# Petitioners Reply Brief — Burks v. Lasker > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385005_1107%3A09 ## Record - **Collection:** Supreme Court brief - **Document type:** Petitioners Reply Brief - **Published:** January 1, 1979 - **Citation:** 441 U.S. 471 ## Text FOR ARGU Minna Supreme Court, U.S. FILED No. 77-1724 ~ «JAN 9 4979 MICHAEL RODAK, JR — ., CLERK Supreme Court of the United States October Term, 1978 HARRY G. BURKS, Jr., et al., Petitioners, Vv. HOWARD M. LASKER, ef ano., Respondents. # 7 PETITIONERS’ REPLY BRIEF ~ January 8, 1979 DANIEL A. POLLACK MARTIN I. KAMINSKY 61 Broadway New York, New York 10006 Counsel for Petitioners Burr, Chalker, Haire, Hutchison and Anchor Corporation LEONARD JOSEPH JOHN M. FRIEDMAN, JR. 140 Broadway New York, New York 10005 Counsel for Petitioners Burks, Hopkins, Kemmerer, Monroney, Phillips and Wade EUGENE P. SOUTHER ANTHONY R. MANSFIELD 63 Wall Street New York, New York 10005 Counsel for Petitioner Fundamental Investors, Inc. INDEX PAGE A. The essential differences between the parties .. . 1 B. The “mootness” argument .................. 3 C. Reply to plaintiffs’ specific points ............ 4 SE Se EE BF 0.60 us coucccivvccsevsues I Te cnc l es cae sccstcsceees 10 Si ee 16 ts vesku wha Vinewaudwied 18 Mr: oso bis eneeebes¥esweees 24 Gg So Sg na 30 ‘3 Citations CASES: PAGE Alleghany Corp. v. Kirby, 344 F.2d 571 (2d Cir. 1965), cert. dismissed sub nom. Holt v. Al- leghany Corp., 384 U.S. 28 (1966) ...13, 17n,* 23n* Auerbach v. Bennett, 64 A.D.2d 98, 408 N.Y.S. BE Ge (SR RRO, BOOP oo 6h 665 sccdensseavass 21 Bankers Trust Co. v. Mallis, 435 U.S. 381 (1978) 4n* Benintendi v. Kenton Hotel, 294 N.Y. 112, 60 PU Se Bee CRED ikceeccckesnasecntaked 10 Blish v. Thompson Automatic Arms Corp., 30 Del. Ch. 538, 64 A.2d 581 (1948) ........ 14, 15, 16 Brody v. Chemical Bank, 482 F.2d 1111 (2d Cir.), cert. denied, 414 U.S. 1104 (1973) .... 16n* Brody v. Chemical Bank, 517 F.2d 932 (2d Cir. SED .. 0'n 0k oh naneedein a baeeun oseaneiets 17n* Brooks v. American Export Industries, Inc., 68 F.R.D. 506 (S.D.N.Y. 1975) ............... 12 Chabot v. Empire Trust Co., 301 F.2d 458 (2d Gk SE ecb cuctuinadeheedsarneeieacse 7 Cohen v. Beneficial Industrial Loan Corp., 337 a Pe SUE cdr iVndues edawecenas kceus 3n* Corbus v. Alaska Treadwell Gold Mining Co., Se Se CD nko vaxn eevee ned ouannin 27 Cort v. Ash, 422 U.S. 66 (1975) .............. 18 Cramer v. General Tel. & Elec. Corp., 582 F.2d eet ke ree rey ye 13, 23, 26 Crowley v. Commodity Exchafige, Inc., 141 F.2d Se Eee a SE Wihnse Kii sb Gckortankedans 10 Daugherty v. Ball, 43 F.R.D. 329 (C.D. Cal. hac tv aku snwkeb cus e deeds - salieadah tn Gy coemiiansae of Gs aia 0 ae not do so.” In support of their argument in Point I B, plaintiffs pany pag i ge ea ine ong oe oad ents’ Brief, p. 24). ab op-ed aemamineen eae ..” and that in this regard.” In support of their claim, plaintiffs cite page 4901 of the reprint of the Senate Report. Examination of ee te a sn for Guten’ cae tae aoe te 2(a)(19) to remedy criticisms of the prior category of “unaffiliated” directors. S. Rep. No. 91-184, 91st Cong. Ist Sess. at 32-33 (1969), reprinted in 3 US. Code Cong. & Ad. News 4897 at 4927-28 (1970). Contrary to plaintiffs’ misleading statements, Congress most assuredly did conclude that disinterested directors were sufficiently independent to protect shareholder interests. Again, as the SEC has said in its amicus brief in this case (SEC paeccceny . The premise of the court of appeals—that dimerted der ar incapable of ating inde Sinn det taaeaatr entainemteen check on management and to provide a means for the repre- sentation of shareholder interests." H.R. Rep. No. 91-1382, Dist Cong., 2d Sess. 13 (1970).” * Finally, the remarks of Chairman Williams of the SEC on the Lasker case, quoted in Respondents’ Bricf, pp. 28- 29 n.