutual fund would be contrary to the public interests which Congress has sought to protect. Accordingly, we reverse the judgment of the distriet court which dismissed the complaint and remand for further proceedings. Howard Lasker and Irving Goldberg commenced this derivative action in February, 1973, against individuals who had been directors of Fundamental Investors, Inc. (the Fund), an open-end investment company ' registered under the Investment Company Act, 15 U.S.C. § 80a-1 to -52, and the Fund’s registered investment alviser, Anchor Cor- poration. The plaintiffs sought to recover losses sustained by the Fund in connection with its purchase between No- vember 28 and December 8, 1969, of $20 million in Penn Central 270-day notes from Goldman, Sachs & Co. The derivative complaint charged the defendants with viola- tions of (§ 13(a)(3) and 36 of the Investment Company Act, 15 USC. §§ 80a-13(a)(3), 80a-35 (1970), breach of their commen-law fiduciary duties, violations of 4 206 of the Investment Advisers Act, 15 U.S.C. § 80b-6 (1970), and breach of Anchor's investment advisory contract with the Fund. It is undisputed that Anchor never made any » indueee- dent investigation of Penn Central’s financial situation be- fore the Fund’s purchase of the notes. Moreover, although reports of Penn Central’s operations in early 1970 showed mounting losses, it was not until May that the Fund officers made any attempt to resell any part of the notes to Gold- ? An open-end investment is defined in § 5(a)(1) of the Investment Company Act, 15 USC. > eee (1970), as an investment company that offers “for sale has outstanding any re- decsiniiie enadiilies ef ettdh fe to Geo loser.” “Investment is defined in § 3(a) of the Act, 15 U.S.C. § 80a-3(a) (1970). A. 41 Opinion of the Court of Appeals man, Sachs, or otherwise to realize on the investment. On June 21, 1970, Penn Central filed a petition for reorganiza- tion which is still in process in the Eastern District of Pennsylvania. Consequently, the Fund’s Penn Central notes were not paid at maturity. In November 1970, the Fund, joined by three other note- holders,? sued Goldman, Sachs in the Southern District of New York for recovery of their losses arising from their purchases of Penn Central notes. In July 1973, then Dis- trict Judge Gurfein stayed the instant action, which had heen commenced five months earlier, pending resolution of the suit against Goldman, Sachs. That suit was settled on behalf of the Fund in July 1974. Under the settlement, Goldman, Sachs took back the Fund’s Penn Central notes, paid the Fund $5,250,000, and assigned to the Fund a 73.75 percent interest in the proceeds of the notes in the reor- ganization proceedings. The Fund’s co-plaintiffs did not settle, and the jury rendered verdicts in their favor against Goldman, Sachs for the full amount of their claims.* On July 24, 1974, the Fund’s board of directors met and diseussed the pending Lasker case. They decided that five of the statutorily disinterested direcvors, none of whom were involved in the derivative action,‘ should decide what action should be taken regarding the Lasker case, and act 2 In addition to the Fund, Welch Foods, Inc., C. R. Anthony Company, and Younker Brothers, Inc. sued Goldman, Sachs in a action. See Welch Foods Inc. v. Goldman, Sachs & Co., 398 F. . 1393 (S.D.N.Y. 1974). * See Welch Foods Inc. v. Goldman, Sachs & Co., 398 F.Supp. 1393 (jury verdict $.D.N.Y. 1974). * Of the remaining six directors of the eleven member board, all were defendants to the Lasker action and/or affiliated with Anchor. A. 42 Opin:on of the Court of Appeals accordingly on behalf of the entire board. This procedure had been discussed prior to the July board meeting by the defendant John R. Haire, president of the Fund and chair- man of Anchor’s board of directors, and Roger Wickers, an officer of both the Fund and Anchor. Upon Haire’s in- struction, W.ckers had ascertained that Stanley H. Fuld, former chief judge of the New York Court of Appeals, would be available to serve as special counsel. The minority directors agreed to consider what should be done about the Lasker case, and instructed Wickers to retain Judge Fuld to advise them. Judge Fuld, in his report of December 5, 1974, supple- mented on December 18, 1974, concluded, on the basis of the information furnished to him, that neither Anchor nor the Fund directors would be found liable under federal or state law. At the same time, Judge Fuld pointed out the absence of legal authority on whether a mutual fund’s investment adviser is required to conduct independent research regard- ing its investment recommendations. He further cautioned that it was ‘‘impossible to predict . . . what a trier of fact will find, particularly in complex cireumstances.’”’ After considering the special counsel’s reports, on January 6, 1975, the minority directors instructed counsel for the Fund to seek dismissal of the Lasker action on the ground that it was their business judgment that further prosecution of the action would not be in the best interests of the Fund. —_- — ~~ * Under the Fund's bylaws and Delaware la the Fund's twelve member board of directors constituted Sone > ~. the entire board. Del.Code tit. 8, § 141 (1975); Fundamental nvestors, Inc., Certificate of Incorporation, Article EIGHTH: Fun- damental Investors, Inc., Bylaws section 4, Article VI. The five directors appointed to review the Lasker action were: Leon Kendal, elected to the board in June 1974; Beryl Robichaud, 1975; Mary OCeane, Gaued in tae lofted tee : onnor, in June 1972; i became a director in the fall of 1971. a A. 43 Opinion of the Court of Appeals Judge Werker, in passing on the motion to dismiss, held that the minority directors, in the exercise of their business judgment, had the power to bar further prosecution of the case, provided they were truly disinterested and independ- ent. As a factual issue had been raised regarding whether the minority directors were independent and disinterested, he granted discovery on that issue. Lasker v. Burks, 404 F.Supp. 1172 (S.D.N.Y.1975). After such discovery, the motion to dismiss was renewed and granted by Judge Werk- er on January 7, 1977. In his second opinion, 426 F.Supp. 844 (S.D.N.Y.1977), Judge Werker found no factual sup- port for the conclusion that the minority directors had not acted independently. In accordance with his earlier opin- ion, he dismissed the complaint. From what this record discloses regarding the Fund’s investment in Penn Central notes on Anchor’s