Brown v. Bullock

• Decision Date: 05 September 1961
• Docket Number: No. 404,Docket 26948.,404
• Parties: Ethel BROWN and Harry Brown, Appellees-Plaintiffs, v. Hugh BULLOCK, Arthur F. Burns, Robert E. Clark, Grayson Kirk, Frank Pace, Jr. and Calvin Bullock, Ltd., Appellants-Defendants and Nathaniel P. Hill, John M. Hincks, Harris J. Nelson, Maxwell D. Taylor and Dividend Shares, Inc., Defendants.
• Court: U.S. Court of Appeals — Second Circuit

294 F.2d 415 (1961)

Ethel BROWN and Harry Brown, Appellees-Plaintiffs, v. Hugh BULLOCK, Arthur F. Burns, Robert E. Clark, Grayson Kirk, Frank Pace, Jr. and Calvin Bullock, Ltd., Appellants-Defendants and Nathaniel P. Hill, John M. Hincks, Harris J. Nelson, Maxwell D. Taylor and Dividend Shares, Inc., Defendants.

No. 404, Docket 26948.

United States Court of Appeals Second Circuit.

Argued May 22, 1961.

Decided September 5, 1961.

David W. Peck, New York City (Sullivan & Cromwell, Alfred Jaretzki, Jr., and Marvin Schwartz, New York City, on the brief), for appellants-defendants Hugh Bullock, Robert E. Clark and Calvin Bullock, Ltd.

Harold L. Smith, New York City (Hughes, Hubbard, Blair & Reed and Francis C. Reed, New York City, on the brief), for appellants-defendants Arthur F. Burns, Grayson Kirk and Frank Pace, Jr.

William E. Haudek, New York City (Pomerantz, Levy & Haudek, Rosenfeld & Silverman and Rosenthal & Gurkin, New York City, on the brief), for appellees-plaintiffs.

Walter P. North, Gen. Counsel, Securities and Exchange Commission, Washington, D. C. (Meyer Eisenberg and George P. Michaely, Jr., Washington, D. C., on the brief), for Securities and Exchange Commission as amicus curiae.

Before the Court in banc LUMBARD, Chief Judge, CLARK, WATERMAN, MOORE, FRIENDLY and SMITH, Circuit Judges.

FRIENDLY, Circuit Judge.

Plaintiffs-appellees in this action in the District Court for the Southern District of New York are stockholders of defendant Dividend Shares, Inc., hereafter the "Fund," a Maryland corporation having its principal office in New York City. The Fund is registered under the Investment Company Act of 1940, 15 U.S.C.A. § 80a-1 et seq., as a diversified open-end management investment company. The individual defendants are the directors of the Fund; two of them, Bullock and Clark, are also officers and directors of Calvin Bullock, Ltd., hereafter the Management Company, also a defendant, which is the Fund's investment adviser and principal underwriter and sole distributor.

The amended complaint, summarily stated, charges that the Fund has been harmed by payments to the Management Company under the investment advisory contract and the underwriting contract, that are claimed to have violated various provisions of the Investment Company Act, some of which will be discussed below. It alleges also that since prior to 1955 the election of directors of the Fund was procured by proxy statements that violated Rule X — 14a-9, 17 C.F.R. 14a-9, promulgated by the Securities and Exchange Commission pursuant to § 14(a) of the Securities Exchange Act of 1934, 15 U.S.C.A. § 78n(a), applicable here by virtue of § 20(a) of the Investment Company Act, 15 U.S.C.A. § 80a-20(a), and the Commission's Rule 20a-1, 17 C.F.R. § 270.20a-1; the reason alleged for this is that the proxy statements said the investment advisory arrangements between the Fund and the Management Company were "similar to the arrangements" between the latter "and five other companies," two of which were intended to be the Bullock Fund, Ltd. and Nation-Wide Securities Company, Inc., whereas in fact they differed in that the fees charged the two latter were ¼ of 1% of net assets but those charged the Fund were ½ of 1% of the first $100,000,000 of net assets and ¼ of 1% of the excess. This, it is claimed, voided the election of directors in general and their annual extensions of the investment advisory contract, §§ 15(a) and 47(b), 15 U.S.C.A. §§ 80a-15(a) and 80a-46(b), in particular, and caused the Fund's shareholders to fail to exercise their statutory right, § 15(a) (3), to terminate the contract or seek its renegotiation. The complaint concludes with allegations, designed to meet F.R.Civ.Proc. 23(b), 28 U.S.C., as to futility of demand on the directors and lack of necessity for and futility of demand on the shareholders.