*, were made without benefit of a reading of the record. In any event, the official position of the SEC is set forth in its amicus brief, from which there is no indication of a dissent by Chairma. Williams. * See also 5. . No, 91-184, Dist , Ist Sess, at 32-33 eee eee oe U.S. Code Cong. & Ad. 4897 at 4927-28 ( ): “The function of these | [prior Sections 2(a)(3) and 10] with respect to ed directors is to supply an in- Spensees nee on and to a means for the ee o interests in investment company “Your committee believes that the definition of ‘affiliated person’ aoraee Sunpere e= caw SES COGS SS GENGEIRY Greet this purpose. . —— a yposec ee SS) SS on oe ficiencie by Tete pron’ Othe othe act which would e the term 10 Reply to Poim U Plaintiffs argue, in Point Il, that a “minority of direc- tors” has no power to prevent or halt derivative litigation (Respondents’ Brief, pp. 30-31)—this is erroneous. The pertinent inquiry is whether or not there is a duly constituted quorum—not whether the quorum is a major- ity or minority of the directors. In this case 5 of 11 direc- tors (constituting more than a quorum) acted with the full power of the Board—would plaintiffs have viewed the matter any differently if 6 of 11 had acted? would 6 of 11 have been any more independent than 5 of 117 The numbers test that plaintiffs seek to impose is wholly arti- ficial and has no support in applicable corporate law. tows beth seerlés Gat 6 Gnasan ar an a power of the Board. Indeed, a majority of a quorum may act with the full power of the Board—this is a fundamental principle of law which plaintiffs seek to overturn. As the Court stated in Benintendi v. Kenton Hotel, 294 N.Y. 112, 119, 60 N.E.2d 829, 831-32 (1945): “the very idea of a ‘quorum’ is that, when that required number of persons goes into session as a body, the votes of a majority thereof are sufficient for binding action.” See also Crowley v. Commodity Exchange, 141 F.2d 182, 188-89 (2d Cir. 1944). A quorum is empowered to act whether it is a majority or a minority of the Board. See, ¢.g.: Potter v. Patee, 493 S.W.2d 58, 64 (Mo. Ct. App. 1973), motion denied; Twisp Min. & Smelt. Co. ¥. Chelan Min. Co., 16 Wash.2d 264, 290, 133 P.2d 300, 310-11 (1943); Stott. v Stott Realty Co., 246 Mich, 267, 271-72, 224 N.W. 623, 624 (1929). As the Court stated in Twisp, supra (16 Wash.2d at 290, 133 P.2d at 311), referring to 2 Fletcher, Cyclopedia of Corporations § 421: “A careful study of Fletcher will, in our opinion, reveal that the text recognizes that the number of directors of a corporation necessary to constitute a quorum may be fixed by the by-laws, if not in- compatible with the articles or statutory law, and that a majority of that quorum may decide any question coming properly before such meeting, although the number of directors present may be less than a majority of the entire board.” Plaintiffs also argue, in Point II, that if a minority of directors could terminate stockholder derivative litigation it “would unsettle the whole doctrine of shareholder demand and excuse therefrom”—this, too, is erroneous. First, it is simply incorrect to contend that the concept of a “majority” is an inherent or essential part of the demand rule. Rule 23.1 does not mention either a majority or a minority. There is nothing in the temand rule that bars a lawful minority quorum from passing on a demand by a putative derivative suit plaintiff. If and when a de- mand is made on the directors, nothing requires all the directors, or even a majority of them, to function on the demand. As with any other corporate business, in the absence of an express by-law or charter provision to the contrary, any duly constituted quorum of the Board can function in response to the demand; and, when it does, the vote of a majority of the quorum would be sufficient. Second, demand is properly excused only when it would be “futile”, not whenever a majority of the Board 12 is named as defendants.* In some cases, demand is futile where a majority of the Board is named as defendants, but that is not always the case. If it were, derivative plain- tiffs could consign the demand rule to oblivion with the stroke of a pen by simply naming all directors defendants, irrespective of their true role in the matter. The test is: can a plaintiff allege facts that show that demand would be futile? See, e.g., Heit v. Baird, 567 F.2d 1157, 1162 (1st Cir. 1977); In re Kauffman Mutual Fund Actions, 479 F. 2d 257, 265 (1st Cir.), cert. denied, 414 U.S. 857 (1973); Brooks v. American Export Industries, 68 F.R.D. 506, 511 (S.D.N.Y. 1975); Phillips v. Bradford, 