advice, we cannot say that, following a trial on the merits, the defend- ants would be found free from liability for the Fund’s losses. We see nothing in the findings of Congress, the legislation regulating investment companies and their ad- visers, or in the decisions of the courts which suggests that under such circumstances disinterested directors, such as the five who acted here, have the power to terminate litiga- tion brought by mutual fund stockholders against the fund’s investment adviser and its majority directors for breach of their fiduciary duties. On the contrary, the findings of Con- gress, the statutory scheme, and the relevant case law per- suade us that the statutorily disinterested directors of a reg- istered investment company were never meant to have the final word in determining whether it is in the best interest of a mutual fund to press claims against their co-directors, and the adviser with which those directors are affiliated, for breach of fiduciary duties. A. 44 Opinion of the Court of Appeals In response to disclosure of grave abuses in the manage- ment of investment companies, Congress in 1940 enacted the Investment Company Act (ICA), 15 U.S.C. §§ 80a-1 to -52 (1970), and the Investment Advisers Act (IAA), 15 U.S.C. §§ 80b-1 to -21 (1970). Congress acted after receiving a report from the Securities and Exchange Commission which showed that investment funds were organized by invest- ment advisers; that the funds were administered under contracts that where highly favorable to the advisers; that the directors of the funds were selected by the investment adviser; and that the board was usually dominated by per- sons affiliated with the adviser. Congress found that nu- merous practices in the management of such funds adverse- ly affected the national public interest and the interest of investors. Accordingly, Congress declared it to be the policy and purpose of the ICA to mitigate and eliminate those aspects of the conduct and administration of the funds which benefitted the managers and adversely affected the stock- holders of the fund.’ The ICA provides that no more than 60% of a regis- tered company’s board of directors can be ‘‘intereste. persons’ affiliated with the investment adviser.” More- over, it gives the statutorily disinterested directors, usually referred to as *‘independent directors,’’ certain powers to supervise management and auditing arrangements.” Thus, * See SEC, Report on the Study of Investment Trusts and Invest- ment Companies. pt. 3, 1-49, 1922 (1940). See also Comment, Duties of the Independent Directors in Open-End Mutual Funds, 70 Mich.L.Rev. 696, 701 (1972). * See 15 U.S.C. § 80a-1 (1970). “See 15 U.S.C. §§ 80a-10, 80a-2(a)(3), (19) (1970). * See generally Comment, Duties of the Independent Director in Open-End Mutual Funds, 70 Mich.L.Rev. 696 (1972). A. 45 Opinion of the Court of Appeals section 15(c) of the ICA, 15 U.S.C. § 80a-15(c) (1970), imposes on the disinterested directors the duty to review and approve the contracts of the investment adviser and the principal underwriter; section 16(b), 15 U.S.C. § 80a- 16(b) (1970), provides that the statutorily disinterested directors will appoint other disinterested directors to fill vacancies resulting from the assignment of the advisory contracts; and section 32(a), 15 U.S.C. § 80a-31(a) (1970), requires that the accountants who prepare the investment company’s Securities and Exchange Commission financial filings be selected by the statutorily disinterested directors. We conclude, therefore, that the statutes were designed to interpose statutorily disinterested directors as a check on the actions of the majority directors controlled by the in- vestment adviser. It would be contrary to the legislative purpose to permit the independent minority to be used to approve majority action so that no stockholder complaint could survive that approval. Congress has not heen satisfied, moreover, that the presence of disinterested directors who observe their duties will be sufficient protection to the stockholders, as it has specifically provided in section 36(b) that shareholders may sue derivatively to recover excessive fees to the ad- viser and the priniepal underwriter. See 15 U.S.C. 6 80a- 35(b) (1970). Section 36(b) was enacted as a part of the 1970 amendments, which resulted in part from the Senate report which indicates that the mere presence of disin- terested directors on the boards of mutual funds was not sufficient to protect funds against overreaching investment advisers."” See 1970 U.S.Code C & Admin.News, pp. 4897, 4901. In 1970 both the ICA and the IAA were substantially amended. Sce Act of December 14, 1970, Pub.L. No. 91-547, 84 Stat. 1413. — ~ eee A. 46 Opinion of the Court of Appeals We have been sensitive to the need for protection of the public interest in accordance with the views of Congress. Thus, in Galfand v. Chestnutt, 545 F.2d 807 (2d Cir. 1976), we found that the investment adviser had abused its posi- tion of trust by securing a favorable modification of its ad- visory contract without fully disclosing to the fund’s di- rectors the ramifications of the changes. Writing for the panel, Chief Judge Kaufman observed that, ‘‘[¢)he rela- tionship between investment advisers and mutual funds is fraught with potential conflicts of interest. The typical fund ordinarily is only a shell, organized and controlled by a separately owned investment company adviser, which selects its portfolio and administers its daily business.’’ Id. at 808. See also Tannenbaum v. Zeller, 552 F.2d 402 (2d Cir. 1977). Moreover, in many instances where no specific authority is granted by statute the courts have inferred that stock- holders may bring suit. See, e.g., Abrahamson v. Flesch- ner, 568 F.2d 862 at 873 (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 liability which may amount to many millions of dollars, and fore- close the stockholders from continuing such litigation, while at the same time stockholders by statute are empowered to recover excess fees paid the adviser and underwriter. In the ordinary routine of running an investment trust, the disinterested directors must constantly deal with inte- rested directors in a spirit of accommodation. Indeed, they are compelled for the most part to rely on the information and expert advice provided by the adviser and the majority directors."" The continued service of the statutorily disin- ~ '' See Comment, supra note 9, at 702. A. 47 Opinion of the Court of Appeals terested directors, for which in this case they were paid from $11,000 to $13,000 per annum"?, depends almost entire- ly on the establishment of satisfactory working arrange ments between them and the majority responsible for their selection, It 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 decision would be likely to result in con- siderabie expense and liability for the individuals con- cerned,.’