Brown v. Bullock

Decision Date31 March 1961
PartiesEthel BROWN and Harry Brown, Plaintiffs, v. Hugh BULLOCK, Arthur F. Burns, Robert E. Clark, Nathaniel P. Hill, John M. Hincks, Grayson Kirk, Harris J. Nelson, Frank Pace, Jr., Maxwell D. Taylor, Calvin Bullock, Ltd., and Dividend Shares, Inc., Defendants.
CourtU.S. District Court — Southern District of New York

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Rosenthal & Gurkin, New York City, for plaintiffs; Pomerantz Levy & Haudek, Rosenfeld & Silverman, Abraham L. Pomerantz, William E. Haudek, New York City, of counsel.

Hughes, Hubbard, Blair & Reed, New York City, for defendants Arthur F. Burns, Grayson Kirk and Frank Pace, Jr.

Cole, Grimes, Friedman & Deitz, New York City, for defendant Dividend Shares, Inc.

Sullivan & Cromwell, New York City, for defendants Calvin Bullock, Ltd., Hugh Bullock and Robert E. Clark; David W. Peck, Alfred Jaretzki, Jr., Marvin Schwartz, Richard Sexton, New York City, of counsel.

Walter P. North, Gen. Counsel, Mitchell S. Rieger, Associate Gen. Counsel, Joseph B. Levin, Asst. Gen. Counsel, Meyer Eisenberg, Atty., SEC, Washington, D. C., amicus curiae.

HERLANDS, District Judge.

Does the amended complaint against the eleven defendants state a claim upon which relief can be granted under the Investment Company Act of 1940, 15 U.S.C.A. § 80a-1 et seq.?

The question is raised by motions pursuant to F.R.Civ.P., rule 12(b) (1) and (6), 28 U.S.C.A., made by the attorneys for defendants Calvin Bullock, Ltd., Hugh Bullock and Robert E. Clark, and by the attorneys for defendants Arthur F. Burns, Grayson Kirk and Frank Pace, Jr.

The motions are opposed by the plaintiffs and, to the extent that certain questions of law are involved, by the Securities and Exchange Commission as amicus curiae.

Because the facts well-pleaded in the amended complaint and the inferences reasonably flowing therefrom are deemed admitted arguendo, the pending motions raise only issues of law. However, counsel differ radically in their formulation of those issues. It has thus become necessary to analyze the allegations of the amended complaint in detail in order to place the issues in correct and sharp focus.

The Investment Company Act of 1940 will be referred to as "the 1940 Act" or "the Act"; the Securities Act of 1933, 15 U.S.C.A. § 77a et seq., as "the 1933 Act"; the Securities Exchange Act of 1934, 15 U.S.C.A. § 78a et seq., as "the 1934 Act"; the defendant Dividend Shares, Inc., as the "Fund"; the defendant Calvin Bullock, Ltd., as the "Management Company"; the Securities and Exchange Commission, as the "Commission"; and the amended complaint as "the complaint."

Allegations of the Complaint.

Jurisdiction

Jurisdiction rests on the Act and "on the principles of pendent jurisdiction" (par. 1). There is no allegation or claim of diversity of citizenship.

Plaintiffs

Plaintiffs are and have been shareholders of the Fund since October 14, 1955 and at the times of the transactions complained of par. 2(a).

Capacities in Which Plaintiffs Are Suing

The action is brought by plaintiffs "derivatively on behalf of the Fund and representatively on behalf of themselves and all other shareholders of the Fund similarly situated" par. 2(b).

"The Fund has about 100,000 shareholders, scattered all over the United States and foreign countries. Their identity is subject to frequent changes by reason of sales of new shares and redemptions of old ones" par 20(d).

"The shareholders constitute a class so numerous as to make it impracticable to bring them all before the Court. Plaintiffs will fairly insure their adequate representation" (par. 21).

The Fund, Its Organization and Character

The Fund, a Maryland corporation organized on July 25, 1932 with its principal office at One Wall Street, Manhattan, N. Y., was and is "registered under the Act as a diversified open-end management investment company" (pars. 3, 17). Its shares "have been and are being offered for sale and sold to the public on a continuous basis" (par. 3).

The Nine Individual Defendants and Two Corporate Defendants

The nine individual defendants are the directors of the Fund. They have served as such directors since prior to October 14, 1955, except that defendants Burns and Kirk became directors in 1958, and defendants Clark and Taylor in 1959. Since prior to October 14, 1955 and to date, defendant Bullock has been the president of the Fund (par. 4).