62 F.R.D. 681, 688 (S.D.N.Y. 1974). The Court of Appeals held in Heit, supra (567 F.2d at 1162): “The plaintiff attempts to make up for the com- plaint’s deficiencies in respect to Rule 23.1 by point- ing out that more than a majority of the present board of directors are defendants in this suit and thereby in a position where they would not assent to its prosecution. To credit this argument, how- ever, would be to permit an obvious bootstrap to relieve putative plaintiffs of their obligations under Rule 23.1. Merely naming disinterested directors as defendants does not allow the prosecutor of a deri- vative suit to avoid his duty to make a demand on them. [citation omitted]” * Untermeyer vy. Fidelity Daily Income Trust, 580 F.2d 22 (ist Cir. 1978), relied upon by plaintiffs, does not hold to the con : The Court of Appeals, on the unusual facts of that case, held mere that demand was futile, and that the District Court erred in specula- ting that the interested directors, who were charged with “self- benefiting” misdeeds, would abstain from voting on the demand to sue themselves. No such issue is presented at bar. —_* 13 Finally, but perhaps most important, plaintiffs miscon- ceive the purpose and significance of the demand rule. The demand rule is designed to protect against unwarranted shareholder litigation, and to insure that whenever possible the decision to pursue or not to pursue a corporate claim is made by the Board of Directors of the corporation, whose function and responsibility it is to manage the cor- poration. See, e.g., /n re Kauffman Mutual Fund Actions, supra (479 F.2d at 263). The demand rule is not a share- holder’s permit to sue. Plaintiffs would have this Court rule, in effect, that satisfaction of the demand rule forever vests a shareholder with a proprietary interest in and con- trol of the corporate claim he seeks to assert derivatively. The claim, however, belongs to the corporation, not to one or two of its stockholders, and the legally elected directors are the ones who must be able to assert continuing control over the claim. The demand rule cannot and does not paralyze a cor- poration from acting or reacting to evolving circum- stances after the case has been commenced. The demand rule comes into play only at the time the derivative action is commenced. Cramer v. General Telephone & Elec. Corp., 582 F.2d 259, 276 (3d Cir. 1978). The cases have always recognized that, so long as they act in good faith and independently, the corporation’s di- rectors have the right and power, based upon subsequent developments, to take over the claim and pursue or end it, as the directors deem best for the corporation. Thus, the corporation itself took over the claim in /n re Penn Central Securities Litigation, 335 F.Supp. 1026, 1040 (E.D.Pa. 1971) and in the underlying litigation which gave rise to Alleghany Corp. v. Kirby, 344 F.2d 571 (2d Cir. 1965), cert. dismissed, 384 U.S. 28 (1966). And 14 the directors were permitted to make direct contact with the alleged wrongdoers to settle and discontinue the un- derlying claim, notwithstanding the pendency of the de- rivative action in Wolf v. Barkes, 348 F.2d 994, 997 (2d Cir.), cert. denied, 382 U.S. 941 (1965) and Goodwin v. Castleton, 19 Wash. 2d 748, 757-58, 144 P.2d 725, 729-30 (1944). And a quorum of disinterested directors was per- mitted to take other corporate action to remove the basis for the claim and thus compel termination of a derivative action against insiders in Blish v. Thompson Automatic Arms Corporation, 30 Del.Ch. 538, 583, 64 A.2d 581, 604 (1948). See also: Meyer v. Fleming, 327 U.S. 161, 167-68 (1946); Nelson v. Pacific Southwest Airlines, 399 F.Supp. 1025, 1031 (S.D.Cal. 1975). The rule proposed by plaintiffs would allow one or two dissentient stockholders to force the corporation on an unalterable course regardless of whether that course con- tinues to be in the best interests of the corporation. Such a rule might unwisely commit the corporation to action not in its best interests. As the Court stated in Goodwin, supra (19 Wash. 2d at 763-64, 144 P.2d at 732-33): “The mere circumstances that a lone stock- holder, or a group of such individuals, has initiated a derivative