* 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 re- quires. It follows that disinterested directors of an invest- ment company do not have the power to foreclose the con- tinuation 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 company to termin- ate a shareholder derivative suit which the court finds to be frivolous. Our conclusion makes it unnecessary to consider the find- ings of the district court that the disinterested directors were sufficiently independent to determine that the litigation '2 In addition to their role as directors of the Fund, each of the five minority directors served on the boards of five other Anchor SS See eee a sat on a sixth Anchor relat , 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). A. 48 Opinion of the Court of Appeals be ended.'* We have no doubt that the five minority direc- tors acted in good faith in all that they did. Reversed and remanded for further proceedings. '* 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 nature of the investment company and its symbiotic relationship with its investment adviser, smal odds cana a Ge Uieameen anen adie by directors of other types Moreover, none of these cases involves the situation ag my where the terminating directors owe their position as directors to the defendants in the suit. COMPLAINT A. 49 Complaint UNITED STATES DISTRICT COURT SourHrrn District or New York 73 Civ. 552 (HFW) tt. a Howarp M. Lasker and Irvine “oLpBERG, Plaintiffs, against Harry G. Burks, Jr., Eowarp B. Burr, THomas F’. CHALKER, Joun R. Hame, Harvey C. Hopkins, ©. P. Hutcutison, DonaLp L. Kemmerer, A. S. Mrke Monroney, Cuarzes F. Puiturs, JeptHa H. Wane, AncHor Corporation, and FuNDAMENTAL Investors, Inc., Defendants. 4) a Puatntirrs Demanp TRIAL By Jury Plaintiffs cllege on information and belief, except as to Paragraphs 2 and 6, which are alleged upon knowledge by each of said plaintiffs: 1. The jurisdiction of this Court over this action is based upon Section 44 of the Investment Company Act of 1940 (15 U.S.C. § 80a-43), Section 214 of the Investment Advisers Act of 1940 (15 U.S.C. § 80b-14) and principles of pendent jurisdiction. 2. Plaintiff Howard M. Lasker is, and at the time of the transactions complained of was, the beneficial owner of shares of Fundamental Investors, Inc. (the ‘‘Fund’’). A. 50 Complaint Plaintiff Irving Goldberg is, and at the time of the trans- actions complained of was, the record owner of shares of the Fund. Plaintiffs bring this action derivatively on behalf and in the right of the Fund. 3. The Fund is, and at the time of the transactions com- plained of was, a corporation organized under the laws of the State of Delaware and a registered investment company under the Investment Company Act of 1940. 4. Defendant Anchor Corporation (the ‘‘ Adviser’’) is, and at the time of the transactions complained of was, a cor- poration organized under the laws of the State of Delaware and a registered investment adviser under the Investment Advisers Act of 1940. 5. Defendants 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 and Jeptha H. Wade (the ‘‘ Fund directors’’) were directors of the Fund at all times men- tioned. 6. This action is not brought collusively to confer upon this Court jurisdiction which it otherwise would not have and plaintiffs will fairly and adequately represent the inter- ests of the Fund and its stockholders in enforcing the Fund's rights. 7. (a) No demand has been made by the plaintiffs upon the Board of Directors of the Fund to institute this action against the individual defendants and the Adviser because the Fund’s Board of Directors is dominated and controlled by the Adviser and the individual defendants continue to be a majority of the Fund’s Board of Directors and they have A. 51 Complaint participated, cooperated and aided and abetted in the wrongful acts, transactions and delinquencies complained of. No action could or would be permitted to be instituted by the Fund without the consent of the Fund directors. The Fund’s Board of Directors for a considerable time has been fully aware of the wrongful acts herein alleged and has nevertheless failed to take action. Consequently, any de- mand upon the Fund’s Board of Directors would be futile and useless and any such action that would be instituted by the Board of Directors on behalf of the Fund would be friendly to the defendants, would not be diligently prose- cuted and would be hostile to the interests of the Fund and its stockholders. (b) No demand has been made upon the stockholders of the Fund to institute this action on behalf of the Fund be- cause under applicable law and the certificate of incorpora- tion and by-laws of the Fund, its directors and officers are vested with the management of the Fund, including the in- stitution of all actions on behalf of the Fund, and the stock- holders as a body cannot by resolution compel the directors to institute suit on behalf of the Fund. A resolution by the stockholders of the Fund directing the institution of this action would be futile and useless because the prosecution of the action would be placed in the control of the Fund’s Board of Directors, the majority of whom are defendants and who had knowledge of and participated, cooperated and aided and abetted in the wrongs alleged herein. Further- more, the stockholders of the Fund are very numerous and the solicitation of proxies from such a large number of stockholders would place an unreasonable and useless bur- den and expense on plaintiffs, and extended delays would result which would be harmful and seriously prejudicial to the prosecution of this action. A. 52 Complaint Fimst Ciam ror Reuier 8. Plaintiffs repeat and reallege Paragraphs 1 through 7 of the Complaint. 9. This claim arises under Section 36 of the Investment Company Act of 1940. 10. On the following dates and in the amounts indicated, the Fund purchased interest bearing commercial paper of Penn Central Transportation Company (‘‘ Penn Central’’) in the Southern District of New York from Goldman, Sachs & Co. (**Goldman, Sachs’’), which acted as principal, by use of the mails and the means and instrumentalities of in- terstate commerce: Amount of Date of Purchase Purchase November 28, 1969 ............ $ 5,000,000 December 2, 1969 ............ 5,000,000 December 4, 1969 ............ 5,000,000 December 8, 1969 ............ 5,000,000 $20,000,000 11. At all relevant times the Fund directors were re- sponsible for determining the basic investment policies of the Fund and the Adviser acted as investment adviser to the Fund and was responsible for making recommendations to the Fund with respect to purchase and sale of all invest- ments, including commercial paper. During 1969 the Ad- viser received, pursuant to its investment advisory contract, in excess of $4,500,000 from the Fund for investment super- visory and corporate administrative services and in excess of $300,000 in net sales commissions as principal under- writer of the Fund’s shares. A. 53 Complaint 12. In making the purchases alleged in Paragraph 10, the Fund directors and the Adviser relied solely and ex- clusively on Goldman, Sachs and made no independent in- vestigation of the financial condition of Penn Central or the quality of its commercial paper including, where feasi- ble, among other things, the following: examination and analysis of quarterly or more frequent financial statements ; calculation of debt-equity ratios; obtaining of lists of open bank lines of credit and inquiry as to whether any such were used; calculation of the ratio of current assets to current liabilities; examination and analysis of debt posi- tion to check for defaults; review of the appropriate Docket of the Interstate Commerce Commission with re- spect to the proposed issuance of commercial paper by Penn Central; verifying creditworthiness of issuer with custodian bank; inquiry with respect to maximum amount of bank lines of credit ever used; examination of percentage of commercial paper outstanding backed by usable lines of credit; obtaining cash flow statement, if available. In fail- ing to make the foregoing investigation, the Adviser failed to meet its responsibility as the Fund’s investment adviser, for which investment management and advice it received the very substantial compensation set forth in Paragraph 11. The Fund directors knew or should have known of, and acquiesced in, the failure by the Adviser to meet its re- sponsibility and failed to meet their responsibilities ax members of the Fund’s Board of Directors. 13. If the Fund directors and the Adviser had made an independent investigation of the financial condition of Penn Central and the quality of its commercial paper in connection with the Fund’s purchase of Penn Central com- mercial paper (including a review of material available in A. 54 Complaint the public press), they would have learned at least the fol- lowing material adverse facts. (a) The commercial paper of Penn Central was not prime quality commercial paper; (b) Goldman, Sachs had made inadequate inde- pendent investigation of the financial condition and affairs of Penn Central and was not continually re- viewing the same to ascertain whether Penn (Central commercial paper was of prime quality or to eval- uate the advisability of purchases of said commercial paper by the Fund; (c) Penn Central had for some time been facing severe cash shortages and difficulties in obtaining financing to meet its operating expenses, improve- ment costs and debt maturities ; (d) Penn Central had for some time been unable to obtain long-term financing and had, since at least as early as 1968, become almost completely depend- ent upon short-term, high interest financing, had been required to maintain substantial compensating balances at its lending banks and had no present prospects for obtaining long-term financing; (ec) Penn Central had virtually exhausted all possibilities to obtain bank loans, had already pledged virtually all of its assets to its bank creditors and had no assets to pledge or otherwise use to ob- tain further loans or financing or to cover or meet its commercial paper obligations ; (f) Penn Central was using the funds which it obtained from the sales of its commercial paper to A. 55 Complaint refinance its debt maturities rather than for its cur- rent operating expenses ; (x) Penn Central was undergoing extraordinarily large and rapidly increasing operating losses and working capital deficits ; (h) During 1970 Penn Central would have to have available far in excess of $200,000,000 merely to meet debt maturities and interest costs and would have to raise other substantial and unavailable sums to meet its other anticipated expenses ; (i) In an application by Penn Central to the Interstate Commerce Commission for approval to issue commercial paper, the Interstate Commerce Commission and its staff had expressed serious con- cern over the heavy dependence of Penn Central upon short-term financing ; (j) Penn Central had no firm commitments by commercial banks to assure that it would have suffi- cient funds to redeem its outstanding commercial paper at maturity, and did not have bank lines of credit sufficient for that purpose; (k) Most banks were at or near their legal or practical lending limits with respect to Penn Central and were looking to reductions of their loans rather than increases and it was highly doubtful that Penn Central could obtain authorization from the Inter- state Commerce Commission to issue additional com- mercial paper beyond the $200,000,000 then author- ized ; (1) In November 1969 Penn Central reported a loss of approximately $40,200,000 for the first nine A. 56 Complaint months of 1969 as compared to a loss of approxi- mately $13,800,000 for the comparable period in 1968 ; (m) On or about November 29, 1969, the Board of Directors of Penn Central’s parent company omitted that corporation’s regular fourth quarter dividend. 14. On June 21, 1970 Penn Central filed a petition for reorganization under Section 77 of the Bankruptcy Act (11 U.S.C. § 205). 15. The Penn Central commercial paper held by the Fund was not paid at maturity and is presently in default and the Fund has not received any payment with respect to such commercial paper up to the date of this Complaint, thereby resulting in a loss to the Fund of $20,000,000 plus accrued interest. 16. By reason of the foregoing, defendants, in contra- vention of Section 36 of the Investment Company Act of 1940, engaged in acts and practices constituting gross mis- conduct and a gross abuse of trust in respect of the Fund. Seconp CLam For Rewer 17. Plaintiffs repeat and reallege Paragraphs 1 through 7 and Paragraphs 10 through 15 of the Complaint. 