The two corporate defendants are the Fund and the Management Company.

Net Asset Value of the Fund

The net asset value of the Fund was $188,548,815 on October 31, 1955 and $254,701,160 on April 30, 1960. Its high was $267,612,897 on October 31, 1959 (par. 5).

The Management Company

The Management Company, a corporation with its principal office at One Wall Street, Manhattan, N. Y., was and is "the investment adviser of the Fund" and "the principal underwriter and sole distributor of the shares of the Fund" (par. 6).

The Management Company was and is "the investment adviser" of two other domestic diversified open-end management investment companies known as Bullock Fund, Ltd. ("Bullock Fund") and Nation-Wide Securities Company, Inc. ("Nation-Wide") par. 12(a).

The operative facts of the occurrences and transactions giving rise to the plaintiffs' claim, as pleaded (cf. Schwartz v. Eaton, 2 Cir., 1959, 264 F.2d 195, 196 note 2, 197 note 3, will be spotlighted by collating related allegations of the complaint. The following recitals are quoted from the complaint or are close paraphrases.

The Complete Domination and Control of the Fund by the Defendant-Management Company and the Defendants Bullock and Clark.

I.

The Management Company has two contracts (annually extended) with the Fund: an "underwriting" contract and an "investment advisory" contract. By the underwriting contract, the Management Company was and is the principal underwriter of the Fund and the sole distributor of the Fund's shares (par. 11). By the investment advisory contract the Management Company was and is the investment adviser of the Fund (pars. 6, 10). The Management Company supervises the Fund's portfolio securities and pays certain of the Fund's expenses (par. 10).

Defendant Bullock is the president of both the Management Company and the Fund. He is also a director of both companies. He owns a majority of the shares of the Management Company (par. 7).

Defendant Clark, the executive vice-president of the Management Company, is a director of both companies (par. 7).

Officers or associates of the Management Company are the three vice-presidents, the secretary and the treasurer of the Fund (par. 7).

II.

The defendants Bullock, Clark and the Management Company completely dominated and controlled the Fund, not only by virtue of their above-indicated intimate and interlocking relationship, but also by their:

A. Selecting and nominating each of the Fund's directors (par. 8). These directors receive substantial compensation as such Fund directors and also receive additional substantial compensation as directors of other investment companies, for which latter positions they were likewise selected by Bullock, Clark and the Management Company (par. 8). The Fund's directors are either affiliated with or beholden to Bullock, Clark and the Management Company (par. 8).

B. Dominating and controlling: (1) the Fund's board of directors; (2) the Fund's management; (3) the Fund's personnel; and (4) the Fund's business and affairs par. 9(a).

The Wrongful Transactions Concerning the Investment Advisory Contract and Its Yearly Extensions.

I.

The relative positions of the defendants in such transactions were as follows: Bullock, Clark and the Management Company "caused" the transactions. The other eight defendants "participated or acquiesced in" such transactions "with knowledge or notice of their wrongful character" par. 9(b).

II.

The voting of the Investment Advisory Contract and its yearly extensions took place under the following circumstances:

A. Since prior to 1955, the Fund's board of directors has annually voted to continue the investment advisory contract with the Management Company (par. 10).

B. The adoption of that contract and its yearly extensions was the result of "the arbitrary action, collusion, gross negligence or reckless disregard of duty of the individual defendants and the Management Company" par. 15(a).

The individual defendant-directors of the Fund "abdicated their functions" by acts of commission and omission par. 15(c), in that they "made no effort to ascertain whether" some organization other than the Management Company could be secured to supply the same investment advisory services "on terms more advantageous to the Fund" and they made no effort to persuade or bargain at arm's length with the Management Company to supply such services on terms more advantageous to the Fund par. 15(b).

C. Since prior to 1955, false and misleading proxy statements (filed with the Commission and mailed to the Fund's shareholders) were used by the defendants to bring about the election of the defendant-directors of the Fund and to induce inaction by the Fund's stockholders with respect to their statutory right under the Act, section 15(a) (3) to terminate the investment advisory contract or to seek its renegotiation on terms more favorable to the Fund (par. 19).

"The proxy statements represented to the shareholders that the investment advisory arrangements between the Fund and the Management Company were `similar to the arrangements between Calvin Bullock, Ltd. i. e., the Management Company and five other companies.' The reference to `five other companies' was intended to and did include the Bullock Fund and Nation-Wide" par. 19(b).

"Such representation was, to defendants' knowledge or notice, an untrue statement of a material fact and omitted to set forth facts necessary in order to prevent said representation, in the light of the...

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