action, and has alleged the existence of facts entitling him or them to maintain the suit in place of the corporation, do not of themselves establish the propriety of the action or the necessity for its continued maintenance, for otherwise, by this device the corporation, its officers, and di- rectors, and the majority stockholders would at once be conclusively shorn of their powers of management and discretion in the conduct of those affairs which are of vital concern to the corpora- tion and all its stockholders. *- * 15 “ ... Their right in such matters is not com- pletely forestalled by the mere fact that a single stockholder or a group of stockholders has taken the initiative by instituting a derivative action.” In Blish, supra (30 Del. Ch. 538, 64 A.2d 581), two years after a derivative action had been filed to nullify certain transfers of stock to two of the inside directors, a quorum of disinterested directors met and voted to ratify the issuance of the shares, thereby mooting and ef- fecting termination of the derivative action. The Supreme Court of Delaware upeld the action of the distinterested directors which had the effect of terminating the derivative action even though the action had been validly com- menced and was not frivolous, stating (30 Del. Ch. at 583, 64 A.2d at 604): “The contention made by the appellant that the ... ratification was ineffective, since such oc- curred subsequent to the day that this suit was in- Stituted below, is without merit. Courts generally look vith apprehension upon ratification of previ- ous corporate acts after an action has been insti- tuted questioning the validity of such acts. How- ever, in the absence of fraud, subsequent action by the Board within director authority will be held to be valid.” The relationship of the demand rule to the business judgment power of the directors was properly recognized in Nelson, supra (399 F.Supp. 1025). Whether a demand must be made is determined at the outset of the action, i.e., when the claim is first asserted. The fact that the composition of the Board may change thereafter, so that demand would no longer be futile, does not necessarily 16 require the shareholder plaintiff to make a new demand.* However, the new directors can, on their own initiative, determine the future course of the action (399 F. Supp. at 1031): “. .. the plaintiffs are not required to seek to have the new directors intervene in the suit. Though the plaintiffs may be bound by the decision of the board, it is the board itself which must initiate such activity. [citation omitted]” : At bar, of course, the directors did themselves initiate the activity at issue, i.e., the motion to dismiss. Reply to Point III Plaintiffs argue, in Point III A, that under Delaware !aw a minority of directors cannot prevent commencement of a derivative action, and, therefore, should not be per- mitted to effect a termination of a derivative action, i.e., that “Delaware precedents are the same as under Federal Rule 23.1” (Respondents’ Brief, pp. 35-36 ).** None of the cases cited by plaintiffs at pp. 35-36 of their brief deals with the business judgment powers of directors. Applicable Delaware authority clearly recognizes the power of a quo- rum of the directors to manage the affairs of the corpora- tion, including the power to make decisions to prosecute or cause the termination of litigation on behalf of the corporation. McKee v. Rogers, 18 Del. Ch. 81, 85-86, 156 A. 191, 193 (Ch. 1931). See also: Blish v. Thompson * If, however, the plaintiff files an amendec complaint or seeks to assert a new claim after the composition of the Board has changed, a new demand is necessary. See, e.g., Brody v. Chemical Bank, 482 F.2d 1111 (2d Cir.), cert. denied, 414 U.S. 1104 (1973). ** As shown supra, Reply to Point II, plaintiffs are in error in their arg. nent that satisfaction of Rule 23.1 by a derivative plaintiff forever after renders directors powerless to act in the best interests of the corporation. 