18. This claim arises under Section 206 of the Invest- ment Advisers Act of 1940. 19. By reason of the foregoing, the Adviser, in contra- vention of Section 206 of the Investment Advisers Act of A. 57 Complaint 1940, by use of the mails and the means and instrumentali- ties of interstate commerce, engaged in transactions, prac- tices and a course of conduct which operated as a fraud and deceit upon the Fund and engaged in acts, practices and a course of conduct which were fraudulent. Turep Cuam For Reuier 20. Plaintiffs repeat and reallege Paragraphs 1 through 7 and Paragraphs 10 through 15 of the Complaint. 21. By reason of the foregoing, the defendants violated their common law fiduciary duty to the Fund and are jointly and severally liable and accountable to the Fund for all loss and damage which it has suffered and will suffer by reason of the acts, transactions and delinquencies complained of. Fovurtsa Ciaim For Reiser 22. Plaintiffs repeat and reallege Paragraphs 1 through 7 and Paragraphs 10 through 15 of the Complaint. 23. By reason of the foregoing, the Adviser breached its investment advisory contract with the Fund and the Fund directors participated and aided and abetted in the breach of said investment advisory contract in that the Adviser failed to make an independent investigation of the financial condition of Penn Central and the quality and safety of its commercial paper and the Fund directors acquiesced in such failure, thereby damaging the Fund as alleged, and the defendants are jointly and severally liable A. 58 Complaint and accountable to the Fund for all loss and damage which it has suffered and will suffer by reason of the breach of the investment advisory contract complained of. Fiera Cram For Revier 24. Plaintiffs repeat and reallege Paragraphs 1 through 7 and Paragraphs 10 through 15 of the Complaint. 25. This claim arises under Section 36 of the Invest- ment Company Act of 1940. 26. From November 28, 1969 to June 21, 1970, the date of the filing of a petition for the reorganization of Penn Central under Section 77 of the Bankruptcy Act, the finan- cial condition of Penn Central worsened steadily and Penn Central commercial paper became an increasingly poor in- vestment. 27. During the period from November 28, 1969 to June 21, 1970, the Adviser and the Fund directors failed to com- mence a thorough and adequate investigation of, and keep under continuous review, the financial condition of Penn Central and the quality and safety of its commercial paper. 28. If such investigation and review had been made (in- cluding a review of material available in the publie press), the Adviser and the Fund directors would have learned at least the material adverse facts, among others, set forth at subparagraphs (a)-(m), inclusive, of Paragraph 13 of this (Complaint as well as at least the following material adverse facts: (a) Penn Central’s losses for 1969 had increased to approximately $56,300,000 from approximately $5,100,000 for 1968; A. 59 Complaint (b) The losses of Penn Central for the first quar- ter of 1970 were approximately $62,700,000 ; (c) On or about February 12, 1970, Penn Central repurchased at face value $10,000,000 of its com- mercial paper from Goldman, Sachs; (d) Penn Central had virtually exhausted its ability to obtain short term financing in the United States; (e) Penn Central and its parent company had begun to borrow heavily at high interest rates in Eu- rope from borrowers who were relatively unsophisti- cated about Penn Central ; (f) On or about April 22, 1970, there commence! a rapid run on Penn Central commercial paper ani it became virtually impossible for Goldman, Sachs to resell Penn Central commercial paper as it became due ; (g) On or about May 9, 1970, high Penn Central officials met with the Secretary of the Treasury with respect to emergency Government assistance for the failing railroad ; (h) On or about May 15, 1970 Standard and Poor’s reduced the credit rating of Penn Central's parent company from BBB to BB. 29. During the period from November 28, 1969 to June 21, 1970, the Fund directors failed in their obligations to make adequate attempts to resell (as did Goldman, Sachs as referred to in subparagraph (c) of Paragraph 28) the Penn Central commercial paper held by the Fund and the Adviser failed to advise the Fund of the advisability of making such attempts. a% . . . {From pp. 13-14] Furthermore, plaintiffs erroneously argue that ‘‘ Anchor controls the selection and nomination of the Fund’s board of directors including the so-called independents’’ (Memo- randum in Opposition, p. 41)—this is simply false and un- informed. The nominees for directorships are searched for and recommended by the Directors’ Qualifications Committee, an independent committee of the Board of Directors con- sisting of two outside directors not affiliated with Anchor and the President of the Funds who is affiliated with Anchor. Majority vote governs recommendation of nomi- nees and, accordingly, it simply is not true, as plaintiffs assert, that ‘‘ Anchor controls the selection and nomination of the Fund’s board of directors including the so-calle | independents.’’ Each of the five disinterested directors who made the decision to terminate this litigation was originally selected by the Directors’ Qualifications Committee. The five come from widely different backgrounds, and have, in common, excellence in their respective fields of endeavor. None of the five had any prior connection with Anchor. PAPERS ON RENEWED MOTION TO DISMISS A. 145 Affidavit of Roger T. Wickers, Sworn to July 23, 1976 in Support of Renewed Motion to Dismiss UNITED STATES DISTRICT COURT SoutHern District or New York 73 Civ. 552 (HFW) yr = Howarp M. Lasker, et ano., Plaintiffs, agamst Harry G. Burks, Jr., et al., Defendants. sy ww State or New York / _ | County or New York | = Rocer T. Wickers, being duly sworn, deposes and says: 1. I am Senior Vice President of Fundamental In- vestors, Inc. (‘‘Fundamental’’), and I submit this affidavit in support of the renewed motion by Fundamental to dis- miss this action. 2. Permission of the Court to renew the motion to dis- miss was expressly granted in the Memorandum Decision and Order dated September 24, 1975, as amended October 17, 1975, and reported at 404 F. Supp. 1172 (S.D.N.Y. 1975) (Werker, J.). For the convenience of the Court, a copy of the Memorandum Decision and Order is annexed hereto as Exhibit A.