Defendants moved to dismiss for failure "to state a claim under the Constitution, laws or treaties of the United States * * * or upon which relief can be granted under the Investment Company Act of 1940, 15 U.S.C. § 80(a) 80a-1 et seq. and, to the extent the amended complaint purports to state a representative claim, for failure to state a claim on which relief can be granted * * *". Judge Herlands denied the motion in an extensive opinion, 194 F.Supp. 207. Later, without "serious objection" from the plaintiffs and with none from the Securities and Exchange Commission, which had been allowed to appear as amicus in support of federal jurisdiction, as it has here, the judge resettled his order to include the certification specified in 28 U.S. C. § 1292(b). This Court, Judge Clark disagreeing, granted leave to appeal under that section, believing that determination in limine of the issue of Federal jurisdiction, an issue of first impression in this Circuit, was desirable in order to avoid a lengthy trial which would be futile if such jurisdiction did not exist, and also that such a determination was likely to have precedential value for a large number of other suits against directors of registered investment companies now pending in the Southern District, see Chabot v. National Securities & Research Corp., 2 Cir., 1961, 290 F.2d 657, 659-660.¹ Since the issue was novel and of public as well as private importance, we also voted that the appeal should be heard in banc.

In addition to the general federal question grant of 28 U.S.C. § 1331, section 44 of the Investment Company Act, 15 U.S.C.A. § 80a-43, entitled "Jurisdiction of offenses and suits," expressly vests the district courts with jurisdiction "of * * violations of, this subchapter or the rules, regulations, or orders thereunder," this presumably referring to proceedings by the Commission under §§ 36 and 42 and to criminal prosecutions, and also "concurrently with State and Territorial courts, of all suits in equity and actions at law brought to enforce any liability or duty created by, or to enjoin any violation of, this subchapter or the rules, regulations, or orders thereunder." Appellants disclaim any contention "that plaintiffs would have no federal remedy were they to allege injury caused by violation of the Act," even though the Act does not expressly create a private claim for such violations, a disclaimer justified, inter alia, by statements in Schwartz v. Eaton, 2 Cir., 1959, 264 F.2d 195, 198 cf. Reitmeister v. Reitmeister, 2 Cir., 1947, 162 F.2d 691, 694. On the other side, appellees, if we understand aright, do not argue that every transgression by directors of a registered investment company necessarily gives rise to a federal claim. Cf. Pan American Petroleum Corp. v. Superior Court, 1961, 366 U.S. 656, 81 S.Ct. 1303, 6 L.Ed.2d 584. Holding, as we do, that violations of two sections of the Investment Company Act are sufficiently alleged, we find it unnecessary to pass on much that was said by the District Judge or to explore other grounds of federal jurisdiction asserted by appellees and found in their favor by him, — at least one of which, that based on the allegedly false or misleading proxy statements, bristles with difficulties, see Howard v. Furst, 2 Cir., 1956, 238 F.2d 790, certiorari denied 1957, 353 U.S. 937, 77 S.Ct. 814, 1 L.Ed.2d 759; Dann v. Studebaker-Packard Corp., 6 Cir., 1961, 288 F.2d 201, and had better be resolved, should resolution be required, with the fuller development of the facts that will come from a trial.

(1) Section 37 of the Act, 15 U.S.C.A. § 80a-36, provides:

"Sec. 37. Whoever steals, unlawfully abstracts, unlawfully and willfully converts to his own use or to the use of another, or embezzles any of the moneys, funds, securities, credits, property, or assets of any registered investment company shall be deemed guilty of a crime, and upon conviction thereof shall be subject to the penalties provided in section 49. A judgment of conviction or acquittal on the merits under the laws of any State shall be a bar to any prosecution under this section for the same act or acts."

Appellees say that the amended complaint, at least when read with the benevolence appropriate on a motion addressed to the pleadings, sufficiently alleges and unlawful and willful conversion; appellants respond that the complaint alleges merely excessiveness of the fees under the two contracts which, if made out, would be a waste of corporate assets giving rise to liability under Maryland law, but not a conversion within Section 37. Discussion of this demands a somewhat fuller statement of the amended complaint than has yet been made.

Although the amended complaint does allege excessiveness of the fees to the Management Company, attaining $921,485 under the investment advisory contract and $403,097 under the underwriting and distribution contract in 1959, it does not stop at that. It alleges that each of the directors of the Fund "has been selected and nominated as such by defendants Bullock, Clark and the Management Company"; that each director receives substantial compensation for acting as such; that each director also serves as a director for one or more other investment companies supervised by the Management Company from which he receives substantial compensation, again at the selection and nomination of Bullock, Clark and the Management Company; that the directors other than Bullock and Clark are "beholden" to them and the Management Company for placing them in such positions; that Bullock, Clark and the Management Company "dominate and control the Board of Directors of the Fund"; that the wrongful transactions alleged were caused by these three defendants and that the others "participated and acquiesced in such transactions with knowledge or notice of their wrongful character"; that the contracts "and their respective yearly extensions were not the result of arm's length bargaining, but were adopted as the result of the arbitrary action, collusion, gross negligence or reckless disregard of duty" of the individual defendants and the Management...