17 Automatic Arms Corp., 30 Del. Ch. 538, 583, 64 A.2d 581, 604 (1948). Plaintiffs also argue, in Point III A, that under Delaware _ law directors may not ratify a fraud (Respondents’ Brief, pp. 36-38). This argument misses the point. First, there was no fraud here, but only an investment loss in the ordinary course of operations. Second, the directors did not ratify anything; they exercised their business judgment in what they believed to be the best interests of Funda- mental. The courts have repeatedly rejected this argument advanced by plaintiffs, and recognized that “The question whether it is good judgment to sue is quite apart from the question of ratification.” S. Solomont & Sons Trust, Inc. v. New England Theatres Operating Corp., 326 Mass. 99, 111, 93 N.E.2d 241, 247 (1950). Accord: Kessler & Co. v. Ensley Co., 129 F. 397, 399 (C.C.N.D. Ala. 1904); Gall v. Exxon Corp., 418 F.Supp. 508, 518n.18 (S.D.N.Y. 1976). The District Court also correctly drew this distinction (A.19), and the Court of Appeals did not disturb this portion of the District Court’s opinion.* * The plaintiffs’ argument, moreover, overlooks the numerous cases where the courts have upheld the power of disinterested direc- tors not to pursue litigation, even though arguably nonratifiable con- duct was at issue. See, e.g., Brody v. Chemical Bank, 517 F.2d 932 (2d Cir. 1975) (involving federal securities acts and fraud claims); Alleghany Corp. v. Kirby, 344 F.2d 571, 573 (2d Cir. 1965), cert. dismissed, 384 U.S. 28 (1966) (involving fraud claims) ; Swanson v. Traer, 249 F.2d 854, 859 (7th Cir. 1957) (involvin fraudulent conspiracy); Gall v. Exxon Corp., 418 F.Supp. 508, 516 (S.D.N.Y. 1976) (involving illegal payments); Goodwin v. Castleton, 19 Wash.2d 748, 764, 144 P.2d 725, 733 (1944) (involving fraud claims). Plaintiffs’ reliance on Mayer v. Adams, 37 Del.Ch. 298, 141 A.2d 458 (1958), is misplaced. The only issue presented in Mayer was the necessity for a demand on share- holders; the role of directors in deciding whether to pursue proposed derivative claims was not an issue. Finally, plaintiffs’ use of Professor Folk (Respondents’ Brief, p. 39 n.*) is misleading: he was obviously talking about fraud in the exercise of business judgment, not fraud in the underlying claim. See Folk, THE DELAWARE GENERAL CORPORA- TION Law: A COMMENTARY AND ANALYsIS 76 (1972). of the ah, deter eet wr and Il, pp. 4-16 and SEC Brief, pp. 20-23. Reply to Point IV gpesgy ten. om a TS ee ee approval procedures do not apply to this situation enh ho aiaiaen ath toe The notice and judicial ap- ee Ne ee ag prarerwelg eapepfios tenn geibives. y= + Fer as at bar. See, e.g. Wolf v. Barkes, 348 F.2d 994, 996-97 (2d Cir.), cert. denied, 382 U.S. 941 (1965); Karz v. Aspinwall, 342 F Supp. 286, 288 (N.D. Ala. 1971), aff'd, 459 F.2d 1045 (Sth Cir.), cert. denied, 409 US. 1000 (1972); Daugherty v. Ball, 43 F.R.D. 329, 335 (C.D. Cal. 1967); Marcus v. Textile Banking Co., 38 F.R.D. 185, 187 (S.D.N.Y. 1965). See also’ Hutchinson v. Fidelity Inv. Ass'n, 106 F.2d 431, 436 (4th Cir. 1939); Moreland v. Rucker Pharmacal Co., Inc., 63 F_ RD. 611, 614-15 (W.D. La. 1974); Miller, Problems of Giving Notice in Class Actions, 58 F.R.D. 313, 331 (1973); Simeone, Procedurai Problems of Class Suits, 60 Mich. L.Rev. 905, 934 (1962). As the Court stated in Marcus, supra (38 F.RD. at 187), in refusing to order notice of a dismissal of a deriva- tive suit for lack of jurisdiction: “The purpose of the provision is the protec- tion . . . against the unjust or unfair settlements in case a plaintil who starts the action becomes eee ee ee ee il a 20 securities laws, the corporation negotiated se.tlements di- moved to enjoin the settlements, claiming that they were legally ineffective without notice to the stockholders and approval by the Court pursuant to then Rule 23(c) [now Rule 23.1]. The Court of Appeals affirmed the denial of ee a a ee their objection Sudes Briony ucts (008 9.26 ot 996. 