* * To avoid unnecessary repetition, I respectfully seek leave of this Court to i rate herein by reference the moving papers and reply papers of defendants on the original motion to dismiss. Those papers are part of the file of this action, and, if desired, an addi- tional set will be made available to the Court. A. 146 Affidavit of Wickers in Support of Renewed Motior to Dismiss Prior ProceepineGs 3. Fundamental, joined by all other defendants, moved to dismiss this action on the grounds that it was not in the best interests of the shareholders of Fundamental. The motion was made pursuant to a determination by a quorum of disinterested directors in the exercise of their business judgment, after receiving the advice of independent special counsel. Plaintiffs opposed the motion on numerous grounds. This Court, in the Memorandum Decision and Order, considered and rejected each and every argument advanced by plaintiffs in opposition to the motion by defendants to dismiss. 4. The sole issue that was left open by this Court in the Memorandum Decision and Order is: were the five members of the Board of Directors of Fundamental who made the decision to move to dismiss this action disinterested and independent, or were they, as plaintiffs contend, interested and lacking independence. This Court wrote (404 F. Supp. at p. 1180): ‘‘If the minority directors were truly disinterested and independent the Court will not substitute its judgment for that of the Board.”’ 5+. This Court then permitted plaintiffs ‘‘to pursue dis- covery with respect to the relationships of the minority directors and the Qualification Committee to determine whether the minority directors were disinterested or inde- pendent.’’ 404 F. Supp. at p. 1180. The discovery has now been completed and the results are described hereinbelow. A. 147 Affidavit cf Wickers in Support of Renewed Motion to Dismiss Tue Discovery ProceEepiIncs 6. Plaintiffs conducted the depositions of each and every one of the five members of the Disinterested Quorum, as well as the deposition of the Chairman of Anchor Corpora- tion (‘‘Anchor’’), the investment adviser to Fundamental. The testimony exceeds 1,000 pages of transcript. In addi- tion, defendants made two major document productions, satisfying all requests made by plaintiffs for production of documents. 7. Despite extensive discovery proceedings, the plain- tiffs have failed to turn up any evidence whatsoever that any of the five directors who made the decision for the Board (Messrs. Kendall, Stephens and Laun, Dr. Robichaud and Mrs. O’Connor) was not truly disinterested and inde- pendent, 8. Each of the five directors submitted himself or her- self to extensive, probing questioning on their business and personal relationships with all of the named defendants. The testimony is abundantly clear that none of these five persons—each a highly distinguished individual in his or her own career—was interested or lacking independence. Each made his or her own decision independently, thought fully and with the advice and assistance of eminent special counsel, Stanley H. Fuld, former Chief Judge of the State of New York. PERTINENT TESTIMONY 10. Dr. Beryl Robichaud, a Senior Vice President of McGraw Hill, Inc., testified that she had no prior business or professional relationship whatsoever with anyone from Anchor or any of the defendants (pp. 120-2) ;* that no one * References in parentheses are to pages of the deposition transcripts. A. 148 . Affidavit of Wickers in Support of Renewed Motion to Dismiss from Anchor attempted to influence her deliberations as a member of the Disinterested Quorum (p. 123); and that she made her decision in this case solely on the basis of what she believed to be in the best interests of the shareholders (pp. 124-5). Copies of the foregoing pages of testimony of Dr. Robichaud are annexed hereto as Exhibit B. 11. Mrs. Mary S. O'Connor, a director and member of the Executive and Trust Committees of the Central Home Trust Company, Elizabeth, New Jersey, and one of the first female officers of IBM, testified that she had no prior busi- ness or professional relationship whatsoever with anyone from Anchor or any of the defendants (pp. 83-6); that no one from Anchor or any of the defendants attempted to influence her deliberations as a member of the Disinterested Quorum (p. 86); and that she felt under no pressure what- soever from anyone at Anchor in connection with making her decision (p. 87). Copies of the foregoing pages of testi- mony of Mrs. O'Connor are annexed hereto as Exhibit C. 12. Leon T. Kendall, President of Mortgage Guaranty Insurance Corporation, Milwaukee, Wisconsin, testified that he had no prior business or professional relationship whatsoever with anyone from Anchor or any of the defend- ants (pp. 217-23); that he had never had any economic relationship of any kind with Mr. Haire (p. 224); that Mr. Haire never attempted to influence his deliberations as a member of the Disinterested Quorum (p. 225); and that he felt under no pressure whatsoever from Mr. Haire with respect to his deliberations as a member of the Disinterested Quorum (p. 225). The sole prior connection that Mr. Kendall had with Anchor Corporation was remote and immaterial; Anchor Corporation had been one of approxi- A. 149 Affidavit of Wickers in Support of Renewed Motion to Dismiss mately 600 members of a trade association called the Invest- ment Bankers Association which was merged into another association called the Securities Industry Association, of which Mr. Kendall was President (pp. 217-23). Mr. Ken- dall, in summing up the situation, testified as follows: Q. Can you tell us once again, in your own words, the extent of your business relationship or profes- sional relationship, if any, with Mr. Haire prior to the time that you became a director of Fundamental Investorst’’ A. I had no business, professional, economic, financial relationships with Mr. Haire. The only relationship that existed was in the Trade Association, which I headed, and of which his com- pany was a member.”’ (p. 226, see also 11-22). Copies of the foregoing pages of testimony of Mr. Kendall are annexed hereto as Exhibit D. 13. William J. Stephens, former Chairman and Chief Executive of Jones and Laughlin Steel Corporation, Pitts- burgh, Pennsylvania, testified that he had no prior business or professional relationship whatsoever with anyone from Anchor or any of the defendants, with the immaterial ex- ception that he knew the late Harvey Hopkins, one of the defendants, when they had both been in the steel industry, but that he had had no business relationship with Mr. Hopkins at any time subsequent to 1958 or 1959 (pp. 130- 5); that no one from Anchor, nor Mr. Hopkins, nor anyone else had attempted to influence his deliberations as a mem- ber of the Disinterested Quorum (p. 135); and that he felt under no pressure whatsoever from anyone at Anchor in his deliberations as a member of the Disinterested Quorum (pp. 136-7). Copies of the foregoing pages of testimony of Mr. Stephens are annexed hereto as Exhibit F. A. 150 Affidavit of Wickers in Support of Renewed Motion to Dismiss 14. Louis F. Laun, Deputy Administrator of the Small Business Administration, washington, D.C., testified that he had no prior business or professional relationship what- soever with anyone from Anchor or any of the defendants (pp. 148-51); that no one from Anchor had attempted to influence his deliberations as a member of the Disinterested Quorum (p. 152); and that he felt under no pressure what- soever from anyone at Anchor with respect to his delibera- tions as a member of the Disinterested Quorum (p. 152). Copies of the foregoing pages of the testimony of Mr. Laun are annexed hereto as Exhibit F. ConcLusion On the basis of the Memorandum Decision and Opinion of this Court, and on the basis of the discovery proceedings had herein, the renewed motion to dismiss this action should be granted. s/ Rocer T. Wickers Sworn to before me this 23rd day of July, 1976. A. 151 Affidavit of James C. Sargent Sworn to September 17 1976 in Opposition to Renewed Motion to Dismiss UNITED STATES DISTRICT COURT Sovutuern District or New Yorx 73 Civ. 552 (HF W) Howarp M. Lasker, et ano., Plaintiffs, against Harry G. Burks, Jr., et al., Defendants. Strate or New York /} County or New York | James C. Sarcent, being duly sworn, deposes and says: 1. I make this affidavit at the request of plaintiffs’ attorneys in connection with the motion by defendants to dismiss this action. 2. I was admitted to the Bar in the State of New York in 1940 and have been a practicing attorney since that time, except for service with armed forces during World War II and as a member of the Securities and Exchange Commis- sion thereafter. In 1955 I was appointed Regional Admini- strator of the Commission’s New York Regional Office. Shortly thereafter, I was appointed a member of the Com- mission and served in that capacity from June 29, 1996 A. 152 Affidavit of Sargent in Opposition until October 21, 1960. I have been a member of the faculty of the University of Virginia Law School and have lectured throughout the country in the fields of proxy contests, securities law and corporate law generally. 3. Traditionally in the mutual fund industry, outside directors, known at various times as ‘‘unaffiliated’’ or ‘‘dis- interested’? directors, have not been independent in any meaningful sense. The absence of real independence has resulted from a variety of causes. Typically, it is the management of a mutaal fund which screens and selects outside directors. Management thereby effectively retains the power to recruit persons friendly to itself to serve as outside directors. True independence is further negated by the pervasive control exercised by investment advisers over the invest- ment and management functions of mutual funds. This pattern of pervasive control has existed from the very inception of the mutual fund industry and was largely responsible for many of the serious abuses which led to the enactment of the Investment Company Act. Still another reason for the lack of independence on the part of the outside directors of a mutual fund is manage- ment’s control of the fund’s proxy machinery. Mutual funds are characterized by extreme diffusion of stock own- ership. Such diffusion of a company’s stock bears a direct relationship to the importance of the proxy machinery in the election of corporate directors—the more widely diffused the stock ownership, the greater the importance of the proxy machinery. For example, a typical mutual fund has tens of thousands of shareholders. There are few, if any, large blocks of stock. The average shareholder’s holdings in the fund are A. 153 Affidavit of Sargent in Opposition proportionately insignificant in relation to the fund’s total outstanding shares. Management, because of its control of the proxy machinery, has the power to nominate a slate of directors which invariably is elected without opposition. It costs many thousands of dollars to clear proxy materia! with the SEC and to make mailings to tens of thousands of fund stockholders. To defray such expense, management has at its disposal the corporate treasury. However, for an individual shareholder of a mutual fund, or for a dissi- dent, truly ‘‘independent’’, outside director, a contested election in opposition to management is economically un- feasible and unrealistic since the enormous costs involved would have to be paid out of his or her own pocket. The oniside directors’ economic investment in the fund, if any, is so slight in relative terms that the cost of filing proxy materials and soliciting shareholders is prohibitive. Consequently, proxy contests for control of mutual funds are virtually nonexistent. It has been, and remains, a fact in the mutual fund industry that control of the fund's proxy machinery is tantamount to control of the fund itself. The power to nominate directors in a mutual fund is tanta- mount to the power to elect them. The power to refuse to renominate a sitting director is tantamount to the power to remove him from office. 4. If a quorum of outside directors, comprising a minor- ity of a mutual fund's board, is asked to make a determina. tion on behalf of the fund and that determination mivht adversely affect the economic interests of the remaining directors, who comprise an absolute majority of the fund's board, and who also thereby control the fund’s proxy machinery, the minority directors, in my opinion, cannot be considered truly ‘‘independent’’ in any meaningful sense. Tnder such circumstances, whether or not the minority A. 154 Affidavit of Sargent in Opposition directors attempt to make their determination in good faith, the fact nevertheless remains that the majority directors would have the unchallengeable power to nominate, in connection with the fund’s next stockholders’ meeting, a slate of directors which would exclude the minority direc- tors and thereby, for all intents and purposes, terminate their directorships. s/ James C. Sarcent Sworn to before me this 17th day of September, 1976. A. 155 Excerpt