97): . If we go behind the letter to the prime ‘mis- chief and defect ee woctholde and his attorey got the sum paid in de, edo trom peliciee the Gnas tion of the corporate claim, he may well assist in ee ee ee cilia tub 4h eas ett uatinal Oo Geiiatean ee a * Judge Friendly also noted (348 F.2d at 997 2.4): “The SEC oops to provide ‘a the Investment oe ay Ay AA ong aad ics e_ forced that could be the target of . the provision not enacted. [citations omitted)” ” se 21 The same considerations apply at bar, where plaintiffs Auerbach Vv. Bennett, 64 A.D. 2d 98, 408 N.Y.S.2d 83 (2d Dept. 1978), is mischaracterized by plaintiffs (Respond- ents’ Brief, p. 50). First, as a state court case, Auerbach did not deal with Rule 23.1. Moreover, in the very next sentence following the quotation by plaintiffs, the Court added (64 A.D.2d at 108, 408 N.Y.S.2d at 88): “That is not to say that after the usual discovery and deposition stages of the action have been com- priate vehicle to terminate the action when the record sil db Gee aie etl) te eae od ho decision of the committee.” The Court held merely that (id.): granted.” (emphasis supplied) The other cases under Rule 23. l cited by r aintif Brief, p. 50). This is most ¢ i contend deowhese in thelr brief that the Distict Court should have ordered the mailing of notice to all shareholders and conducted “a full exploration of the relevant circum- merits” wo weigh the propriety of the dsmisal under Rul tors of a mutual fund do have the power to terminate stock- as the SEC points out. the business judgment rule is itself r nt shareholder protection device” (SEC Brief, p. 22). ; onus > Ges Ginttan cane ts Celle Sls en (3) their judgment must be reasonable (SEC Brief, pp. 16- 20.) The SEC acknowledges that its first two criteria were met in this case (SEC Brief, pp. 23-24) but suggests that ee ee ram's decison at “he reasoned jgment” (A 38) whic 23 Es, 58, SEND Sp Suara cane “a reasoned de- ermination™ (see SEC Brief, p. 20 n.16).* Moreover, necessarily implicit in the finding of good faith by the District Court wos the conclusion that the gy «See tio of the reasonableness of the directors’ Sain a her om readily be made from the record now before this Court. In fact, the SEC states (SEC Brief, p. 25 1.21): “Although we suggest a remand, this Court could determine — mahicne if it wist ' We do not believe a remand is necessary or appro- priate here. tty habe aay esigmusen 7 eamandines exercise of business judgmer in this case falls * “outside re. . nied Sibaiins & Slesvenie Corn $82 wher thr a ore GS 1978). The record evidence over- m4 138-139) and that they were eutiedy indepent (A.142-143, 147-150). 24 Reply to Point V Se Oe ee Jisintere: 56-62). Plaintiffs, alone, are of this view. The District Court found, after extensive discovery on the issue (A.28): “Plaintiffs have not adduced any factual sup- pan Oe Oe ee ee eee “Meine out hat he ve minty The SEC, which examined the record in this case and filed an amicus brief wrote (SEC Brief, p. 23): “We S not db mery- the district court's findin, ing record evidence that the disinte = to carp and cavil about the disintereste 25 mittee, and two of the three members of that committee were, at all times, disinterested directors as that term is defined in Section 2(a)(19) of the Investment Company Act of 1940. Next, all of the disinterested directors were ominat.d for election by the full board of directors, which, at all times, consisted of a majority of disinterested directors. Finally, all of the disinterested directors were elected by the stockholders as their lawful representatives (A.142-143). The root of the error of plaintiffs’ position is their mistaken notion that merely by naming a disin- terested director a defendant in a derivative action, he or she, without more, is disqualified, both prospectively and retrospectively, from functioning as a director. If this were the rule, plaintiffs in derivative actions could control the corporate destiny without any restraint by merely naming all directors as defendants. Plaintiffs also contend that the five disinterested direc- tors were not independent because of “a long history of social and business relationships with a number of defend- ants” (Respondents’ Brief, p. 59). This is an utter dis- tortion, as a reading of the record shows. The District Court made this finding (A.28): “Although each of the minority directors knew ee ce on oe cme 2 GF Sn wes ominated, the relationships which existed between the minority directors | and the defendant directors were de minimis. . At another point in their brief, plaintiffs assert that “Each member of the quorum had been screened, se- lected and nominated for office by