from Minutes of Meeting of Board of Directors of Fundamental Investors, Inc. of July 24, 1974 FUNDAMENTAL INVESTORS, INC. Mixvutes or Meetine or Boarp or Directors July 24, 1974 The regular meeting of the Board of Directors of Funda- mental Investors, Inc. was held at the offices of the Fund, Westminster at Parker, Elizabeth, New Jersey, on Wednes- day, July 24, 1974, at 1:30 P. M. There were present: Edward B. Burr John R. Haire S. P. Hutchison Donald L. Kemmerer Leon T. Kendall Louis F. Laun Thomas A. Martin Mary 8S. O’Connor Charles F. Phillips Beryl Robichaud William J. Stephens constituting the entire Board of Directors. There were also present Mr. Melvin Intriligator, Execu- tive Vice President—Operations of the Fund; Mr. Roger T. Wickers, Vice President and Secretary of the Fund; Mr. Arthur M. Kesselhaut, Treasurer of the Fund; Mr. James S. Little, Assistant Vice President and Assistant Secretary of the Fund; Douglas B. Steimle, Esq., of Counsel to the Fund; and the following officers of the Investment Division A. 156 Excerpts from Minutes of July 24, 1974 of Anchor Corporation: Mr. James J. MeGonigle, Execu- tive Vice President; Messrs. Ronald L. Welburn, Frank I. Smith, Jonathan P. White, Leonard Brooks, Jr. and Ira Ross, Vice Presidents. Mr. Edward B. Burr, Chairman of the Board, called the meeting to order and presided, and Mr. Roger T. Wickers, Vice President and Secretary of the Fund, acted as Seere- tary of the meeting. The Secretary referred to the settlement between the Fund and Goldman, Sachs & Co. executed on July 9, 1974, a copy of which had previously been sent to each director, as a result of which the Fund’s suit against Goldman, Sachs & Co. was settled and discontinued. He reviewed and dis- cussed the terms of the settlement pursuant to which the Fund sold the notes (which had been purchased by the Fund in 1969 for $18,687,500 and valued by the Board of Directors of the Fund at $2,000,000 since February 24, 1971, to Goldman, Sachs & Co. for $5,250,000 in cash, representing 26.25% of the face value of the notes plus 73.75% of such amount or other consideration, if any, which Goldman, Sachs & Co. or any subsequent assignee may receive upon such notes in the reorganization of the railroad. The Secretary then discussed the Lasker v. Burks suit against the Fund, its directors and Anchor Corporation arising out of the Fund’s purchase of Penn Central Trans- portation Company commercial paper, and referred to the motion granted by the Court staying further proceedings in that suit pending the outcome of the Fund’s suit against Goldman, Sachs & Co. He stated that because the Fund’s suit against Goldman, Sachs & Co. had been settled, the stay granted by the Court in the Lasker action would expire A. 157 Excerpts from Minutes of July 24, 1974 twenty days following the settlement of the suit against Goldman, Sachs & Co. The Secretary said that at the time the Board of the Fund determined to commence action against Goldman, Sachs & Co. it reserved whatever rights it might have against Anchor Corporation until the final outcome of the Goldman, Sachs case. He stated that Messrs. Haire, Burr, Hutchison, Phillips and Kemmerer, among others, were named as defendants in the Lasker suit and that Mrs. ©’Connor, Miss Robichaud, and Messrs. Kendall, Laun and Stephens, not being directors at the time of the Penn Cen- tral transaction, were not named as defendants. The Board then discussed the matter following which the Board determined that the five directors who are not named as defendants in the Lasker suit and who constitute a quorum of the Board should make the decision, after consulting with independent counsel, as to what further action, if any, the Fund should take. The Secretary stated that Judge Stanley H. Fuld, for- mer Chief Judge of the Court of Appeals of the State of New York, had indicated his availability to consult with and advise the directors if they so desired. A discussion ensued among the five directors following which the Sec- retary was instructed to contact Judge Fuld and request that he review all relevant aspects of the Fund’s purchase of Penn Central commercial paper, the case against Gold- man, Sachs & Co., and tue Lasker complaint, with a view towards meeting with the five directors on September 25th, prior to the Board meeting, for a review of his opinion as to what further action, if any, the Fund should pursue. Memorandum to Mr. Leon T. Kendall Mr. Louis F. Laun Mrs. Mary 8S. O’Connor Miss Beryl! Robichaud Mr. William J. Stephens FunpAMENTAL Investors, Inc, This memorandum is intended to respond to the Board’s inquiry by outlining the procedures which would have to he followed and the problems which might arise in case the Board reached the decision to terminate the Agreement (the ‘‘Agreement’’) for Investment Supervisory and Cor- porate Administrative Services between Fundamental In- vestors, Inc. (the ‘‘Fund’’) and Anchor Corporation. 1. The Board of Directors of the Fund may terminate the Agreement at any time, without penalty, on 60 days’ written notice to Anchor, under the terms of the Agreement and of Section 15(a)(3) of the Investment Company Act of 1940 (the ‘‘Act’’). Aside from termination, the Board could allow the Agreement to lapse by declining to approve renewal for the annual period commencing May 1, 1975. Even in such event, however, it would be advisable to give Anchor at least 60 days advance notice to avoid a claim of breach of the Agreement by the Fund. 2. If the Board were to exercise its right to terminate the Agreement, it would have to consider whether it should exercise that right with respect to the agreements with the A. 159 Seward d Kissel Memorandum, Dated January (6, 1975 other six funds in the Anchor Group. The Board might decide to terminate the agreements for some but not all of the funds in the Group, although it would have to be able to offer adequate justification for such a decision. 3. The Board would have to select a new investment adviser willing and able to furnish the Fund with invest- ment supervisory and corporate administrative services for an acceptable fee. 4. If the Board were to serve notice on Anchor of inten- tion to terminate the Agreement before a new investment adviser was selected and agreed to serve, the Fund would have to suspend the offering of shares for sale to the public until the selection was made, since the prospects would be deficient if it [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385005_1107%3A04. Public record. Not legal advice.