Anchor and the indi- vidual defendants who, as majority directors, at all times had the absolute power to effect their removal.” (Respond- ents Brief, p. 8). Plaintiffs offer no citation of authority 26 —either record or legal—for these assertions. The fact is that Anchor did not screen, select or nominate any director (A.142-143) and neither Anchor nor any com- bination of the so-called majority directors had any power to remove the so-called minority directors—all directors served, in accordance with law, until their terms expired and their successors were duly elected and qualified. Dela- ware Corporation Law, § 141 (b) and (k), Del. Code tit. 8, § 141(b) and (k) (1975). Plaintiffs also argue, in Point V B, that the action has “merit” (Respondents’ Brief, p. 63). The disinterested directors and their special counsel, Judge Fuld, found other- wise (A.82), but the important point is that they carefully considered the merits, as the District Court found (A. 36).* Even assuming, arguendo, that the action has “merit”, that is only one of many factors to be considered in arriving at a sound business judgment. And the law is, and always has been, as stated in Cramer, supra (582 F.2d at 275): “Even if a particular suit has some merit, the litigation costs and the adverse effect on the busi- ness relationship between the corporation and the * Plaintiffs erroneously contend that Judge Fuld “overlooked” Matter of Winfield & Co., Inc. (R ts’ Brief, p. 63). First, there is no evidence in the record that Judge Fuld failed to consider that case. Second, that case is not in point: it was an uncontested SEC enforcement proceeding involving an investment adviser who, in recommending purchase i securities by the fund, relied on unsubstantiated representatiuns of other ne described by him as “research sources” but who, in fact, had a substantial eco- nomic interest in such restricted securities. No such facts are present here: Anchor relied, among other thi on the “Prime” rating of Penn Central by NCO (a subsidiary of Dun & Bradstreet), the fore- most independent commercial paper rating in the country (A.86, 122). In addition, Anchor was about Penn Central since Penn Central Company had been a recent equity hold- ing of Fundamental (A.125). Finally, since Matter of Winfield & Co., Inc., was an SEC enforcement no finding of scienter was necessary for liability. To the contrary, in a private damage ac- tion such as this one, as Judge Fuld correctly concluded, proof of “fraudulent intent” is essential to recovery (A.94). Ee 27 potential defendant might outweigh any potential recovery in the lawsuit.” This Court long ago stated in Corbus v. Alaska Tread- well Gold Mining Co., 187 U.S. 455, 463 (1903): “The directors may sometimes properly waive a legal right vested in the corporation in the belief that its best interests will be promoted by not in- sisting on such right.” Plaintiffs make numerous overstatements and mis- statements throughout their brief with respect to the merits. For example, plaintiffs assert that the Court of Appeals made “a further finding that the plaintiffs’ claims were substantial and meritorious” (emphasis supplied) (Respondents’ Brief, p. 10). This is false. The Court of Appeals nowhere found or even stated that plaintiffs’ claims were meritorious. The Court of Appeals said only “. . . we cannot say that, following a trial on the merits, the defendants would be found free from liability for the Fund’s losses.” (A.43) This hardly constitutes a finding of meritoriousness of plaintiffs’ claims by the Court of Appeals. Plaintiffs also misleadingly assert that Anchor “violated two out of the three investment guidelines which it had established to safeguard the Fund”, i.e., the 10° guideline and the buy-back guideline (Respondents’ Brief, p. 3). This is false. As to the 10% guideline, Fundamental purchased $20 million out of a total! of $200 million of Penn Central commercial paper outstanding, and, thus, was within its guideline (A.109-110, 122). And, as to the buy-back guide- line, Anchor believed on the basis of its prior talks with Goldman, Sachs & Co., which had always bought back paper previously, that it had such an understanding (A.84, 121-122). Goldman, Sachs & Co., under the pressure of the situation, simply failed to honor its commitment in this case (A.124). 28 Other examples of overstatement and misstatement by plaintiffs with respect to the merits abound. However, since they are essentially an attempt to re-argue facts found by the District Court, and do not affect the funda- mental issue before this Court, no further response will be made in this brief. Plaintiffs next argue, in Point V C, that the minority directors were misinformed by Mr. Haire and by Mr. Souther (Respondents’ Brief. pp. 68-73). The District Court made express findings to the contrary. As to Mr. Haire, the District Court found (A.35): “The court is of the opinion that Haire’s state- ments 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 minority directors reached a different conclusion: that pros- ecution of the suit ‘would necessarily cause the Fund to seek to obtain a different investment ad- viser immediately.’ ’’* As to Mr. Souther, the District Court found that his participation was “equally innocent” (A.32). The full findings as to Mr. Souther by the District Court are set forth at A.32-33 and will not be reprinted here in the interest of brevity. Plaintiffs now also claim that a memo- * The claim that Mr. Haire “misled” the disinterested directors is exposed as baseless by a review of the discovery proceedings. Plaintiffs read Mr. Haire’s statement to Mr. , who testified flatly “I differ with Mr. Haire on his conclusion.” (Stephens Tr. 116-119.) Mr. Haire had one view as to whether Anchor could con- tinue to act; the disinterested directors had another view. Mr. Haire did not mislead anyone about anything. 29 randum prepared for the disinterested directors, at their request, by Mr. Souther’s firm (A.158-161), was “biased”; however, the memorandum is factually and legally correct and plaintiffs did not and could not demonstrate other- wise. The final argument raised by plaintiffs in Point V D, to wit, that because Anchor is no longer the investment adviser, the continued prosecution of this action cannot possibly injure Fundamental, has been dealt with earlier in this Reply Brief at pp. 3-4. The adversary relationship was just one of many factors considered and relied upon by the disinterested directors in reaching their conclusion that this derivative litigation was contrary to the best in- terests of Fundamental and its shareholders and should be terminated. The numerous other factors are set forth in the moving affidavit of Mr. Kendall (A.77-79), the minutes (A.137-141) and the letter of Mr. Stephens (A.131-136). * * * Respondents’ Brief is, in sum, a “skillful assemblage of suspicions, surmises and conjectures.”* Reflection upon the true issue in this case leads one inescapably back to this proposition: plaintiffs and the Court of Appeals would have this Court rule that disinterested directors of a mu- tual fund, who constitute a quorum and have been found to be truly disinterested and independent, are incapaci- tated, as a matter of law, from exercising their business judgment to terminate a stockholder’s derivative action they find to be contrary to the best interests of the fund and its shareholders. The per se disqualification of the disinterested directors is in conflict with the intent of Con- gress as expressed in the Investment Company Act of 1940 and does violence to sound and logical principles of cor- porate governance. * Marco v. Bank of New York, 272 F. Supp. 636, 640 (S.D.N.Y. 1967), aff'd, 398 F.2d 628 (2d Cir. 1968). 30 CONCLUSION The judgment of the Court of Appeals should be reversed and the Complaint should be dismissed. Respectfully submitted, DANIEL A. POLLACK MARTIN I. KAMINSKY 61 Broadway New York, New York 10006 Counsel for Petitioners Burr, Chalker, Haire, Hutchison and Anchor Corporation LEONARD JOSEPH JOHN M. FRIEDMAN, JR. 140 Broadway New York, New York 10005 Counsel for Petitioners Burks, Hopkins, Kemmerer, Monroney, Phillips and Wade EUGENE P. SOUTHER ANTHONY R. MANSFIELD 63 Wall Street New York, New York 10005 Counsel for Petitioner Fundamental Investors, Inc. January 8, 1979 --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385005_1107%3A09. Public record. Not legal advice.